Oeic, investment trusts or Paifs: which should you choose?

However, there is a wide selection of both closed and open-ended collective investment vehicles into which investors can put their money.

The most common vehicle that UK financial advisers use to put their clients’ money is the open-ended fund, which can be either open ended investment company (Oeic) or a unit trust. The other mainstream option is a closed-ended investment trust, while several fund groups have recently started launching specialist vehicles known as property authorised investment funds (Paifs).

Leaving Paifs aside for one moment, the key differentiating issues between an open or closed ended property fund are liquidity and volatility.

Investment trusts have fixed pools of capital, which is raised all in one go and then given to the investment manager to invest in what they want. Investors into the trust buy shares which reflect the value of the underlying assets, but can increase to more than the value of the property assets (a premium) or less than the assets (a discount).

Gavin Haynes, managing director of Whitechurch Securities, explains that this makes investment trusts more volatile.

He explains: “If you are holding property within a closed ended investment trust it will be more volatile as it is priced like any other listed share and the trust can move to discount or premium, which can increase fluctuations.”

By contrast, an open-ended fund is not a fixed pool of capital and is valued solely on the value of the underlying properties – what you see is what you get when you’re buying an open-ended property fund.

However, this also has its drawbacks when it comes to managing inflows and outflows into open-ended funds.

Adrian Lowcock, senior investment manager at Hargreaves Lansdown, points out that both inflows and outflows cause a problem for open-ended property fund managers.

“The money flows in usually when the fund managers don’t want or need it and then back out when they would like to have more money, for instance when prices have fallen and there are some attractive investment opportunities,” Mr Lowcock says.

The problem of outflows is a much greater one for open-ended funds, because of the difficulty in selling the underlying property assets. The need to meet redemptions means that investment managers have to keep a fairly high proportion of their assets back as cash.

As Mr Lowcock explains, “this has a drag on performance and on the dividend yield.”

But the drag on performance is better than the alternative, which is when the cash buffer isn’t enough to cover the number of people who want to sell out, meaning that investors are trapped in the fund until the manager can sell an asset, which happened with the New Star International Property fund.

Investment trusts do not have to deal with this problem, due to the fixed pool of capital. This means investment trust managers can be fully invested if they want to be, and do not have to worry about redemptions.

Mr Lowcock thinks that this ability to be fully invested, which helps both capital gains and the dividend yield, makes investment trusts a better option for investors than open-ended property funds.

However, he points out that most investment trusts in the Association of Investment Companies universe are trading on quite substantial premiums to their net asset values, with several on premiums of more than 10 per cent.

This could potentially lead to some heavy losses for investors if sentiment swings against the property sector and the share prices start to fall, though the sector seems to be on an upward trend in terms of sentiment currently.

In terms of costs, the advent of the RDR has meant that the cost differential between closed and open-ended property trusts is not particularly large.

However, due to a surge of inflows into the sector, some open-ended funds have changed the way in which they are priced, moving from new investors paying the mid price (between the bid and offer price) to the offer price.

In property funds, this can make a considerable difference and investors should be aware of which price they are paying on each particular fund.

Paifs

A further problem that open-ended unit trusts have when investing in property is that they are subject to a 20 per cent tax on income generated, which investment trusts are not. To get around this, the new structure of Paifs was first introduced in 2008.

Mr Haynes says that many fund groups are looking to convert their property unit trusts into Paifs because of the tax efficient benefits of the new wrapper.

“Within a PAIF, rental income generated is taxed in the hands of the investor,” explains Mr Haynes. “This means it is particularly tax efficient if held within a pension and ISA wrapper.”

M&G Investments was the first to convert its property fund to the Paif format but other fund groups are following suit. Kames Capital launched a Paif at the start of this year and Ignis Asset Management is set to convert its property fund later this year.

However, in spite of the extra tax benefit, the Paif still suffers from the same drawbacks as other open-ended property funds do.

An additional small wrinkle is that many fund platforms have yet to adapt their technology to be able to support Paifs, which has led to the use of feeder funds, in which the investor puts their money into the feeder fund on the platform, which then invests in the Paif.

The issue of availability on platforms is one of the reasons why open-ended funds are more widely used for property than investment trusts, because many platforms traditionally did not hold investment trusts and many have been slow to adjust their technology to be able to list them.

But the consensus from investment experts is that, if you can deal with the volatility, investment trusts seem to be a better option for those looking to invest in property. However with most trusts trading on large premiums it is definitely a case of buyer beware.

Jim Wood-Smith, chief investment officer at discretionary management firm Hawksmoor Investment Management, says that while he wants to buy into commercial property at the moment, he cannot do so.

He thinks that investment trusts are trading on far too high a premium right now and he says refuses to ever invest in open-ended property funds as he dislikes them due to concerns such as liquidity.