how are fund units valued?

ggb1979 wrote: »

Hi

Another possibly daft question on my mse learning journey.

As per title how are fund units valued?

Is it as simple as the total value of all shares in the fund divided by the number of units?

Yes, if you are talking about a 'fund' i.e. an open ended investment company (OEIC) or Unit Trust. All the assets split across all the shares or units gives you a value per share.

Sometimes there is a small difference between the buy price and the sell price (a "bid-offer spread") to reflect the costs of getting new investors in or paying back old investors who leave ; or they just move the day's price one way or the other a little bit away from the actual net asset value, to accommodate high numbers of joiner or leavers. But basically you get to deal at roughly the value of the existing shares, because the funds are open ended and the fund manager can just create new shares to get more cash into the fund, and go and buy the same mix of assets with the new money ; or redeem shares to allow people to exit in an orderly fashion... with people placing orders ahead of one fixed dealing cut-off time each day.

Does supply and demand play a part? Ie hypothetically could demand for a particular fund (eg cos of a sexy mgr) force unit price above its intrisic value (or likewise down)

That's how an Investment Trust or a closed-ended (not open ended) investment company works. They are floated on the stock exchange and traded in real time so supply and demand values the company at something that might be more than the sum of its parts (premium above net asset value), or less (discount to net asset value).

How then do dividends get valued into the fund? (In an acc fund)

Over the course of the year, the underlying companies that the fund is invested in, will give some of their assets back to their owners - the shareholders, including the fund. That means that on each company's dividend day, if they have one, the individual companies have less cash and assets and go down in value slightly, but the fund gets some cash in its hand. The fund owns lots of companies so it saves up the received cash ready to distribute on to its own investors in due course on fixed dates each year. So by the end of the quarter or half-year or year, it will have a chunk of cash as well as a big portfolio of investments.

What actually happens next depends on the type of fund, inc or acc.

Does the manager essentially get the cash, go and buy more shares thus increasing the value of each fund unit?

In an inc fund i assume the dividends are dipersed as cash in proportion to unit ownership?

Not quite but close. In an ACC fund, the fund is sitting on all these received dividends, so the manager still declares the dividend (so us investors all know what income we technically 'got' and need to pay our taxes on), but we are never sent the cash.

So, if the fund is worth £100m, that might be attributable to £99,000,000 worth of shares or bonds in listed companies around the world and £1,000,000 of cash. If the fund has 100m units in issue, they'll be a pound each. The ACC fund doesn't have to distribute the million of cash because the dividends are just a paper exercise. So it will go and reinvest the £1,000,000 of cash on more shares and bonds etc. At that point it doesn't actually 'increase the value of each fund unit'. It simply has £100,000,000 of investments and £0 cash, but it's still all worth £1 a unit.

But by contrast, the INC fund does physically pay out the £1,000,000 of cash as a dividend from the fund. All of the 100m unitholders will get 1p each. The fund assets will now be £99,000,000 of investments and £0 cash. With 100m units in issue, the shares are now worth 99p each and each unitholder has 1p cash in his hand. While the ACC holders have units worth 100p. If the INC unit holders want, they can go and reinvest their dividend income in buying more units at 99p each and repeat the cycle for the next quarter or next year, or they can keep the cash and spend it. If the ACC unitholders want, they can sell a unit or two and get some cash in their own hands and spend it. Ultimately everyone still gets the same return.

The only bit that you might not have quite clear, is that the ACC units don't 'add' value on dividend day. Instead, the INC units 'lose' value on dividend day as the cash goes back out to the investors. So relatively speaking the ACC units are of course more valuable than the INC units over time but you could say that's because the INC units keeping giving cash away and shrinking, while the ACC units just keep plodding on.

If you can't be bothered to keep manually investing your dividends, and want to stay invested, or you're on a platform with transaction charges that makes manual reinvestment expensive, the ACC units are probably for you. But the tax treatment is exactly the same and some people prefer the INC units, either because they want to spend the income, or because the cash in their hand without having to manually sell, is useful for rebalancing the typical portfolio which has some funds going up or down in value at different rates to others.

Probably more info than you needed but I pasted most of it from a similar post a while back.

ggb1979 wrote: »

Is one way to determine the historical dividend pay out on a given fund the price spread between the acc and inc options?

Not reliably because the acc and inc options might have launched at different times and prices (e.g some funds are only available as one or the other) and there can be a variety of different classes with different fee rates to confuse everything

Also how do fund charges work? I noticed in my pension that my charges are applied by deducting units from me. Who do these units go to? Does the fund manager hold a portion?

To literally take a percentage of units off the investors and give them to the manager, or to issue free units to the investors, is one way to handle fees or fee rebates.

It's more common that the fund will just pay a flat fee to the manager in cash. So if the fee was 0.25% a year, and the fund is £100m, they could literally accrue an extra £1,000 of costs every working day of the year when they publish the share price, so that at the end of the year the fund has say £99,000,000 of investments, 1,000,000 of cash as in the earlier example, and also has a £250,000 debt to the manager, so its net asset value is £99,750,000 and the units are worth 99.75p a share.

At some point every so often they will pay off the manager so they'll have no debts and £250k less cash but you won't specifically see the fee being paid. Also in reality it won't be a flat £1k every day, the fee will be linked to the actual asset value on a more real time basis, rather than just the asset value at the beginning or end of the year.

What prevents a fund manager just creating and selling new units without buying additional shares (and thereby diluting the value of existing units)?

As long as the new units are issued at a pro rata price that reflects the fair value of the assets, nobody gets diluted.

For example if we take that example fund with £100,000,000 of assets (whether 100,000,000 of investments, or 99,000,000 of investments plus 1,000,000 of cash) and 100m units in issue, they are all worth £1 each. If I want to buy in with £1000, I will give the fund my £1000 and get 1000 units. So at that point the fund will have £100,001,000 of [investments plus cash] and there will be 100,001,000 units that are still all worth £1 each. Nobody has been 'diluted'.

If the fund manager just keeps my £1000 cash as cash in the fund bank account, and doesn't bother to buy any extra investments, and the investments double over a year, the fund will be worth £200,000,000 + £1000 cash, which isn't quite as good as if the fund manager had bought another £1000 of investments with my money and let the £100,001,000 double to £200,002,000.

So, the cash sitting idle is a drag on performance. However, there can be sensible reasons to keep some amount of cash on hand, because I or some other investor might want to take £1000 out of the fund tomorrow or next week and it is a waste of time for the fund manager to spend money on broker fees, custody fees, admin fees, stamp duties and other transaction costs if he's just going to sell the assets tomorrow to get the cash back for a departing investor.

The fund manager will want the fund to keep some cash around for redemptions and new investment purchase opportunities at advantageous prices - unless he's following a defined index tracker strategy in which case he is probably not so bothered about needing cash for buying opportunities, as he is about managing liquidity for redemptions

Also you mention tax above, am i correct in that any earnings be it through dividend payouts or savvy trading of fund units within a share isa are tax free, providing you only pay max 15k cash per annum into it. Ie if through some freak of trading my 1quid share isa grew to 1000000 this year and i sold out i could keep all 1000000?

That's right.

- No income tax to pay on dividend distributions.

- No income tax on interest distributions either; any tax withheld at source is reclaimed for you by the ISA manager.

- And no capital gains tax so if your £10k investment grows 100x into £1 million over a year, or 100x into £1 million over 50 years (which is a bit more realistic, only 9.6% annual compound return), you can take it all away and spend it as you wish. Or you can sell the investments and simply buy some other ones so as not to actually lose the (now huge) ISA wrapper that's sitting around your assets.

puk999 wrote: »

I'm currently working my way through your message and assume this is a typo and you mean £1k every day here?

Yeah, it was a typo as originally I had used a bigger fee to avoid the fees coming out to a tiny fraction of a penny on NAV. Now edited!

plunt wrote: »

also remember in an ISA you cant offset any losses against capital gains elsewhere!!

PS: wish i had bought my tesco shares outside of my ISA!

That is true. But if you buy your riskiest and most volatile investments (i.e. individual company shares) outside an ISA to give you the best chance of having some allowable losses outside the ISA to accumulate for future years, you are also giving yourself a chance of making those big unwrapped gains that actually need the losses to be available - and also you are missing the opportunity of growing the total size of your ISA wrapper substantially, when the risky investments pay off.

also buying shares within an ISA doesnt really have much benefit unless you are a higher rate tax payer or plan to make big capital gain. as for dividends the standard 10% deduction auto applies and you cant request it back

This is true. For many people on low rate tax it is not a great benefit until you start to need to worry about CGT or a significant level of dividends, or if you are holding some bonds within your portfolio, which the average investor probably should. And then it can become very valuable indeed. See recent "Is an S&S ISA Worthwhile for Mr Average?" thread.

However it is a bit of a misconception that you pay a 10% tax deduction when holding shares or equity funds in an ISA. You don't. If the company declares and pays 10p per share dividend or a fund declares and pays 100p per unit as a dividend distribution, you get that full 10p or 100p. You don't pay any tax whatsoever. However, if you are a nil rate or basic rate taxpayer outside an ISA you get the 10p or 100p and don't pay any further tax whatsoever, either. The only people worrying about extra taxes on dividends are the higher rate taxpayers (or those who get pushed into becoming higher rate taxpayers by receiving a lot of income outside the ISA wrapper) who have to pay income tax on their dividends and find that the notional tax credit isn't enough to cover the total tax bill.

So, a basic rate taxpayer doesn't get much of an advantage using an ISA for equities or equity funds, because he wasn't going to pay income tax on his dividends from equities or equity funds anyway. His benefits are really 'just' the savings in potential CGT, the reclaim of withholding tax on bond interest income (or interest distributions from funds) and all the recordkeeping relating to purchase prices, sales prices, CGT, interest income and dividend income. I say 'just' in quotes as a bit of sarcasm because it seems plenty useful enough to me.

...unlike funds!

I presume this was a typo and you mean "unlike bonds!" ?

Tax withheld at source on interest from bonds or interest distributions from bond funds can be claimed back in an ISA or a SIPP. This tax recovery is better than being outside an ISA or SIPP

Tax withheld at source on dividends from equities or dividend distributions from equities funds can not be claimed back in an ISA or a SIPP, because there isn't any tax withheld at source to even worry about. This lack of tax recovery of the zero tax that you'd suffered (some notional concept) is no better than being outside an ISA or SIPP.

However, outside an ISA or SIPP, there is a nice notional tax credit for basic and nil rate taxpayers meaning they don't need to pay any taxes on dividend income they received. It generally encourages people to invest, just like the 11k CGT allowance. Higher rate taxpayers find that the tax credit isn't enough, meaning they still pay some tax on their dividends, and even basic rate taxpayers have to count the dividends within their total income to see whether they are a higher rate taxpayer or not. So, many people will be very happy to wrap their equities and equity funds in a tax wrapper.