Unit trusts and Open-Ended Investment Companies (OEICs) are by far the most popular investment funds available to the general public and, on the face of things, they have a lot going for them. Firstly, there are thousands of these entities to choose from, each with the own specialisations and niche markets to operate in. They are an effective way of diversifying your long-term investments because, even if you put all your capital in one single fund, you’ll indirectly be investing in a multitude of different shares and sectors just by doing so. Also, just as trading on a spread betting platform is beyond the reach of the taxman, if an investment in a fund is held via an ISA wrapper then they too can be a regular source of 100% tax-free income.

All of this sounds great. So, where’s the rub? Well the exposure of a systemic weakness in funds and the increased market volatility caused by recent events have shone a light on the reasons why unit trusts and OEICs could be a far riskier investment than they might initially seem.

What are Unit trusts and Open-Ended Investment Companies (OEICs)?

When you buy shares (OEIC) or units (unit trusts) in these funds, you are handing your savings over to a fund manager who lumps your money together with those of other investors and invests this sum in the fund’s underlying assets.

In either case, you own a proportional slice of the overall fund and if the value of the underlying assets either rises or falls, the value of your investment will do so in kind. The overall fund size will also increase and decrease as more investors either buy or sell their units/shares.

Thanks to their simpler structure and the fact that they can be sold across Europe’s borders, OEICs have become a lot more common in recent years and a great many unit trusts have converted into this newer structure. In reality, from a prospective investors point of view, the subtle differences between them are negligible and they are both open-ended in nature.

The Costs

One of the big appeals of Unit trusts and OEICs is that once you’re initially invested, the fund’s employees will take all of the difficult day-to-day trading decisions on your behalf; don’t think however that you aren’t paying for this privilege. These operating charges and costs are normally taken direct from your fund, so your investment will need to perform sufficiently to cover these and still give you a worthwhile return for the risk that you’re taking. These management charges can include:

  • Initial Charge – Varies between funds but typically around 2% of your unit/share purchase.
  • Bid-Offer Spread – Many funds have a slightly higher ‘bid’ (buy) than their ‘offer’ (sell) prices.
  • On-going Charges Figure (OCF)/ Total Expense Ratio (TER) – These give a good indication of the annual cost of investing in a manager’s fund but exclude One-Off Charges, Incidental Costs and Portfolio Transaction Costs.
  • Annual Management Charge (AMC) – A yearly fee for the manager’s services which could be 1.5% or more of the value of your shares.
  • Transfer Out Fee – If your units are held within an ISA or a pension and you change platform then you’ll normally have to pay a transfer out fee. They are usually charged individually (per fund) and cost up to £25 each.

Locked Out Of Your Money

When day or swing trading using a spread betting account, you are fully in control of how long your investment is tied up for and can place stops to put limits on your losses in case things really go awry. When things go wrong in a fund this is most definitely not the case. In fact, particularly in the last couple of years, hundreds of thousands of OIEC investors have made the horrifying discovery that they can be frozen out of their investments due to Fund Managers having the power to suspend the sale of units in the event of a crisis.

In 2019 investors in the now infamous Woodford Equity Income OEIC found £3.7bn worth of their investments completely inaccessible due to suspension following an avoidable liquidity crisis. Nearly 25% of the whole fund was invested in stocks that would take 180 days or more to sell and, when investors flooded the fund with redemption requests, the house of cards came crashing down. The fund was frozen from June but later in the year, the administrator announced that the OEIC would have to be shut down with the stricken investors strapped in for the ride. Investors received between 46p-58p per unit in the first payment and between 3.1p-3.9p per unit in the second; substantially less than the 100p each unit initially cost at launch. As of September 2020, around £500 million of assets remain trapped in the fund awaiting to be returned to unit-holders.

However, it’s not just unwise management decisions that can see you parted from your money for an undefined period of time. Many funds holding illiquid assets (such as property) were forced to freeze unit sales following the uncertainty of the 2016 Brexit vote and, more recently, even big-name asset managers like Legal & General’s £2.9bn worth of funds and the £2bn Janus Henderson UK Property fund were forced to suspend dealings in response to the coronavirus pandemic.

Whether it’s by a crisis of their own making or market volatility on a global scale, your right to sell your units and therefore cash your gains is far from guaranteed with unit trusts and OIECs. Furthermore, once suspended, if the fund is unable to remedy its issues then the scale of your losses on a trade made maybe years beforehand is unknowable and firmly in the hands of the administrator.

There’s Only One Way To Make Money

With a unit trust or OEIC, the fate of your investment is intrinsically linked to the success of the fund. That means the only way to personally take advantage of wider market fluctuations is to wait until the fund’s unit price is suffering as a result of big events (think 2008, 2010 DOW Jones flash crash, 2015–16 stock market selloff, tariff wars) before upping your investment in the fund. Of course, when trading during those turbulent economic times, you’ll have to hope that the fund isn’t especially exposed and the unit price will continue to slump after your trade.

When you’re in the driving seat, either day trading or swing trading, you can bet on a falling market. This crucially means you don’t need to wait for a wide-ranging fall and the fund’s recovery to see if you’ve profited from trading at that time; you’ll know in a matter of days or weeks. In a spread betting account, if you’re worried about your short-term exposure to a certain index but you still want to hold those assets long-term (and definitely don’t want to incur the costs and time spent selling your main portfolio holdings) then you are able to hedge your position. Usually, any profits of shorter-terms positions on unit trusts get cancelled out by the fees (Initial Charge or Bid-Offer Spread) so most unit-holders have to hang on for the long-term and hope for the best.

Abandon All Hope – Making An Informed Choice On Funds

Obviously choosing what fund to invest with needs to involve more than just hope and details on the funds’ current assets, past performance, rating and all sorts of other data sets are available either on the platform itself or on a host of specialist trading websites. However, all of these sites and platforms put great stress on the fact that their advice, selections and ratings are absolutely not personal recommendations to buy or sell in any particular fund and if you are unsure about the suitability of an investment you need to speak to an authorised financial adviser. Long story short, you are on your own.

With all of this data and variables to make sense of, most amateur investors when choosing a fund look over its past few years’ performance and try to get a feel for its overall reputation. Unfortunately, as SEC Rule 156 requires funds to tell their investors, past performance is not indicative of future results. As for reputations, to paraphrase Warren Buffet, they take 20 years to build and five minutes to ruin. To use our earlier example, Neil Woodford was counted amongst the UK’s most successful and popular investment managers with a flagship fund holding, at its 2017 peak, a record £10.7bn of investors’ money. Flash forward to present day and he is a City pariah.

Now, you might be thinking “Fund Managers are professionals with years of experience; sure there’s a few bad eggs but most of them must perform exceptionally”. Sadly, study after study confirms that only a tiny fraction of actively-managed funds ever do better than passive index funds over the same period.

The Pitfalls Of Passive Trading

With doubt cast on the reliability of an experienced Fund Manager to generate a decent return, you might now be tempted to invest in one of these passive funds. As there’s nobody employed to choose what assets to buy and sell, the fund can afford to charge you much lower annual management fees. Another plus, again because the fund only follows their benchmark index, is that it’s always clear what underlying assets a passive fund is holding; there’s much greater transparency compared to the opaque performance data of an actively managed OEIC.

Thanks to the lower management fees your investment doesn’t need to perform spectacularly to cover the cost of these, which is very fortunate because passive funds pretty much never beat the market, even during times of great market turmoil. Furthermore, they still retain many of the downsides of funds detailed previously; they don’t yield good profits unless the market itself booms, you can’t short any market slumps and your money will likely need to be tied up for years at a time to ride out the bumps. Once again, you are taking a risk and it is for you to determine whether the potential for profit outweighs the chance of losing out; with passive funds there might be less risk, less human intervention in the trades but by removing that dynamism and tethering yourself to an index you are also removing your opportunity to make big profits.

Learn How To Trade And Take The Reins Yourself

With active funds you are putting an unnecessary middleman in-between you and the market as well as paying for the privilege so that they can take a cut of your hard-earned investment. Although Fund Managers might have greater access to company bosses and arguably better sources of data, they are hardly the infallible Gods of Trading that they like to make themselves out to be and can easily fall from grace with a very heavy bump. Their greatest benefit to you is investment experience and knowledge of how the market moves but this is something that you too can learn with a bit of discipline, concerted effort and the right training.

Although funds are often touted for their ease and simplicity, choosing the right one to invest in can often feel like stab in the dark. Unit trusts and OEICs like to tell you that once invested you don’t need to do anything more but, in reality, you will still need to regularly check on their performance or invest more money with them on a regular basis (pound-cost averaging) to smooth out any ups and downs in unit price. Just like any form of trading the market, the risk of losing money in a bad investment is still present with unit trusts and OEICs. Yes, there are risks in trading for yourself but unlike trading via funds there are mechanisms like Stop-Losses available to you to automatically stop your investment from going into freefall. The only reason for paying these, sometimes exorbitant, charges is that the fund says it will do all the work for you and yet you still need to need to supervise the funds managing your money. So, what are you paying for?

Day or swing trading using a spread betting platform can yield much higher returns in a much shorter timeframe. Although you’ll be doing the work yourself, don’t listen to the Fund Managers, it’s not a full-time job. Go to any country club or private members’ bar on a weekday and just ask around to see how much free-time they can afford. A successful trading strategy with a steady equity curve can be achieved with as little as 15 minutes work in the morning; especially whilst learning the ropes, it can easily fit around your normal schedule with very little hassle.

By becoming a retail trader, you make the decisions. You have access to a huge range of asset classes, you can take positions on any major stock, index, currency and commodity in the world. You have the ability to make money from short trades when the market takes a hit. You can stop needlessly paying extra for a “professional” to manage your money and instead invest in yourself. Put those management charges towards learning how to trade and start building on your own expertise and experience.

Come along to our free Learn to Trade Online course to learn more. Stop feathering a Fund Manager’s nest and start feathering your own.