UK puts its trust in OEICs

The publication of the consultative paper on open-ended investment companies (OEICs) by the Securitys and Investments Board (SIB) in October last year, means that considerable progress has now been made towards finalising the regulatory framework for the introduction of OEICs into the UK savings market.

Over the past few years, pressure has grown in the UK fund management and savings industry for the introduction to the UK of OEICs as a savings vehicle. It has long been recognised that unit trusts and investment trusts, which until now have been the principal savings vehicles used by individuals for pooled investment in equities and bonds, have a number of structural deficiencies.

Unlike OEICs, neither method is readily recognisable in other countries of the EU. It is hoped that the introduction of OEICs into the UK will enable British fund management groups to market their expertise more widely in the EU, and beyond, from a UK base.

Many UK fund management groups have already taken advantage of the existing frameworks for OEICs based in the International Financial Centre in Dublin and in countries such as Luxembourg and have set up funds there. This, coupled with a more flexible regulatory climate in such places, has led to fears that a significant part of the UK fund management business will be forced to move offshore. The Treasury, therefore, has acted to address these concerns.

The gradual implementation of the single European market in financial services has also brought the need for a more flexible response from the UK authorities. As a result of the UCITS Directive, adopted as far back as 1985, it is already possible for pooled vehicles such as OEICs and unit trusts to be marketed in any other country in the EU. The implementation of the Investment Services Directive from 1 January this year will continue the process of opening up financial markets in Europe.

OEICs have several benefits. In effect, the proposed OEICs will be an amalgam of many of the characteristics of existing investment trusts and unit trusts but will be structured to make them more appealing to the savings industry.

Like an investment trust, an OEIC will be a corporate body with limited liability and will issue shares to its investors. The money raised from investors will then be pooled and invested on their behalf.

However, unlike an investment trust, the OEIC will have the power to redeem its shares at a price related to the underlying net asset value. At the moment, investors in investment trusts must buy or sell their shares on the stock market and the price for such shares is governed by normal market forces and the performance of the underlying investments held by the investment trust.

While in recent years a lot of effort has been made to ensure that investment trust shares trade at a price at, or near, net asset value, many continue to trade at a discount to net asset value which may range from a few percentage points to more than 10 per cent. The prospect of selling at a discount is not appealing to investors.

Unlike investment trusts, unit trusts have always given investors the ability to redeem at a price linked to net asset value. However, they have suffered from the disadvantage that different prices apply depending on whether an investor is buying or redeeming his units. The concept of single pricing will be introduced by OEICs which should be more easily understood by investors.

At the moment, the price of units on sale is calculated by valuing the underlying securities on an 'offer' basis while redemption prices are calculated on a 'bid' basis. This gives rise to a pricing spread to which must be added the purchase of units, the preliminary charges most fund managers levy on the issue of units, and the charges associated with the dealing costs in respect of the acquisition or sale of the underlying securities. Consequently the difference between buy and sell prices is often 5 to 6 per cent.

However, under proposals made by the SIB OEICs will have a single pricing structure. The underlying property will be valued on a mid-market basis when calculating both the purchase and sale price of shares in an OEIC for investors. This should make it easier to understand for investors and allow them to buy and sell at one price related to net asset value.

Fund managers will continue to levy charges on the sale of units, but these will be deducted from an investor's funds before being invested in the shares.

Another advantage of OEICs is the 'umbrella' structure which will be used by many of them. This should allow each OEIC to set up separate sub-funds which may have completely different investment policies; for example, one fund may invest in the US and another in Japan.

Different series of shares will be issued depending on which particular fund the investor wishes to invest in and each series will give the right to share in a separate pool of assets. As a result investors will be able to create a balanced portfolio within one investment vehicle. It should also cut the cost of running and administering an OEIC as well as making it cheaper for investors to switch between different sub-funds.

The tax structure for OEICS has still to be finalised but it should be similar to that applying to unit trusts. Broadly speaking, investors will still be liable to capital gains tax on the disposal of their shares in an OEIC and liable to income tax on any distributions received. If this is the case investors may still prefer to invest offshore.

For example, the tax regime which applies to 'non-distributing' funds based in Dublin can offer investors tax advantages. A non-distributing fund is one which does not distribute its income each year but rolls up such, and this accumulated income is reflected in the share price. UK investors holding shares in such funds do not normally pay tax until the shares are realised, and at that time income tax is only payable on the increase in the price of the shares between the date of acquisition and disposal.

As a result of the deferral of tax, investors who expect to be paying a lower rate of tax at the time of disposal, perhaps because of retirement or lower earnings, may be able to reduce the tax bill which would otherwise be payable.

Companies such as Glasgow-based Murray Johnstone have already produced a product which takes advantage of the structure of offshore OEICs. It has launched a short-dated financials bond fund which produces a gross yield of about 7.5 per cent and is a low-risk investment. It can take advantage of the unique tax position of roll-up funds in a way which can match and, in certain circumstances, outstrip the benefits of PEPs.

This sort of product will be more popular in the future as people recognise the numerous applications of these funds.

Increasingly, the UK authorities will have to be aware of the flexibility which the introduction of the European single market will allow UK investors and be much more willing to react to the needs of the UK fund management industry.