Managed funds offer many different structures

For something that's meant to make life easier, managed funds can get ridiculously complicated.

The basic idea is simple enough - you pool your money with other investors, have it managed by professionals and share the gains, or losses - but it gets much less simple the moment you start delving into the different structures fund managers use.

If you're neither an accountant nor a lawyer, it's easy to dismiss these matters as being well beyond your boredom threshold. But the fact is, structure matters; the same underlying investment can produce very different returns, depending on the management structure used.

Here are some of the structures you're likely to encounter if you go shopping for managed investments.

New Zealand-based unit trusts

These are probably the best-known form of managed investment.

When you give your money to a unit trust manager, in return you get units, each of which is a share in a pool of investments.

The manager then uses your money to buy more investments to add to the pool - typically after extracting an entry fee, though there are ways to avoid that.

The value of each unit is the value of all the fund's investments, divided by the number of units on issue. As the value of the fund's investments rises and falls, so will the value of each unit.

When you want to get out, the manager takes back the units and pays you whatever they are worth at the time.

"Takes back the units" is an over-simplification; there are different ways for a manager to cash your units, and the choice can have tax implications.

As long as you own the units you may also receive regular dividends.

Unit trusts are taxed like companies, which means they pay 33 per cent tax on their income and any capital gains - unless the unit trust in question is classified as a "passive" fund, in which case capital gains aren't taxed.

Because their capital gains are taxed, most unit trusts are at a tax disadvantage compared with investing directly or through some other forms of managed funds.

Any unit trust dividends can include imputation credits, which you can use to reduce your tax bill.

Group Investment funds

These operate in much the same way as unit trusts, although they have a different legal structure.

Tax is similar, too - capital gains and income are taxed at 33 per cent and dividends can include imputation credits.

However, some group investment funds - typically those which aim to produce income, as opposed to capital gains - can pay dividends which have tax deducted at your own rate, if you give the manager your IRD number.

Insurance bonds

Legally, these are a form of insurance policy, but in reality they're an investment that works similarly to a unit trust.

They suffer the same tax disadvantages, too, paying tax on any income or capital gains. Any payout is tax-free - although "tax already paid" would be a more accurate description.

Superannuation schemes

These have their own legal structure, and tend to be less flexible than the competition - the rules may lock in your investment to a certain date, which may be useful if you don't trust your willpower, but could be awkward if circumstances change.

Again, they pay tax at the company tax rate on income and capital gains and any payout is "tax free."

Australian-based unit trusts

Many local managers offer Australian-based unit trusts, which work in much the same way as their New Zealand counterparts.

Australia's tax rules mean all income and realised capital gains must be paid out to unit-holders, who are then taxed on those returns. That means capital gains, which in many cases would be tax-free for a direct investor, are converted into taxable income.

Australian trusts also suffer because any imputation credits can't be passed on to New Zealand investors.

Listed trusts

These are just companies whose only business is owning investments. The "listed" bit means they are listed on a sharemarket, either in New Zealand or overseas. Rather than units, investors in these buy shares.

You'll sometimes see these referred to as "closed-ended" funds. That means the number of shares on issue is set; once all the shares are sold, the only way to get in is to buy shares from an existing investor. That's in contrast to a unit trust, where the manager goes on issuing new units and the trust can, in theory, keep growing forever.

Rather than buying from the manager, you buy through a sharebroker, paying brokerage instead of an entry fee. And when you want to get out you sell your shares through a broker rather than asking the manager to buy them back.

The way these are priced is also different. With unit trusts and similar investments, the manager re-prices the units regularly, calculating the value of the underlying investments and dividing by the number of units on issue. But with a listed trust, the price is whatever the market is willing to pay.

That may be more than the trust's investments are worth or it may be less, depending on the state of the sharemarket and attitudes towards your fund.

That scares some investors, who worry that the underlying investments are volatile enough, without adding an extra layer of volatility.

On the other hand, listed investments can be cheaper to run, you may get a bargain - buying shares at a discount - and when you want to get out you're not relying on a manager's ability to pay you.

The way these are taxed depends on where they are based. If it's New Zealand, they're taxed like any other company, meaning they suffer the same tax disadvantage as unit trusts, unless they are classified as "passive" investors, in which case capital gains are tax-free.

Australian listed trusts, some of which are traded on the New Zealand exchange, also pay tax on their capital gains as well as their income.

If it's in Britain, they don't pay tax on capital gains, making them very attractive for New Zealand investors, who get the capital gains tax-free.

To make buying and selling easier, about a dozen UK-based listed trusts trade on the local sharemarket.

Open Ended Investment Companies

These are a relatively new type of investment fund based in Britain.

They're frequently known by their acronym, OEICs (pronounced "Oiks", should you want to impress people with your knowledge of such matters).

While these are companies, they operate like a unit trust - you buy shares from a manager and sell them back to the manager for their underlying value.

The fund doesn't pay tax on capital gains, which are used to increase the value of the units. If you sell those units for a gain, that profit will generally be tax-free.

Largely because of their tax advantages, OEICs are now being offered by several local fund managers.

Mastertrusts

These are "umbrella" funds, set up by organisations such as financial planning companies. Investors can put their money into a single mastertrust but split it up among various sub-funds - so much into international shares, so much into fixed interest and so on.

The attractions are convenience and, possibly, the chance to pay less for investment management, because the mastertrust organiser gets a bulk discount from investment managers.

However, there may also be a cost, in the form of an extra layer of fees to be paid to the mastertrust organiser.

Foreign Investment Funds

This isn't a specific structure, but it's worth knowing about.

Foreign Investment Funds are a category of investment created by the tax laws. That category includes things such as unit trusts or super schemes based in low-tax countries. If you invest in a fund that the IRD puts into this category, you may face particularly tough tax rules.

The rules can be complicated, but generally speaking you're safe if you invest in unit trusts or companies in Australia, Canada, Germany, Japan, Norway, Britain or the US, or if your investments in such things are worth less than $50,000, or in an "employment-related foreign super scheme". Some other exemptions apply, but if you're contemplating an investment that may fall into this category it would be well worth getting expert advice.

* Mark Fryer is the Herald personal finance editor.

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