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What are Unit Trusts?


What are Unit Trusts?

Published Date: 2018-06-06 | Source: INCE|Community | Author: Chris Gilmour

What are Unit Trusts?

Unit trusts, referred to as Mutual Funds in the US and sometime as "Collective Investments" in South Africa these days, are a very convenient way for the unsophisticated investor to get a foothold into the share market. The word "unsophisticated" should not be seen in a pejorative way; it is used merely to differentiate a casual investor from someone who spends their time doing little else but concentrating on investments and investment concepts. A "sophisticated" investor is someone who probably has a portfolio of shares that is managed on a discretionary or non-discretionary basis.

Unit trusts offer the purchaser a convenient way of accessing a very broad and diversified portfolio of financial assets, at relatively low risk. They can be bought in a lump sum investment or on a convenient monthly debit order basis.

Unit trusts are managed by institutional fund managers, people who manage the assets of pension funds and other large institutions and unit trusts serve as a type of "shop window" into the philosophies of these fund managers. Of course, there is great competition among fund managers to outperform each other and the various benchmarks that are constructed to measure their performance.

Normally, competition is seen as a good thing, keeping fund managers on their toes. But because unit trust performance is measured literally on a daily basis, there is a danger of certain fund managers adopting a short-term approach to performance and trying to be too clever, rather than taking a more measured, long term view of investment.

The very first unit trust in South Africa was the Sage Fund, which was established in 1965. Since then, the sector has proliferated to the point where there are now around 1 500 unit trusts, which is a multiple of the number of shares listed on the Johannesburg Stock Exchange. And there is a tremendous variety of unit trusts as well, not just equity unit trusts. One can buy bond unit trusts as well as offshore unit trusts and tracker funds as well.

The issue of costs in unit trusts is quite a thorny one and the industry has had to cut back on its costs considerably in recent years. Not so long ago, a typical unit trust would charge 1.5% ongoing fees plus up to 3% for the financial intermediary involved. When the Total Expense Ratio (TER) of investing in unit trusts was calculated using these types of costs, it soon became clear that strong performance on an ongoing basis would be required to compensate the unit holder for the fees incurred. In markets that go sideways to down, costs are still being incurred and this invariably impacts negatively on net performance of the funds (after costs).

Although costs have come down considerably in recent years, they are still significantly higher than the costs associated with investing in ETFs, which also offer the unsophisticated investor a broad diversification of risk.

Unit trust fund managers always have a disclaimer in their marketing packs, to the effect of "Past performance is no indicator of future performance". And prospective unit trust purchasers should be aware of this and act accordingly, either in their own right or with the assistance of a financial advisor. A unit trust that has outperformed its peers and the market one year is by no stretch of the imagination guaranteed to outperform in the current year or beyond. Thus careful consideration must be given to the track record of the unit trust fund manager involved in a potential purchase of those unit trusts.

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