Investment Fundamentals

Establish a strong foundation to build your investments.

When looking at investments there are two key aspects we need to focus on:

  – The products (the wrappers or ‘pots’ that you hold your investments in)

  – The assets (the underlying investment holdings)

The two should not be confused! This is important!

For example, Open-Ended Investment Companies (OEIC’s) are not in themselves ‘risky’ investment products. OEIC’s can be cautiously invested, and if so, they are suitable for cautious investors. They can equally be invested in highly speculative asset classes, in which case they are only suitable for speculative investors, comfortable with potentially very high volatility.

For basic summary of information on investment products:

Open Ended Investment Companies (OEICs)

OEICs are hybrid investment funds, like a cross between Investment and Unit Trusts. They are companies that issue shares on the London Stock Exchange.

They use money raised from shareholders to invest in other companies. Unlike investment trusts, they are open-ended which means that when demand for the shares rises the manager just issues more shares. With an investment trust, if demand exceeds supply, the response may be a rise in the share price. The price of OEIC shares is determined rather differently, with the key factor being the value of the underlying assets of the fund.

In contrast to unit trusts, there is no bid/offer spread, so the price of the shares should be the same whether you are buying or selling. OEICs have been popular on the continent but were only launched in the UK in 1997.

The direct tax treatment of OEICs is established by the Authorised Investment Funds (Tax) Regulations 2006 (SI2006/964) which came into force on 1 April 2006. OEICs are one class of authorised investment fund (AIF) as defined by the regulations and authorised unit trusts (AUTs) constitute the second major class of AIF.

In broad terms, the gains of an OEIC are not subject to Corporation Tax and shares in an OEIC, like units in a unit trust, are treated in the same way as other shares. It also means that provisions in the Tax Acts and TCGA 1992 which are generally applicable to companies but which do not apply in relation to authorised unit trusts – for example, the group relief rules – do not apply in relation to OEICs.

Unit Trusts

Unit trusts are collective funds that allow private investors to pool their money in a single fund:

  – spreading their risk across a range of investments

  – getting the benefit of professional fund management

  – reducing their dealing costs.

Unit trusts are open-ended (unlike Investment Trusts) and different trusts have different objectives:

  – income or growth

  – small companies or large

  – geographical regions

Investment Bonds

Investment bonds are designed to produce medium-to-long-term capital growth, but can also be used to give you an income. You pay a lump sum to a life assurance company and this is invested for you until you cash it in or die. There will usually be a charge if you cash in the bond during the first few years.

The bond includes a small amount of life assurance and, on death, will pay out slightly more than the value of the fund.

For most investment bonds, you take the risk of losing some money for the chance of making more than you could get from putting money in a savings account. Some investment bonds offer a guarantee but this will cost you more in charges.


Any growth in investment bonds is subject to income tax. The investment will pay tax automatically while it is running so, if you are a:

  – non-taxpayer – you will not have to pay any further income tax but you cannot reclaim any tax;

  – basic-rate taxpayer – you will not normally have to pay any further income tax; and

  – higher-rate taxpayer (or close to being one) – if you withdraw more than 5% of the original investment amount in a year or you have made a profit when you cash in the investment, you may be liable for more income tax.

Depending on your circumstances, the overall amount of tax you pay on investment bonds may be higher than on other investments.

Offshore Investment Bonds

Offshore bonds benefit from ‘gross roll up’ which means that the investments within the bond grow virtually free of income tax and capital gains tax. But, there may be tax to pay when you take benefits from the bond

Venture Capital Trusts

VCT’s encourage investment in small companies. HMRC approval is needed, and if approved, VCT offer:

  – 30% income tax relief (set against actual income tax, irrespective of rate paid)

  – Free from capital gains tax

  – Free from Corporation tax

  – VCTs are only available to private UK investors, aged 18+. Only new ordinary shares, with no preferential rights and no redemption within 5 years. The maximum investment in each tax year is £200,000.

Enterprise Investment Scheme

The Enterprise Investment Scheme is designed to help smaller, higher-risk companies raise finance by offering tax relief on new shares in those companies that qualify. In a similar way to VCT’s, it’s a tax efficient way to invest in small companies.

The EIS is aimed at the wealthier, sophisticated investors. People can invest up to £1,000,000 in any tax year and receive 30% tax relief. However, they are locked into the scheme for a minimum of three and a half years. EIS seeks to encourage investment into unlisted companies.

Investment Trusts

The price of the investment trust shares depends on two main factors.

Firstly, the value of the underlying investments and the popularity of the investment trust shares in the market.

This second point applies to investment trusts but not to open-ended investment funds or life assurance investments. The reason is because they are closed-ended funds. The laws of economics say that if there is a high demand for something, but limited supply, then the price goes up. So, if you own some investment-trust shares and there are lots of people queuing up to buy them then you can sell them for more money. On the other hand, if nobody seems to want them, then you will have to drop the price until someone is prepared to buy.

The result is that investment trust shares do not simply reflect the value of the underlying investments, they also reflect their popularity in the market. The value of the investment trust’s underlying investments is called the net asset value (NAV). If the share price is exactly in line with the underlying investments then it is called trading at par. If the price is higher because the shares are popular then it is called trading at a premium and if lower, trading at a discount. This feature may make them more volatile than other pooled investments.

Exchange Traded Funds

ETFs are Investment vehicle traded on stock exchanges which hold assets such as stocks or bonds and trade at approximately the same price as the net asset value of its underlying assets over the course of the trading day.

Most ETFs track an index, such as the S&P 500, and can be attractive as investments because of their low costs, tax efficiency, and stock-like features.

Only so-called authorized participants actually buy or sell shares of an ETF directly from/to the fund manager, and then only in creation units, large blocks of tens of thousands of ETF shares, which are usually exchanged in-kind with baskets of the underlying securities. Authorized participants may wish to invest in the ETF shares long-term, but usually act as market makers on the open market, using their ability to exchange creation units with their underlying securities to provide liquidity of the ETF shares and help ensure that their intraday market price approximates the net asset value of the underlying assets. Other investors, such as individuals using a retail brokerage, trade ETF shares on this secondary market.

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