Unit trusts and OEICs

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20. Diversification

One of the rationales of collective funds is that they enable investors with limited capital to pool their money with others, and invest it across a wide range of securities, thus reducing risk.

This important principle is enshrined in FSA rules which require fund managers to diversify their portfolios and not concentrate investments in too few companies.

The main rules are:-

• A fund investing in equities cannot put more than 10% of its money in the shares of any one company
• A fund cannot have more than four share holdings that amount to 10% of the value of the fund each, with other individual share holdings not constituting more than 5% of the fund each. Effectively, this means that the minimum number of share holdings is 16.
• A fund investing in UK gilts cannot put more than 30% of its money in one stock and must invest in at least 6 different stock issues overall.

The diversification rules can create problems for index tracker funds, whose portfolios are designed to replicate the constituents of a particular index like the FTSE100, because if two companies in the index merge, the combined company can acquire a weighting of more than 10% by market capitalisation.

• On the one hand, the fund has to replicate the index
• On the other it's not allowed to put more than 10% of its money into one company

Tracker funds deal with this problem by exchanging surplus shares for debentures that mimic the behaviour of the shares.

1. What is a unit trust? 2. What is a unit? 3. The trust deed and scheme particulars 4. The people behind a unit trust 5. Charging structure of unit trusts 6. Pricing of units - FSA rules on maximum offer price 7. Pricing of units - FSA rules on minimum bid price 8. Pricing of units - in practice 9. Pricing of units - historic and forward pricing 10. OEICs - Open Ended Investment Companies 11. Shares in OEICs 12. OEICs - pricing 13. OEICs - charges 14. Taxation of unit trusts and OEICs - Introduction 15. Tax treatment of dividends from equity funds 16. Tax treatment of coupons from non-equity funds 17. Capital Gains Tax 18. Tax shelters 19. Investment powers of fund managers: 'eligible investments' 20. Diversification 21. Fund classification: risk gradings 22. Selecting a fund: Defining your objectives 23. Selecting a fund: Active vs passive 24. Selecting a fund: lump sum vs regular savings 25. Selecting a fund: Past performance 26. Where to buy unit trusts and OEICs 27. Buy with or without advice? 28. The mechanics of buying 29. The mechanics of selling 30. Share exchanges and fund switches 31. Investor protection 32. Conclusion

• Exchange-Traded Funds