Traditional vs Alternative Investments - Part 1 - Finance - PersonalFinance

Traditional vs Alternative Investments - Part 1   by Stuart Mitchell

in Finance / PersonalFinance    (submitted 2012-01-25)

The financial services and investments world has much been in the news over the last few years as large institutions have made controversial investment decisions, stock markets have been impacted and individuals have suffered through their private investment portfolios and pensions. There is of course still money to be made out there so it is perhaps a good time to take a look at what investment opportunities are available, both obvious and less so.

The following is a sample of traditional investment choices, but it is by no means exhaustive as even these can exist in many guises with differing levels of risk profiles:

Cash

The vast majority of us will have at some stage saved cash on deposit in a bank account and we may not think of it as an ‘investment’ as such however, by choosing a competitive interest rate cash can be a secure way to grow your money. Often the best returns will be available if you are prepared to lock up you money for the length of a fixed term. The capital you save will be protected barring the extremely rare event of your bank suffering financial collapse in which case £85,000 of it (per person per bank) is still protected by the government. The return on the investment takes the form of interest that is accrued on periodic basis.

Equities

Otherwise known as shares or stocks, equities are investments that are traditionally made in public listed companies. By buying a share you are buying a piece of that company and if the company makes a profit you will be paid a slice of that profit in the form of a dividend. The value of the shares fluctuates in line with their supply and demand which in turn is influenced by the performance of the company and the likelihood and size of dividend payments to its shareholders.

Serious investors will tend to manage diverse portfolios of shareholdings to spread the risk. If you invest only in one company and they fail or lose money then you will lose money, but by investing in a broad selection of companies, any losses in one company or across a particular sector of industry are offset by successes and gains in others. Due to the complexities of managing and analysing the companies and their risks, as well as the individual costs of making transactions, private investors often invest into funds where a fund manager in turn manages an underlying portfolio of equities.

Traditional sharedealing portfolios will usually be made up of companies which are publicly listed on a ‘recognised’ stock exchange (recognised by the HMRC in the UK) so that there is an indication as to how robustly and transparently the finances of the company are run. For those willing to take on more risk, there are also exchanges such as London’s Alternative Investment Market which lists up and coming companies where there is a potential for bigger gains, but with it a higher risk of company failures and therefore losses.

Gilts and Bonds

Bonds are in essence an investment vehicle through which you lend a company or organisation a set amount of money for an agreed length of time (term) in exchange for a pre-agreed level of interest and the return of your original money (capital) at the end. Bonds that raise money for companies are known as corporate bonds and bonds relating to governments are called gilt-edged bonds or simply gilts and are seen to have a relatively low risk of not being repaid.

Unit Trusts

A unit trust is a collective investment whereby you put your money into a ‘pot’ with that of other people to collectively invest in a portfolio of investments such as equities. In return for your money you get an allocation of units. Unit Trusts are termed open ended meaning that the size of the pot can grow - when people buy (add their money to the pot) they get a certain number of newly created units depending on how much the existing units are worth and how much they put in. As a consequence nobody needs to sell units for anyone else to buy in and therefore the value of each unit is dictated by how the money invested by the fund manager is performing rather than supply and demand of units. If the value of the investments grow the value of the fund will grow proportionately and your slice of the pie will be worth more.

A unit trust is run by one or more fund managers who will use their expertise in the markets to decide how and where the money will be invested/disinvested. However, each unit trust will have a theme depending on factors such as risk profile, ethical profile, industrial sector and the geographical location of the underlying companies which will dictate which companies the fund manager can invest in. So, if you think the car industry in Japan is set to boom, you can invest in a fund where the fund manager in turn invests in such companies.

Investment Trusts

These are another type of collective investment similar to a unit trust where money is pooled together and invested into other companies. In this case however the fund is actually a standalone company, so although it is run by a fund manager(s) it does not sit within a (financial) business which performs other functions and runs other funds. An investment trust’s sole purpose as a company is to invest into other companies as a single fund.

Investment trusts are listed on stock exchanges as distinct companies and therefore investors buy shares in that company. As with equities they are close ended so that there are only a limited number of shares available to buy. Generally someone needs to sell shares for someone else to buy them - extras share are not just created. Consequently the value of a share is determined by the demand and supply of shares in the market which in turn is driven by the success and of the trust.

OEICs

Open Ended Investment Trusts (OEICs) are a type of investment that is more similar to a unit trust in that they are open ended vehicles where the number of shares/units that make up the fund can change as and when they are sold. Again because they are open ended, the value of the shares does not change with supply and demand. Conversely however, they are also distinct companies in the same fashion as investment trusts.

Due to a number of advantages, OEICs are gradually replacing unit trusts in the UK. They are generally simpler and cheaper than unit trusts to administer and have no bid-offer spread (just a single price). Moreover, they are able to contain separate sub funds with slightly different themes that can suit different investors.

Further Investments