Unit trusts.

What is a unit trust?

A unit trust is a type of mutual fund where money from many investors (called "unit holders") is managed by a fund manager to achieve a specific return. This fund manager then creates a portfolio of investments and assets.

Mutual funds are investments that are made up of pooled money from investors, which holds various securities such as bonds and equities. However, a unit trust differs from a mutual fund in that a unit trust is established under a trust deed, and the investor is effectively the beneficiary of the trust.

How does a unit trust work?

Unit trust investment follows these general steps: 

1. Money you invest is pooled together with other investors into one fund
2. The fund manager invests this money in different asset classes - to spread and reduce the risk
3. Then the total fund is divided into equal units, which are what investors buy
4. You hold the unit(s) and hope to make money as the value of its assets rise in value over time
5.  You can exit the fund by selling the unit(s) at the bid price. To make a profit this needs to be higher than the offer price you initially paid for the unit(s).

What is a unit? 

Each unit you buy has an individual price called the Net Asset Value (NAV). More units are created to meet your demands, so there is no limit to how many units are created in a single unit trust. The NAV reflects the value of the overall unit trusts' assets - that is, the investments the fund manager has made with the fund.

Here is an example of how the NAV is calculated:

1. Unit trusts assets are worth £100,000
2. 50,000 units have already been issued
3. To find out the NAV, divide the value of assets by the number of units issued. In this example: £100,000 (units value) ÷ 50,000 (number of units issued) = £2
4. Giving a NAV of £2

The NAV does not represent the price you will pay for a unit in a unit trust. The price of a unit will be affected by administration costs, such as the initial charge.
 

Things to be aware of when investing in unit trusts.

Benefits of unit trusts:

• Diversity - Investing in just one unit spreads your money across different investments. There is a vast choice of unit trusts available covering most global market sectors. 
• Accessibility - No fixed term means you can buy and sell into a unit trust when you need to.
• Regulation - Unit trusts are regulated by the Financial Conduct Authority (FCA).
• Management - Unit trusts are managed by a professional fund manager.

Disadvantages of unit trusts:

• Risk - Purchasing a unit trust carries a certain level of risk.
• Costs - Every unit trust charges fees to cover the management costs. You have to pay these even if the fund performs poorly and you lose money. These can include an upfront charge when you buy into a unit trust, alongside annual fees.
• Limited control - Your investment is entrusted to a fund manager, so performance levels can depend on their level of expertise and experience.
• Capital risk - Like all investments, there is a chance you could lose some or all of the initial capital invested in a unit trust.