Open-Ended Investment Companies (OEICs)

Open-Ended Investment Companies (OEICs) are stock market-quoted collective investment schemes. Like investment trusts and unit trusts they invest in a variety of assets to generate a return for investors. They share certain similarities with both investment trusts and unit trusts but there are also key differences.

• What is an OEIC?
• What are the benefits of investing in an OEIC?
• What will investing in an OEIC cost me?
• What's the tax situation with OEICs?
• How are OEICs valued?

What is an OEIC?

An OEIC (Open Ended Investment Company - pronounced 'oik') is a pooled collective investment vehicle, in company form. OEICs first became available in May 1997 and were introduced as a more flexible alternative to established unit trusts.

An OEIC may have an 'umbrella' fund structure, allowing for many 'sub-funds' with different investment objectives. This means you can invest for income and growth in the same umbrella fund, moving your money from one sub fund to another, as your investment priorities or circumstances change. Some OEIC providers allow you to do this without charge as you stay within the same share class (with the same charging structure). OEICs may also offer different share classes for the same fund.

By being "open ended", OEICs can expand and contract in response to demand - just like unit trusts. The share price of an OEIC is the value of all the underlying investments, divided by the number of shares in issue. As an 'open-ended fund' the fund gets bigger and more shares are created as more people invest. The fund shrinks and shares are cancelled as people withdraw their money.

You may invest into an OEIC through a stocks and shares Individual Savings Account (ISA). Each time you invest in an OEIC fund, you will be allocated a number of shares. You can choose either income or accumulation shares - depending on whether you are looking for your investment to grow or to provide you with income - providing they are available for the fund you want to invest in.

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What are the benefits of investing in an OEIC?

Like unit trusts, OEICs provide a mechanism of investing in a broad selection of shares, thus aiming to reduce the risks of investing in individual shares. Therefore, you have an opportunity to share in the growth potential of stock market investment. However, do remember that your capital is not secured and your income is not guaranteed.

You have access to your investment when required, although you should regard investing in an OEIC as a medium to long term investment. You may invest by lump sum and / or by regular monthly payments. Through the OEIC structure there is the flexibility to switch easily between the investment funds provided by your OEIC manager.

Do remember that the value of your fund(s) and any income you choose to take depends on the performance of investments in that fund. Where a fund invests overseas, exchange rate changes may also cause the value of your fund to fluctuate.

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What will investing in an OEIC cost me?

OEIC shares are bought and sold at a single price. All charges, such as the initial charge, are shown separately, making it easier to understand exactly what costs are involved. Like unit trusts, the initial charge you face on OEICs will be detailed in management group literature and in a Key Features document. It can sometimes be as much as 6%.

So for each £100 initially invested, with an initial charge of 6%, only £94 is actually put into the fund. Obviously the lower the initial charge, the greater the proportion of your initial investment that will be actually invested. Equity funds tend to have the most expensive initial charge at 5%-6% and Index Trackers and Money Market funds the lowest at 0%-1%. Additionally, there is an annual management charge, which is typically 1-1.5%.

Funds with low or no initial charges may have a penalty exit fee for short term investors. This is to encourage people to keep their investment in the fund; the charges decrease the longer the time invested. Most funds have different charges for each share class.

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What's the tax situation with OEICs?

Your tax situation will depend on the type of distribution you receive, which in turn will depend on the type of OEIC you have invested in. Do remember, if you have invested in an OEIC via a stocks and shares ISA, you will not have to pay any further tax. Income from investments held within ISAs does not have to be declared on your tax return.

If you are holding an OEIC investment outside an ISA and you receive a distribution, you will receive a tax voucher from the fund manager showing both the amount that you are getting and the amount of tax on the distribution that has been paid by the manager.

OEIC funds invested in gilts, loan stocks and other interest-bearing investments pay out interest distributions. Outside an ISA, you will receive these distributions net of 20% tax. You cannot register to have the interest paid gross but, if you are a non-taxpayer, you can reclaim any tax overpaid. Dividend distributions are paid net of 10% tax.

The information on all the tax vouchers you get during a tax year should be recorded in your tax return. If you have not received a tax voucher, you should ask your fund manager to supply one.

How much, if any, tax you will then have to pay will depend on your status - non-taxpayers may reclaim tax paid on interest but not on dividends, basic rate taxpayers will have no further tax to pay but higher rate taxpayers will face a further tax bill.

On the sale of your investment in an OEIC there may also be a Capital Gains Tax liability. Subject to the annual exemption, £9,600 for the 2008 / 09 tax year the gain will be taxed at 18%. Once again, any OEIC investment held within an ISA would be sheltered from any further tax liability and there would be no tax to pay on disposal.

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How are OEICs valued?

Each OEIC has its own investment objective and the fund manager has to invest to achieve this objective. The fund manager will invest the money on behalf of the shareholders.

The value of your investment will vary according to the total value of the fund, which is determined by the investments the fund manager makes with the fund's money. The price of the shares is based on the value of the investments the company has invested in.

Investment Trusts sometimes see their shares trade at a discount to the underlying value of the assets they hold. However, OEICs cannot fall to a discount. They always trade at a true 'net asset value' (NAV).

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20 May 2008 © Moneyextra.com

Our senior editor Robin Amlôt recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.