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Some investors are highly active and enjoy researching and choosing individual shares, bonds and other investments. However, this ‘hands-on’ approach can have disadvantages. For instance, it can be difficult to obtain sufficient diversification without incurring high transaction costs, and it can be a challenge to devote enough time to monitoring a portfolio consisting of many different holdings.

This is where collective funds such as unit trusts and investment trusts can offer a convenient solution. These spread your money – and risk – across dozens of different companies, and are either managed by a professional fund manager with a defined strategy or designed to simply track a particular index.

For instance, an equity fund manager typically selects a range of shares, usually 50 to 100, which means less reliance on the performance of any one company. The same applies to other asset types such as bonds or properties; specific or ‘idiosyncratic’ risks can be partially mitigated through diversification – not having ‘all your eggs in one basket’.

Collective funds can be a cheaper way to invest too. By pooling your money with other investors you could save money compared to building a portfolio of individual shares yourself, especially if you are investing a modest sum. Paying dealing commission on a large number of individual stocks can add up to a significant amount.

Importantly, you can also gain the expertise of a professional with an established investment process. Active fund managers often engage directly with company management and analyse a business thoroughly to work out whether its shares represent good value. Although they can and do make mistakes, such as selecting stocks that underperform, they can also sometimes keep you from major pitfalls. Meanwhile, passive funds simply invest in the largest constituents of an index, meaning no human judgments but usually lower cost.

Types of collective funds

Unit Trusts and OEICs (Open Ended Investment Companies) are the most common way of pooling investors’ money to invest in a range of assets. The major difference between unit trusts and OEICs is their legal structure – unit trusts are established as trusts whereas OEICs are incorporated as companies, though in practice they are very similar. Being “open ended” both unit trusts and OEICs expand or contract the number of units or shares in issue according to investor demand: The more people invest the bigger the fund gets. The price of each unit fluctuates according to the value of the underlying assets and is usually calculated and announced on a daily basis.

In contrast to unit trusts and OEICs, investment trusts are ‘closed ended’ funds, which means there is a fixed number of shares. Therefore the price is dictated by supply and demand rather than a calculation of underlying asset values. This means they can trade at a ‘premium’ or a ‘discount’ to their inherent worth – which can bring added risk or opportunity. Another key difference is that investment trust shares are traded on a stock exchange – so like any individual company share there is continuous pricing during market hours and you pay stock broking fees when buying and selling.

Many investment trusts have the ability to borrow to invest, which most unit trusts and OEICs don’t. This can magnify investment returns but can also mean greater falls when markets go down. This coupled with the impact of supply and demand on the share price means investment trusts are typically more volatile (have bigger ups and downs) than an equivalent unit trust or OEIC.

Exchange Traded Products (ETPs) is the collective term encompassing Exchanges Traded Funds (which track the performance of indices of stocks) Exchange Traded Commodities (which enable investors to track one or a selection of commodities), Exchange Traded Currencies (which track the relationship between a pair of currencies) and Exchange Traded Notes (ETNs) that are based on other, often more complex, indices or assets.

ETPs are normally passively managed – they are designed simply to replicate the performance of an index or with relatively low cost. They do this either by physically holding the assets underlying the index or by holding derivatives – special financial contracts based on the price of an asset. Like investment trusts ETPs are closed ended and are traded on a stock exchange so they can be bought and sold at any time during market hours.

The risks of ETPs vary significantly. Not only do they invest in all sorts of different areas, some of which can be exceptionally volatile, but they have a variety of different structures which makes it important to understand what you are buying. In particular, ETP’s based on derivatives have additional risks attached. For instance if a ‘counterparty’ to the derivatives transaction (often an investment bank) runs into trouble there is a chance the ETP could lose money.

Choosing collective investments

There are thousands of collective funds available so it can be difficult to know where to start. Some are broad, encompassing a range of assets, other specialise in certain areas or geographies. To help we have created the Charles Stanley Direct Foundation Fundlist to provide some ideas for investors’ own research. This represents our preferred investments across the major sectors, and comprises funds where we have conviction that the manager is likely to outperform over the long term as well as some passive fund or “trackers”. In addition the Foundation Portfolios blend a handful of Foundation Fundlist Funds into ready-made portfolios for specific objectives.

This website is not personal advice based on your circumstances. No news or research item is a personal recommendation to deal. Investors should be aware that past performance is not a reliable indicator of future results and that the price of shares and other investments, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. Investment decisions in fund and other collective investments should only be made after reading the Key Investor Information Document or Key Information Document, Supplementary Information Document and Prospectus. If you are unsure of the suitability of your investment please seek professional advice.