Lump sum Investments and pensions, Glasgow, Scotland

Tel: 0141 563 3260
between the hours of 9am to 5pm

Mobile: 07714 090845

Email: info@mil-ifa.co.uk

Investment Funds

Investment funds (also known as collective investment schemes) are pooled investments run by fund management companies and designed to produce medium- to long-term capital growth, income or a combination of the two. There is are many different types of fund available to you.

How they work

You buy units or shares in the fund, which then invests that money on your behalf according to the fund's rules, either:

  • in the hope that the value goes up over time as the prices of the underlying investments rise; or
  • to get income from the assets in which the fund has invested.

Some funds might offer both.

You can invest a lump sum or save regularly each month. You can buy funds directly from the investment management company or through a financial adviser, a stockbroker, private client investment manager or fund supermarket or other type of platform.

If you invest directly, without using an adviser, you may receive discounts on the charges but you won't be protected against mis-selling if things go wrong.

If you use a fund supermarket or other type of platform, you can choose from the funds of several fund management groups. This can make it easier to keep track of your investments and can make switching between funds in the future cheaper and easier. Fund supermarkets or other types of platform tend to offer mainly unit trusts and Open-Ended Investment Companies (OEICs).

Where your money is invested

You can choose from a range of funds which can invest in, for example, UK and overseas shares, fixed interest securities, other pooled funds, property and cash.

Some funds might also use derivatives, which may make the return they are likely to provide different to the returns generated by funds that don't use derivatives. However, not all fund managers use derivatives for investment purposes. Some only use them to help offset the risk involved in owning assets or in holding assets valued in other currencies.

Think carefully about how you want to invest your money and consider taking professional advice. It is often the case that one fund cannot meet all of your investment needs.

Whatever funds you choose, it is sensible to review them regularly to make sure they continue to meet your changing needs in the future.

Risk

Investment risk can never be eliminated but it is possible to reduce the ups and downs of the stock market by choosing a range of funds and/or other investment products to help you avoid putting all your eggs in one basket. This is known as Diversification. Different asset classes tend to behave in different ways and are subject to different risks. Putting your money in a range of different investment asset classes can help reduce the loss should one or more of them fall.

Charges

There are a huge number of funds and other investment products on the market, and firms are coming up with increasingly more sophisticated investment strategies. Charges are likely to be higher for these newer funds, and the risks will be different from more standard funds. Make sure you read the information you get from the firm so that you understand the impact of charges, the risks involved and how the fund is expected to perform in different market conditions. If you do not feel that you understand these points, ask questions until you do. If you still do not understand everything, do not invest your money.

If you want to move from one fund to another, this may incur a tax liability on any investment growth at that time. You may also be charged a new initial charge for switching to new funds.

Funds generally have three types of charge.
  • Initial charges – when you invest in a fund, you usually pay an initial charge which is shown as a percentage by which your investment is reduced. For some funds which only use a single price to buy and sell units this will be charged separately. In other cases, there is a difference between the price at which you invest your money (the offer price) and the price at which you can withdraw money (the bid price) – this is known as the bid/offer spread and the offer price will include the initial charge. In either case, the initial charge is often around 5% (so, effectively, the amount you invest is reduced by 5% at the outset). Fund supermarkets or other types of platform are often able to reduce initial charges, sometimes quite substantially. Some funds have no initial charge, but there may be a cash-in charge instead.
  • Annual charges – each year you will pay annual charges to cover ongoing costs (such as the costs of fund management and administration). The amount you pay will vary from one fund to another. You can compare these ongoing charges between funds, by looking for the total expense ratio (TER) that firms quote in their literature. It is often around 1.75%. This ratio gives an estimate of the ongoing costs of the fund and is calculated on a standard basis.
  • Cash-in charges – when you decide to withdraw some, or all, of your money, you may be charged to do so (particularly if you withdraw money in the early years).

Charges tend to be lower on passive funds than active funds.

Switching charges

If you want to change investment funds in the future, you may have to pay initial charges on the new fund. If you choose a new fund offered by your existing fund manager or fund supermarket or other type of platform, the charge may be lower than if you move to a fund offered by a new provider. If you move funds often, this may mean that it is more economic to invest via a fund supermarket or other type of platform than to go directly to a fund manager.

Some fund supermarkets or other types of platform do not allow you to transfer your investments to another fund supermarket or other type of platform (or similar service). This means that you could incur costs, as you would have to sell and then repurchase the investments to do this. For example, this could potentially include transaction costs, loss from being out of the investment market for a while and/or liability to tax on capital gains.

Withdrawing money

You can usually take out some or all of your money whenever you wish, but with some funds there may be a charge if you take money out (particularly in the early years). In addition, from time to time, it may be difficult to take your money out of certain funds, depending on the type of assets in which they invest. You should make sure that you understand whether this risk is relevant to a fund in which you are considering an investment and, if so, whether or not you are happy to take this risk.

If you have held the fund for a long time, it may have grown in value significantly so you may want to check whether there will be a liability to Capital Gains Tax. The Capital Gains Tax allowance in the current tax year (2015/16) is £11,100.

Taking an income

As well as taking out a lump sum from the investment, you can also often arrange to take an income (for example interest on cash or dividends on shares). You can usually choose whether you take this income out of the fund or if it is reinvested within the fund to provide additional capital growth.

Many income-producing funds will pay you income twice each year, but some pay it more regularly. As the income you receive is based on the underlying assets, it is likely to vary over time. Some funds prioritise paying income over ensuring capital growth, so you may find that although providing you with a high level of income, the capital value does not rise over time. Other funds aim to provide an increasing level of income and capital value, but the income from these is likely to start at a lower level.

Some firms have an option where you can specify the amount of money (subject to a minimum amount) that you would like to withdraw. You can often choose how often you want these withdrawals. The money withdrawn will come from the capital held in your investment and, if the fund is not growing fast enough to cover the withdrawals, the investment value will go down over time.

Tax

If you hold an investment fund within an ISA or other tax wrapper, the tax position will be different from the one outlined below.

The income from the underlying fund assets is liable to income tax, whether you withdraw it or not. The precise amount of tax paid will depend on the type of asset in which the fund invests and the rate of tax that you pay.

  • Non taxpayers will pay Income Tax within the fund. You cannot reclaim this tax when it is paid on income from shares but you can reclaim it for funds investing in other types of asset.
  • Basic-rate taxpayers will pay Income Tax within the fund and you will have no further liability.
  • Higher-rate taxpayers will again pay Income Tax at the basic rate within the fund but you will also have a further liability to Income Tax.

You will not be liable to Capital Gains Tax while the money remains invested. But, when you sell your investment, you may have a Capital Gains Tax liability. Bear in mind that you have a personal Capital Gains Tax allowance that can help you limit any potential tax liability. This allowance is £11,100 in the 2014/15 tax year and, if you plan ahead, you may be able to avoid paying Capital Gains Tax or minimise your liability.

Please note that this is only a summary of the tax position as at April 2010. You should be aware that tax legislation changes frequently and you should check the current position.

The main types of investment fund

You may come across any of the following:

  • unit trusts;
  • Open-Ended Investment Companies (OEICs), also known as Investment Companies with Variable Capital (ICVCs);
  • investment trusts; and
  • Exchange Traded Funds (ETFs).

You may even come across some funds that are run from other European countries but which are allowed to be sold in the UK, such as SICAVs (Société d'investissement à capital variable) and FCPs (Fonds communs de placement).

You can hold many of these funds in an Individual Savings Account (ISA) or other types of tax wrapper to benefit from their special tax position. Or you can hold them directly.

There are some important differences between unit trusts and OEICs, investment trusts and ETFs.

Unit trusts and OEICs

The price of units in unit trusts and shares in OEICs directly reflects the value of the underlying assets. So, if the fund invests in UK equities and they increase in value, your fund will go up in value to the same degree. The assets of a unit trust or OEIC are held by a body that is responsible for making sure that the fund manager is acting within the rules of the fund and the Financial Services Authority (FSA), the UK's financial services regulator. Charges for these funds tend to be higher than for similar investment trusts and ETFs.

Investment trusts

Investment trusts are listed on the stock market, like companies. The price of shares in investment trusts depends on the value of the underlying investments but also on the popularity of the investment trust on the market. This means that the price of an investment trust does not always reflect the value of the investments it holds. So, for example, if the investment trust invests in UK equities and they increase in value, the value of the investment trust is not guaranteed to go up in value to the same degree. However, investment trust charges tend to be lower than the charges for similar unit trusts and OEICs.

Investment trusts can borrow money that can be used to buy more investments. This is known as gearing. If the borrowed money is used to buy shares that then grow in value, then you would get more than you may have expected. On the other hand, if the borrowed money is invested in shares that later fall in value, you can lose more than you invested, as the loan must still be repaid. Gearing can make investment trusts more risky than unit trusts, OEICs and some ETFs. However, not all investment trusts use gearing. You can find out whether an investment trust uses gearing from a number of sources. For example, the Association of Investment Companies has information on this – see Related links.

Split capital investment trusts are a type of investment trust that sells different types of shares – they can be used for capital growth or income and run for a fixed term. The shares will have varying levels of risk, as some investors will be ahead of others in the queue for money when the trust comes to the end of its term. Investors at the end of the queue may not get back all of their money. Split capital investment trusts do not guarantee to return capital in the future, so you may lose your money. There have been problems with the sale of this type of investment trust in the past, where people did not understand the risks to which they were exposing their money. You should make sure you understand all the risks involved before you invest.

Exchange Traded Funds (ETFs)

These are listed on an exchange such as the London Stock Exchange. Most ETFs will attempt to replicate an index (such as the FTSE 100) by investing in the same assets in the same proportions as that index.

The theory behind ETFs is that by buying one ETF share you get the equivalent performance of the index that it replicates, less any fees or charges the ETF has to pay. So, if you buy an ETF that replicates the FTSE 100 and the FTSE 100 goes up 10% in a year, you will have made a 10% gain on your ETF share (less those fees and charges). However, if the FTSE 100 goes down then so will the value of your share.

ETFs that replicate an index are passively managed funds. This is because there is no stock selection by a fund manager as there would be with an actively managed fund. As a result, ETFs are cheaper to operate and the fees the fund manager charges are significantly lower than actively managed funds. ETFs are also currently exempt from stamp duty.

Historically, most ETFs tracked well recognised indices such as the FTSE 100 or the S&P 500. However, in the last few years ETFs have become available that track much more risky and exotic markets. As such, investors are now able to access markets that were previously only available to professional and institutional investors such as big banks or hedge funds.

Some ETFs have also begun to replicate the performance of indices by using derivatives rather than shares. These funds are typically called 'synthetic ETFs' and expose investors to the risk of losing money in the event that the party supplying the derivative becomes insolvent. Some ETFs may also use derivatives to 'short' the index that is replicated. This has the effect of the fund generating profit when the index or market falls instead of when it rises (and therefore losing money where the index or market rises). It is often not immediately obvious whether an ETF invests in shares or is based on derivatives, so make sure you find out.

These funds tend to be high risk and complex, and may not be suitable for retail investors, so you should make sure you understand all the risks involved before you invest.

Other types of investment funds

Exchange Traded Notes (ETNs) work differently to ETFs and tend to be of greater risk than ETFs. Although their returns are also linked to the performance of a market or index, they are technically a debt security and their value may be affected by changes to the credit worthiness of the issuing firm. If the firm that issues the ETN goes bankrupt or has its credit rating downgraded, the ETN will lose value even if the underlying index is unchanged.

Exchange Traded Commodities (ETCs) use derivatives to track movements in the value of commodities (such as precious metals, oil or wheat), or may even hold the commodity in a vault with each share representing a proportion of the commodity held. Commodities are generally regarded as higher-risk assets and the use of derivatives, as noted above, may add to the risk of using ETCs.

Hedge funds or alternative investment funds are typically aimed at professional investors and cannot be marketed directly to the public. They often use advanced investment techniques, such as complex derivatives, or invest in asset classes that are considered too specialist for inclusion in the kind of funds discussed above. As a result, they may expose their investors to significantly higher levels of risk than other types of fund.

Things to think about before investing in an investment fund

Before you invest in a fund you should be given a Simplified Prospectus or Key Features Document that explains the main advantages and disadvantages of a particular company's fund. A financial adviser can help you understand the fund and the risks and implications of investing.

You should consider whether a fund is suitable for your circumstances or if a different investment would be better. Think about the following when considering whether a fund is right for you.

Fund choice – think about which fund or funds to invest in and whether you should spread the risk by investing in different funds.

Risk – make sure that you are happy with the different types and level of risk you take and that you can afford a loss in value. If you are investing in an investment trust, remember to consider the fact that it can be geared and the fact that your investment value will not just depend on the performance of the underlying assets.

Charges – make sure you understand all of the charges that you will pay on the fund and their effect on your investment. Be sure that you are comfortable that the likely benefits justify paying them.

Inflation – this means that your money will buy less each year. Think about whether the funds you choose are likely to grow sufficiently to cover both the charges and inflation. If not, the investment may not be good value for money.

Tax – make sure you understand the tax implications of the fund and whether a different product would be better for you. If you have not yet used your ISA allowance for the current tax year, it may be sensible to invest within an ISA first.

Commission – if you are getting advice, ask how much commission your adviser will get. Make sure you are happy with the answer. Ask if the commission pays for advice for the lifetime of the investment.

Fund supermarkets or other types of platform – if you are thinking of using a fund supermarket or other type of platform, check whether you can transfer your investments to another provider in the future, or whether you would have to sell your funds and buy them back again.

Things to think about if you already have an investment fund

If you already have an investment fund, you should regularly check to see how it is doing. You can check your latest statement or ask the provider for some current information about it. Some product providers will publish the price of buying or selling units or shares in each fund in the newspaper every day. You may also have an adviser who you could ask for help. If so, you should check if this will cost you any money. It may be that they have already promised to provide ongoing reviews paid for from commission they receive from your investments.

  • Consider making use of your annual Capital Gains Tax allowance. If you're not holding the fund inside an ISA, you should consider making use of your annual Capital Gains Tax allowance (currently £11,100 for the 2014/15 tax year), so that you minimise any future Capital Gains Tax liability. By cashing in some of your investment each year and then reinvesting the money in a new fund, you can avoid paying some Capital Gains Tax in the future.
  • You should consider how often you switch funds. You are likely to pay new initial charges when you move from one fund to another (and you may have to pay a cash-in charge on some existing funds). If you reinvest with the same fund manager, fund supermarket or other type of platform, the charges might be lower than if you move to a new provider. If you move funds often, it may be more economic to invest via a fund supermarket or other type of platform than to go directly to a fund manager.
  • You should regularly check whether the fund choice remains suitable for your current needs. For example your appetite for risk might have changed, you may feel that one investment fund is likely to do better than another in the future, or you might want to rebalance your choice of investment funds. Remember that you may face new initial charges (and possibly a cash-in charge on some funds) and a Capital Gains Tax liability if you switch funds.
  • If you are thinking of cashing in your fund in order to buy another type of investment (like an investment bond), or have been advised to do so, make sure that this is in your best interests. Investment bonds have different charges and tax implications. It might be better to keep your existing funds or switch to new investment funds rather than to invest in a new type of policy. Find out how much the new investment costs compared with your existing funds and what else you are giving up when cashing in a fund, and decide if what you are getting makes up for that loss.

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