Investment Overview

A way of achieving a well diversified investment portfolio is to invest in collective investment funds, such as unit or investment trusts. These funds offer a potentially less risky solution than holding a small number of shares directly. Under the supervision of a fund manager, an investment fund pools together money from many investors. This combined pool of money is spread across a number of investments with the aim of reducing the risk of the overall portfolio.

Each fund has an objective which describes what it aims to accomplish for its investors and how it plans to achieve it. Some fund managers will aim to achieve high returns by investing in riskier stocks, which offer potentially higher returns but could also result in higher losses. Others are more defensive, seeking reasonable gains without the threat of big losses. However, no matter where they invest, the value of investment funds may go down as well as up.

Investment funds contain the facility to achieve diversification across a range of investments. The fund pools together money from its investor base to collectively invest in a wide range of stocks, bonds, properties or other financial instruments. Each fund will have an investment objective which outlines its aims and what it is looking to achieve for its investors. The fund manager sticks to a mandate which will dictate the asset allocation and stock picking criterion to which the fund focuses on. For example, some funds will only invest in large companies and others in medium to small companies.

Investing in a collective vehicle, such as a unit trust or investment trust should be viewed as a medium to long term investment to be held for five years or more.

Unit Trusts

These are collective investments whereby your money becomes part of a larger fund that is invested by a fund manager according to the ‘trust deed’. This specifies the primary objectives of the unit trust, together with what sort of investments it can hold and in what proportion. Unit trusts vary in risk profile from extremely cautious to highly speculative. So it is important to match your risk profile to the type of unit trust you buy. The majority of the underlying investments held by unit trusts will vary in value both up and down on a daily basis according to market conditions. This obviously means that the value of your holding in the unit trust will also vary on a daily basis. However, over the medium to long term unit trusts have consistently outperformed interest rates paid on deposit accounts. You should bear in mind that past performance is not necessarily a guide to future performance. Therefore, a unit trust investment should be considered a medium to long term investment and you should aim to hold it for a minimum of five years.

Open Ended Investment Companies (OEICs)

OEICs are similar to unit trusts in most respects although they have a simpler charging structure, specifically no bid-offer spread.

Investment Trusts

Investment trusts are similar in concept to unit trusts, but are significantly different in the technical detail. The effect of this is that they tend to have lower charges, but are a great deal more volatile. In general, they are ideal for the more speculative investor.

Individual Savings Accounts

There are two types of ISA: cash ISAs and stocks and shares ISAs. You are allowed to invest up to £5,760 into a cash ISA or £11,520 into a stocks and shares ISA in each tax year- which is from April 6th and April 5th. You either "use it or lose it"- in other words, you cannot fund against past tax years where you did not maximise contributions. There is no need to commit your money for a minimum period; nor any restrictions on how you spend the proceeds. Further, you do not have to declare income or profits from any ISAs in your tax returns.

Stocks and Shares ISAs

A stocks and shares ISA, sometimes referred to as an equities ISA, is effectively a tax advantaged wrapper which has wide ranging investment powers. Investments which can be held within an equities ISA include unit trusts, investment trusts and open ended investment companies (OEIC). These are all diversified investment vehicles where the risk is spread across a basket of individual shares which have been selected for purchase by a Fund Manager. There is an extensive range of equity funds to choose from, covering a wide range of geographical sectors, investment styles, risk profiles, size of companies, as well as ethical mandates. However, there are other non-equity based funds which can be accessed via an ISA which can add to the diversified nature of a portfolio. Some funds specialise in commercial property, other invest in government and corporate bonds which are loans to be repaid by the issuing government or company.

Investment Bonds

Investment bonds are non-qualifying single premium whole of life policies. There is no fixed term to the investment. The money invested is used to buy units in a selected fund. Most insurance companies offer a wide range of funds from high to low risk - this includes ethical funds. There is an ability to switch between a wide range of geographical funds. Usually the investor is allowed one free switch each year and thereafter there is a fixed charge for each switch. For information on ethical insurance funds past performance, please click here. The bond has no fixed term so it can be encashed in whole or part at any time, but may be subject to encashment penalties in the early years. Hence, it is sensible to keep it in force for at least 5 years to recoup the initial charges. From an on-going administration point of view, an investment bond is simple to operate, since you do not have to be concerned about dividend vouchers and complications on your tax return.

Investment bonds enjoy taxation advantages over other investments. Income paid out by the bond is deemed by HM Revenue & Customs to be net of basic rate income tax- hence the basic rate tax payer has no further tax to pay. The funds themselves benefit from being free from capital gains and income tax, provided you are the owner of the investment bond. It is possible to take a regular income by encashment of units- withdrawals of up to 5% of the initial investment amount (for the first 20 years, or until the original capital invested is returned if withdrawals of less than 5% per annum are taken), tax deferred. If the value of the withdrawals you receive exceeds 5% (cumulative) of the original investment amount, you will be taxed at your highest marginal rate of income tax on the amount above 5%. If you are a higher rate taxpayer, you would be taxed at 40%, less the basic rate of tax on savings deemed to have been paid already at 20%. If a bond is fully cashed in, there may be a liability for income tax on any amount over and above the level of your original investment, in other words the growth. On full or partial encashment, a chargeable event will occur. If you are close to the higher rate band this may give rise to a charge to higher rate income tax. If the gain has been made over a number of years, the gain is divided by the number of years the policy has been in force. This process is known as “top slicing”. Provided the “slice” does not put you into the higher rate tax band, there is no further tax to pay as the insurance company has already paid tax on the fund. This process of top slicing is efficient from a taxation point of view, since you are only taxed when a chargeable event occurs, as opposed to being taxed each year, at source, as you would be for savings interest or share dividends.

Investment bonds are not considered suitable for non-taxpayers- since they are unable to reclaim the basic rate tax deducted from the bond. However, if the non tax payer is married and the spouse is a higher rate taxpayer, it creates a valuable tax planning opportunity. This is because the investment bond can be transferred by means of a deed of assignment by the higher rate taxpayer to the non taxpaying spouse prior to triggering a "chargeable event", such as full encashment. This would mean that further liability to income tax can be avoided.

For older clients, investment bonds have an additional advantage in that income withdrawals up to 5% per annum of the original sum invested are disregarded when calculating income which would reduce a person's age-related allowances. This gives bonds an important advantage when compared to any other source of income. Hence an investment bond can be a very useful vehicle when used in conjunction with pensions for retirement planning. This is particularly the case for individuals who are currently higher rate taxpayers, but expect to become basic rate taxpayers when they retire. Even if you and any spouse are a higher rate taxpayer in retirement, you can still withdraw 5% of the original amount invested for up to 20 years without incurring a further tax liability. Since the allowance is cumulative, you could withdraw 4% per annum for 25 years. This ability to carry forward unused relief means that a bond holder who has not used their 5% withdrawals for a year, can withdraw up to 10% in the second year with no immediate liability to taxation- regardless of their tax position.

We are pleased to offer you access to investment bonds at heavily reduced prices. We do this through our Investment Bond Shop, where you can access ethical funds via both on and offshore investment bonds available from the leading providers.

You can find out which ethical funds are available from the investment bond providers in our Ethical Investment Bonds section.

Charges

A fund management group will typically charge a yearly management fee of between 0.3% and 2.2% - most charges tend to be between 1.0% – 1.5% per annum. In addition to this, they often charge separately for the fund’s “additional expenses” such as distribution fees and servicing costs. These two charges combine to form the Total Expense Ration (TER), which is deducted from a fund on a daily basis .There are also initial charges to consider which vary from 0% - 5.5%. These are deducted from contributions and affect the allocation rate of the investment. Combining all charges to assess the effect of charges given assumed rates of investment growth gives a figure known as a “Reduction in Yield”. The reduction in yield shows the amount by which a fund’s charges can be expected to reduce the investment return on a policy. There may also be a product charge if the fund is accessed within a wrapper, such as a pension.

Tax Treatment

Cash ISAs are completely free of all taxes. Equity ISAs are completely free of all capital gains tax, however there is a small tax which the fund managers pay on dividend income from shares.

Both cash ISAs and equity ISAs are subject to Inheritance tax- currently levied at 40% of the value of an estate above £350,000.

Ethical investment portfolios

Seven Steps to Investment Portfolio Construction

With such a wide range of funds available, selecting the right funds can be a daunting task. However, if approached with the right methodology, to this end the following strategy should assist you in selecting a well diversified, balanced investment portfolio.

  1. Attitude to investment risk.

    Some people are, by their nature, extremely cautious who have little risk tolerance. Risk averse people who cannot accept volatility inherent with investing, should consider carefully whether they would be better suited to keeping their funds in deposit accounts or very low risk investment vehicles, such as National Savings products. You need to carefully consider your tolerance to risk. Overly investing in just one asset class will increase the overall risk of a portfolio- so diversification is key.
  2. Consider any ethical factors which you feel are important to you. Our attitudinal questionnaire should assist you with this and also takes into account your attitude to investment risk. Once you have positioned yourself on the spectrum of ethical investing and of risk, we have produced examples of diversified ethical portfolios which, in conjunction with the other research modules available, should be of assistance.
  3. Take into account your

    investment objectives

    . Are you investing a lump sum for income? Investing for income would suit somebody approaching retirement with a need to generate an income and needed to supplement their pension. You need to consider what level of income is required, and when you want it to begin. If an income is to be taken, do you want it to increase over time in an effort to combat inflation? If so, the capital has to grow over time. In order to do this, ither not all of the ‘growth’ can be taken from the capital, or the risk of your portfolio remaining sustainable has increased. You may be looking to build up capital for the future. This would suit somebody who is currently earning and who's income matches or exceeds their outgoings. These kinds of objectives have a considerable bearing on the choice of investment strategies and hence asset allocation.
  4. Age and investment duration.

    Age is critical in determining investment horizons. For example, a young investor may have a higher tolerance to risk, since they have sufficient time to recoup short term losses caused by volatility. Conversely, older investors may seek a more cautious approach to investment, since they may wish to preserve capital as they go into retirement. A key factor in the reduction of any risk associated with an investment is the length of time for which it is held. In most cases, the longer the term of the investment the lower the risk. If you are likely to need access to the funds at short notice, you may be better served by a deposit based account as opposed to a collective investment vehicle which is subject to initial charges. As such, we consider an investment in a collective, equity based fund as a medium term investment where your time horizons need to be for five years or more.
  5. Affordability

    is implicit in determining investment decisions. Investors need to carefully consider whether they can afford to take risks. For example, someone with high levels of personal debt would be better off paying these debts off before embarking on investment portfolio construction.
  6. Tax implications.

    You need to take into account the wider impact your investment portfolio will have on your income, capital gains and inheritance tax position. ISA's, for example, cannot be placed in trusts, since they are already contained in a trust and this can impact adversely on inheritance tax planning which often relies on trust work. Equally taking income from your investments can impact on means tested benefits and so the consequences need to be considered diligently. Triggering chargeable events from unit trusts can have adverse consequences if they exceed your capital gains tax allowances. If you have any doubts you should consider seeking advice from an accountant or independent financial adviser.
  7. On-going monitoring and supervision.

    After you have decided on your asset allocation, it is important that you keep the funds under on-going monitoring and supervision. Financial markets are constantly changing, providing new opportunities, or "buying opportunities" and also risks, such as sectors which have become overvalued- indicating that it is appropriate to look to take profits and crystalise gains. Re-assessing and re-balancing a portfolio is critical in ensuring optimal performance. The performance of a fund is often compared to a benchmark index and/ or with sector average performance. Sector averages denote the average performance of all funds within that particular sector. It is important to look for funds and fund managers that consistently out-perform the sector average over a sustained period of time.

Attitude Towards Investment Risk and Return

The level of risk which you may be prepared to accept as an investor is a key consideration. Different asset classes have different risk profiles.

The Golden rule is that risk and reward go hand in hand. It is important that any investment vehicle matches your feelings and preferences in relation to investment risk and return. Hence your asset allocation needs to be commensurate with your attitude to risk.

The table below shows how different asset classes are graded in terms of risk and reward:

Diversification

Risk is an implicit aspect to investing: shares can fall, economic conditions can change and companies can experience varying trading fortunes. There are a wide variety of different asset classes available to invest in and commensurate risks attached to each one. Whilst these implicit risks cannot be avoided, they can be mitigated as part of the overall investment portfolio, by diversifying. By spreading your investments over a wide range of asset classes and different sectors, it is possible to avoid the risk that your portfolio becomes overly reliant on the performance of one particular asset.

Key to diversification is selecting assets that behave in different ways. Some assets are said to be “negatively correlated”- for instance, bonds and property often behave in a contrarian way to equities by offering lower, but less volatile returns. This provides a “safety net” by diversifying many of the risks associated with reliance upon one particular asset.

It is also important to diversify across different “styles” of investing- such as growth or value investing as well as across different sizes of companies, different sectors and geographic regions. Growth stocks are held as investors believe their value is likely to significantly grow over the long term; whereas value shares are held since they are regarded as being cheaper than the intrinsic worth of the companies in which they represent a stake. By mixing styles which can out or under perform under different economic conditions the overall risk rating of the investment portfolio is reduced.

Picking the right mix of these depends on your risk profile – it is essential to chose an investment portfolio commensurate with your attitude to investment risk.

Risk Warnings