Collective investing: the main types and what they can add to your portfolio

In the UK, collective funds can be described as collective investment funds or collective investment schemes. Here we look at how collective investing works in the UK, the main options and some things to think about.

What is a collective investment scheme?

As the name suggests, collective investment schemes, or collective investment funds, pool your assets with those of other investors. This pooled fund is run by a professional fund manager, with economies of scale for trading and administrative costs.

Collective funds will tend to specialise in specific areas. These may be different regions – the US, Europe, UK or emerging markets, for example, or different types of investment – smaller companies, technology, value or growth. They may invest in bonds, commercial property or infrastructure.

Collective funds can bring tax advantages

In general in the UK, if you are buying and selling individual securities, you are potentially liable for Capital Gains Tax (CGT). With collective funds, you are only potentially liable for CGT when you sell the fund itself.

Having looked at what collective investment funds are, we can consider the five main types you may come across as a UK investor.

Unit trusts

These are by far the most widely used type of collective investment scheme. They are structured as trusts and have a board of trustees. They comprise a flexible, or open-ended, number of units. When more people buy into the fund, new units are created and when they sell out those units are liquidated. Where income is generated from the underlying assets, it needs to be paid out to investors in full.

For most liquid assets, unit trusts are an efficient and cost-effective way to manage large pools of capital. However, they are not as good an option for illiquid areas such as commercial property. Several commercial property funds had to close to redemptions during the pandemic because they could not sell underlying assets quickly enough.

Open-ended investment companies (OEICs)

OEICs are similar to unit trusts, except they are structured as limited companies rather than trusts. A depository holds the securities and fulfils a similar role to a unit trust trustee. One complicating factor for OEICs is that many of them operate as umbrella funds, so investors may buy in to the sub-fund of an OEIC. Each sub-fund may have different investment objectives.

Unit trusts and OEICs can also have different share classes for different types of investor. This can add complexity, with each share class potentially having its own minimum investment levels and charging structures for example. In general, most investment platforms will now only offer accumulation (where income is rolled up in the fund) and income (where it is paid out) share classes.

Investment trusts

Investment trusts are a type of listed company, traded on the stock market. Investment trusts have a board, which is there to look after shareholder interests. They were the first collective investment funds, with the Foreign & Colonial Government Trust (now known as the Foreign & Colonial Investment Trust) established in 1868. As such, collective investment trusts have some pedigree.

As with all companies traded on the stock market, price is at least partly determined by demand. Investment trusts can therefore trade at a discount or premium to the value of their underlying assets, potentially creating opportunities. Because they can borrow money to invest and can invest in companies themselves not trading on the stock market, collective investment trusts can be more volatile than either unit trusts or OEICs.

One potential attraction of investment trusts is that their structure allows the fund manager to reserve income in good years to pay out in lean years for a more consistent flow to investors. The UK Association of Investment Companies has identified a group of trusts – the ‘dividend heroes’– each of which have consistently increased their dividends for 20 or more years in a row.

Exchange Traded Funds (ETFs)

An ETF is also bought and sold on a stock exchange in the same way as a normal share. It is a type of tracker fund, which seeks to replicate the performance of an index, commodity or currency. ETFs can even be used to track specific investment strategies or factors – value, income or growth.

ETFs have seen an explosion in growth in recent years. They offer diversified access to global stock markets at relatively low cost. They are easy to access and pricing is transparent. There is also a lot of choice with ETFs offering targeted investment in anything from wind power to cloud computing to the price of copper.

Unregulated collective investment schemes (UCISs)

Generally one to avoid for most investors, UCISs are a type of collective investment fund that are not regulated by the Financial Conduct Authority (FCA). That means investors usually have no redress in the event of fraud or poor management. UCISs are not subject to the scrutiny and disclosure requirements applied to regulated schemes (like unit trusts and OEICs) and ‘recognised’ schemes from other countries. Typically, these funds are invested in complex, esoteric assets and are often mis-sold as lower risk. The FCA says of UCISs: “This is considered a high risk investment, and you should be prepared to lose all your money.”

The Fineco platform offers a broad range of collective investing options - unit trusts, OEICs, investment trusts and ETFs - across global markets and currencies. With Fineco’s Replay service you can make regular collective investments too.