Unit trusts use a dual pricing system which means that at any one time a unit has two different prices - one for buyers and one for sellers.
The daily listings of unit trust prices in the newspapers quote both the offer and bid prices. The difference between them is known as the 'spread'. Wide spreads are unattractive to investors because the moment they buy units, they are staring at a loss. (It's like buying a car for £10,000 and then trying to sell it back five minutes later and being told that it's worth £9,500.)
The trust managers can't just make up the bid and offer price according to how they feel, nor is it decided by supply and demand in the market (which is how a share gets its price). Instead, the managers have to stick to a strict FSA formula which determines what the maximum offer and minimum bid prices can be.
Calculation of the Maximum Offer PriceThe maximum offer price is based on the Net Asset Value (NAV) of the underlying portfolio. Net Asset Value sounds a forbidding concept but is in fact very simple. To calculate it, the managers value all the underlying assets in the trust at their mid-prices.
The trust has to use the same valuation point each day - in other words, midday or 4pm or whatever.
Having valued all their public holdings, the managers then add the value of any other trust property like uninvested money and net accrued income.
Then they subtract liabilities - money the trust owes, including fees, charges and other expenses. The resulting total gives the NAV of the portfolio.
But it's not over yet. The managers still have to add the notional dealing costs of buying the portfolio (e.g. broker's commission and stamp duty). Once that's done they divide the total by the total number of units in issue and round the sum to 'four significant figures' (e.g. 55.55p).
If the unit trust you are joining is one which makes an 'Initial Charge', typically this will be about 5% of your initial investment, each unit will appear to be be more expensive than the simple offer price. The reason is that although you might invest £5,000 in the trust, 5% of your money (£250) is used to pay the Initial Charge and only £4,750 actually goes to buy units. You spend £5,000 but only £4,750 buys units, so the cost to you of each unit is higher.
This resulting price represents the maximum that the managers can charge investors for buying one unit. It is called the creation price because it literally measures the full cost of creating a unit.
Example
A Unit Trust has 1,000,000 units. It owns 1,200,000 shares in Company A, 400,000 shares in Company B, 50,000 shares in Company C and 600,000 shares in Company D. The mid-prices are calculated at midday and, on a day, are A) 135p, B) 61p, C) 217p and D) 18p. Dealing costs are 1.5%, uninvested money is £163,000 and liabilities are £375,000. The initial charge is 5% of the amount invested.
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