These managed funds operate as unit trusts, a well-established and cunningly effective way of dealing with pools of money for collective investment where new participants in the pool can easily join and departing participants can be paid out without disrupting things for the other participants.  The participants in these structures are called “unitholders”. 

When a new unitholder joins (or an existing unitholder invests more money in the pool) new units are issued by the fund manager.  When an existing unitholder leaves, their units are redeemed by the fund manager.  So, new units could be issued and existing units redeemed every day impacting the number of units on issue.  The price at which new units are issued or existing units redeemed is where the effectiveness of this structure comes in.

The fund manager would value the investments held in the collective pool, typically every day where prices are readily available.  These investments could include cash deposits, interest-bearing securities and listed shares.  Physical properties are valued less frequently.  So, the total value of the collective investment pool is calculated (let’s say this is $100,000,000) then the number of units on issue is sourced (let’s say this is 25,000,000 units).  Dividing the value of the pool by the number of units on issue gives the worth of each unit (in this example $4-00 per unit).  If no new units were issued nor existing units redeemed and the underlying value of the investments in the pool increased the next day to $100,500,000 then each of the 25,000,000 units would have an underlying value of $4-02.  In practice the numbers would not be neat and round as shown here.

So, if new units are to be issued the underlying worth of each unit might be $4-00; many unit trusts would charge a small premium for issuing new units, so the actual issue price might be $4-01.  A new investment of $25,000 would receive 6,234 units at $4-01 each.  If existing units are to be redeemed the underlying worth of each unit would also be $4-00; many unit trusts charge a small amount for redeeming existing units, so the actual redemption price might be $3-99.  A redemption of 5,000 units would receive proceeds of $19,950 at $3-99 each unit.  The “buy/sell” difference between the issue price, redemption price and unit price is retained by the fund and is designed to avoid continuing unitholders being negatively impacted by transaction costs incurred when new units are issued or existing units redeemed.

So, unit trusts are a simple and effective way to administer pools of investments where new participants can join and existing participants leave with minimum fuss.  Stay tuned for the next article on demystifying managed funds that will cover how entitlement to income such as interest and dividends is handled and the two different ways it may be passed onto unitholders.

Chris Heyworth is an associate member of The Institute of Chartered Accountants in England and Wales and a Certified Financial Planner with over 25 years’ experience.

Please note: The information provided in this article is general advice only. It has been prepared without taking into account any person’s individual objectives, financial situation or needs. Before acting on anything in this article you should consider its appropriateness to you, having regard to your objectives, financial situation and needs.

Photo credit: kenteegardin via Visual Hunt / CC BY-SA