CHAPTER 6 INVESTING IN THE STOCKMARKET THROUGH A UNIT LINKED FUND

WEALTH WARNING

The charges on unit linked funds are very high and can seriously damage your wealth. The cheapest unit-linked fund for a lump-sum is the Quinn Life Freeway. Its 1% might seem very small, but the effect of compounding makes it huge.

On a £ 10,000 investment for 20 years, you would be £11,000 better off investing directly in shares than investing in the Quinn Life fund and don't forget, this is the cheapest fund available.

Many unit linked funds have complicated charging structures, with initial units, allocation rates, bonus rates, bid/offer spreads, policy charges, exit charges. These make these products very bad value in the short term and not very good value in the long term either. New Ireland charges the following for its Elite Bond and you can see the encashment value after each year.

WHEN IS A UNIT LINKED FUND APPROPRIATE?

INVESTING IN AN EQUITY BASED SSIA
You can only do an SSIA through a unit linked fund.

INVESTING SMALLER SUMS OF MONEY
You need about 10 different shares to get an adequate spread. The minimum amount to do a share deal is about £2000. So if you have £10,000, you can only buy 5 shares. You will be taking an extra bit of risk. If you are happy with this risk, then buy shares directly. If not buy a unit linked fund until your capital has risen to £20,000 and then cash it in and buy shares directly.

INVESTING OVERSEAS
Unless you are a very large investor, there is too much hassle and expense investing outside Ireland, the UK and perhaps the US. For example, if you want to invest in the Far East, you really do need to go through a unit linked fund

SHORT TERM INVESTMENT
If you want to put your money in the stockmarket for less than 3 years, the stamp duty and brokers' charges make direct investment uneconomical. Buy a unit linked fund which has no initial charges instead. See Chapter 8 for more information on short term investing.

INVESTING IN PROPERTY
If you want to invest in property, you will need either a large amount of money or else you will need to borrow very heavily. You can invest in a Unit linked property fund from as low as £5,000 (check).

INVESTING IN A PENSION
Most pensions are unit linked. Unless you have £100,000 or more in your pension scheme, the costs of setting up a self administered pension scheme are too high.

SOME MYTHS ABOUT UNIT LINKED FUNDS

UNIT LINKED FUNDS HAVE LOWER CHARGES THAN INVESTING DIRECTLY IN SHARES
Many advisors and journalists recommend unit linked funds on the grounds that the typical annual management charge of 1.5% is good value. They say that this is a lot cheaper than the costs of buying and selling shares directly where the stamp duty and commissions amount to around 4% for the buying and selling of shares.

But this is absolute rubbish. The fund manager charges his annual management fee in addition to all the costs of buying and selling the investments. So a holder of unit linked funds has a return of 1.5% lower than the direct investor in shares. Unit linked funds often have other charges such as custodial and trustee charges which are charged to the fund and which a direct investor in shares doesn't pay.

Fund managers claim that they pay much lower commission rates than the small investor. While this is technically true a big buyer of shares often pushes the purchase price up while a big seller of shares often pushes the price down. So fund managers probably pay more and receive less for their shares than the private investor.

THE PROFESSIONAL FUND MANAGER PERFORMS BETTER THAN THE AVERAGE INVESTOR
The fund managers would have you believe that their well paid employees can pick shares better than the average woman in the street. While this might appear intuitive, it is completely false. Fund managers do no better than a portfolio picked at random. The average fund manager consistently underperforms the market in which he invests. This is discussed in more detail in Chapter .

ONLY A LARGE FUND CAN GET THE DIVERSIFICATION NECESSARY TO REDUCE RISK
If you hold 10 different shares, you get adequate diversification. Each extra share over this adds very little to reducing the risk of the portfolio. It is easier however, for a fund manager to diversify by investing overseas.

IGNORE PAST PERFORMANCE WHEN SELECTING A FUND MANAGER

Most funds are actively managed funds. They employ a team of investment analysts who study the accounts and economics and markets of various companies and buy the companies which they think are good value. They monitor their investments carefully and sell out as soon as they think their shares are no longer good value. You might think that these well paid accountants and economists and bright young things would be able to identify good value and so make a much better return than the market in general. But these guys are the market. If Irish Life decides to buy Smurfit who can they buy them from except another fund manager ? So New Ireland must have decided to sell Smurfit. The net effect of all this is that the average fund manager can only expect average performance.

OK, but who wants average? Why not select a fund manager who consistently beats the average? Simple isn't it?

Illustration: newspaper headlines and adverts claiming such a fund is the best

Have a look at the ads in the attached illustration. You will quickly realize that every fund manager seems to be the best. Obviously they can't all be. The advertisers are very clever in showing how their fund appears to be the best performing fund. They have a number of tricks in their bag. They compare their fund with a selection of poor performing funds. They select the period which suits them best. They may have many funds and they pick the fund which has done best and they ignore the poor performing fund. If their performance is really bad, they compare their performance with a bank deposit.

The reality is that every fund manager has a period when they do well and a period when they do badly. In the long term their investment performance tends towards the average.

Bizarrely, there is just no relationship between past investment performance and future investment performance. A fund which has done above average for the past 10 years has only a 50% chance of doing above average over the next 10 years.

TRACKER FUNDS

It is widely accepted in America that fund managers cannot outperform the average consistently over a period of time. This realization is dawning on British and Irish consumers. So many fund managers have got rid of their expensive investment analysts and now just buy a portfolio of shares which tracks the index. They don't try to beat it. This means that the costs of running such a fund would be much lower. So in America and the UK , consumers have had their annual management charges reduced to as low as ½%. The cheapest trackers in Ireland are still very expensive by international standards.

LOOK FOR LOW CHARGES

Look for the lowest charges
All other things being equal, a fund with lower charges will perform better than a fund with higher charges. The lowest charging funds are the Quinn Life Freeway products

Askaboutmoney maintains up to the minute information on charges on its website, so if Quinn Life raises its charges or if another company becomes cheaper, we will highlight it.

IF YOU BUY A BROKER FUND, GO TO A DISCOUNT BROKER
We recommend funds such as Quinn Life because they are cheaper. Their range of funds covers Irish and International equities so it should be adequate for most people.

However if you have a specialist requirement not covered by Quinn Life, go to a discount broker who will be able to get you reduced charges. Don't go directly to the company as you will pay full price.

Such a specialist requirement might be : a property fund, an ethical fund, a far eastern fund, an emerging market fund etc.

SOME DO's AND DON'Ts ON UNIT LINKED FUNDS

The same advice applies to unit linked funds as applies to investing directly in shares.

Don't panic when the stockmarket crashes.
Don't try to time the market
If your fund is performing poorly, don't switch to a different fund manager. A poor fund is just as likely to do well in the future.
Don't buy a balanced fund i.e. a fund which invests in a mix of equities, cash and bonds. Put whatever you are comfortable with in a 100% equity fund and put the balance in a deposit account yourself.

APPENDIX 6 A GUIDE TO CHARGES

Quinn Life has a very simple and transparent charging structure. They are also lower than the other products.

If you do decide to opt for another product look out for charges. These are often not highlighted in their brochures, but they are very high.

INITIAL AND EXIT CHARGES

Bid/Offer Spread: You buy units at 100 and sell them at 95, so there is an effective 5% initial charge.

Exit charges: A lot of funds now charge you 5% if you cash within the first year, 4% in the second year and so on.

Initial / Allocation/accumulation Units. If you see these mentioned, don't look any further. It means that up to 90% of your first year's premiums can go in charges.

102% Allocation. Sometimes a fund will add that they are adding 2% to the value of your fund if you invest before a certain deadline or if you invest more than say, £200 per month. While this extra allocation will be highlighted , they will hide some other larger charge in the small print which cancels out the extra allocation.

ANNUAL CHARGES

Annual Management Charges: Every fund charges an annual management charge. The fund itself pays a fee to the fund manager, so the fund value is correspondingly reduced.

Monthly Policy Fees: Some funds charge you £2 per month for running the scheme. This can be a very high percentage of a small monthly premium, so watch out for this.

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