Unit trusts are found in Fiji, Ireland, Isle of Man, Guernsey, Jersey, New Zealand, Australia, Namibia, South Africa, Zimbabwe, Kenya, Singapore, Malaysia, and the UK, and offer access to a wide range of securities.
A Unit Trust fund is a professionally managed investment fund, and with a larger sum of capital, fund managers can invest the money into the stock market, bonds, money market, property, or others according to the investment objectives of the specific fund.
What is a unit trust?
A unit trust is a form of collective investment that is constituted under a trust deed. A unit trust pools investors’ money into one single fund that is managed by a fund manager.
Unit trusts offer investors access to a wide range of investments that may, depending on the trust, invest in securities such as shares, bonds, properties, mortgages, and cash equivalents.
Investors in the trust own “units” of which the price is called the “net asset value” (NAV). The number of these units is not fixed, and more units are created when more is invested in a unit trust through investors opening accounts or adding to their accounts.
Each fund has a specified investment objective that determines its management aims and limitations.
Investors can achieve their financial goals with unit trusts, due to the following benefits:
- Minimal risk due to diversification, as it invests in many different sectors or asset allocations
- Managed by professionals
- More liquid than shares
- Opportunity to invest in the bond market or a foreign stock market, where individual investors cannot invest normally.
The first unit trust was launched in 1931 in the UK by M&G under the inspiration of Ian Fairbairn. The rationale behind it was to match the comparative robustness of US mutual funds through the 1929 Wall Street crash.
The first trust was called the ‘First British Fixed Trust’ and held the shares of 24 leading companies in a fixed portfolio that was not changed for the fixed lifespan of 20 years. It was relaunched as the M&G General Trust and later renamed the Blue-Chip Fund.
By 1939 there were around 100 trusts in the UK, which managed funds of about £80 million.
Different investment structures
There are several collective investment schemes – Unit Trust, Open-ended investment company, Mutual fund, Unit investment trust, Closed-end fund – with similar objectives that are often confused with each other.
Other variations include open-ended and closed-ended, business trust or management company actively managed or un-managed funds.
These are organized as business trusts where the legal owner of the underlying assets is the trustee, and the unitholders are beneficiaries.
Unit Trusts have a “bid-offer spread”, meaning the investor pays more to buy units of the trust than they receive when selling them – a difference that goes to the trust management as a profit and can vary.
Open-ended investment company
These entities have a company form, not a trust. They have a single price for the purchase and sale of units (no bid-offer spread), making them like mutual funds.
These open-ended, actively managed funds have been an extremely popular form of collective investment. Like Unit Trusts, their investors are unit-holders and there are infinite units in issue. Units can increase or decrease according to net sales and repurchase by existing unitholders.
They are limited liability companies with investors as shareholders in a company. Although open-ended mutual funds do not have a bid-offer spread, they may have sale charges, known as “loads” and other fees paid to fund management.
These funds are of a collective investment model based on issuing a fixed number of shares that are not redeemable from the fund.
Investors own shares rather than units and buy and sell the shares on the stock market, rather than from the fund itself. New shares are not created by managers to demand from investors.
Exchange-traded funds (ETFs)
ETFs are also traded in the market and not bought and redeemed from the fund. Unlike closed-end funds, however, the price is not only determined by the valuation of the market, and trades in a narrow range close to its net asset value.
Unit investment trust
This is an exchange-traded fund with a fixed (unmanaged) portfolio of securities and a fixed lifespan before it liquidates and distributes its net asset value as proceeds to the unitholders. It differs from a unit trust in being closed-end, unmanaged, and having a termination date.
Unitholders are the owners of trust property and a trustee administers the trust and has a fiduciary duty to ensure that unitholders are treated equally.
The trustee appoints a fund manager to manage the investment of the trust assets. The fund manager runs the trust for management and sometimes also a performance fee.
Profits of the Trust are either distributed as income to unitholders or reflected as capital gain in the unit prices when sold.
The trustee ensures that the fund manager keeps to the fund’s investment objective and either of them may appoint a custodian to safeguard the trust assets.
The trustee is required to maintain a registry to allow the transaction of units.
Bid offer spread
The fund manager makes a profit in the difference between the purchase price of the unit or offer price and the sale value of units or the bid price.
This difference is known as the bid-offer spread. The bid-offer spread will vary depending on the type of assets held and can be anything from a few basis points on very liquid assets like UK/US government bonds to 5% or more on assets that are harder to buy and sell such as property.
The trust deed often gives the manager the right to vary the bid-offer spread to reflect market conditions, to allow the manager to control liquidity. In some jurisdictions, the bid-offer spread is referred to as the “bid-ask spread”.
To cover the cost of running the investment portfolio the manager will collect an annual management charge or AMC.
Typically, this is 1 to 2 percent of the market value of the fund. In addition to the annual management charge, costs incurred in managing and dealing with the underlying assets will often be borne by the trust.
If this is the case, the provider will extract revenue equal to the AMC without incurring any expenses managing the fund. This makes the charges in such vehicles lack transparency.
In a unit trust, units are managed within what is known as the “Managers Box”.
The Box Manager of the fund will decide at each valuation point whether to Create (add) or to Liquidate (Remove) units.
This is based on the final net sales and redemptions before the next valuation point where the Fund is priced on a “Forward Basis”, or at the actual valuation point where the fund is priced on a Historic basis. Forward pricing is the most common.
The underlying value of the assets is always directly represented by the total number of units issued multiplied by the unit price less the transaction or management fee charged and any other associated costs.
Each fund has a specified investment objective to determine the management aims and limitations.
A unit is created when money is invested and canceled when money is divested. The creation price and cancellation price do not always correspond with the offer and bid price.
Subject to regulatory rules these prices can differ and relate to the highs and lows of the asset value throughout the day. The trading profits based on the difference between these two sets of prices are known as the box profits.
In the UK, many unit trust managers have converted to open-ended investment companies (OEICs) in recent years. OEICs normally have a single price for purchase and sale, although recent regulatory change now permits dual pricing too, in line with unit trusts.
The motivation for the conversion is often cited as a simplification and precursor to offering funds Europe-wide under EU rules.
Unit Trusts in South Africa
The unit trust industry in South Africa is governed by the Unit Trust Act that was first drafted in 1947. Amendments had been made over time and currently, the unit trusts industry in South Africa is regulated by Financial Services Board (FSB).
The FSB is an independent institution that oversees the South African non-banking financial services industry which includes retirement funds, short-term and long-term insurance, companies, funeral insurance, schemes, collective investment schemes (unit trusts and stock market), and financial advisors and brokers.
In South Africa, unit trusts are included in asset portfolios such as equities, bonds, cash, and listed property, in which investors can buy units and allow them to spread their risk, whilst getting the benefits of professional fund management.
The following types of unit trust funds are available:
- Equity funds that grow capital by investing in the broader stock market or specific equity sectors such as resources, financial and industrial funds.
- Fixed Interest Bond funds invest in a variety of interest-bearing assets such as bonds and fixed deposits.
- Income funds invest in a variety of interest-bearing assets such as bonds and fixed deposits.
- Money market funds, also known as cash funds, that allow investors to “park” their money short-term.
- Asset allocation funds, or balanced or managed funds where a fund manager invests in a spread of assets such as equities, bonds, and cash, depending on market conditions.
- Global funds where unit trusts offer exposure to international markets with a range of international rand-based and foreign-denominated funds to choose from.
How Unit Trusts Work
The basic value of assets in a unit trust portfolio is determined by the number of units issued multiplied by the price per unit, with transaction fees, management fees, and any other associated costs subtracted.
Fund managers run the trust for gains and profit and assigned trustees must ensure that the fund manager runs the trust following the fund’s investment goals and objectives. The trustees are charged with managing assets on behalf of a third party whose interests must come first.
Owners of unit trusts are called unit-holders, and they hold the rights to the trust’s assets. Registrars act as middlemen or liaisons for both parties between the fund manager and other important stakeholders.
How Unit Trusts Make Money
Unit trusts are open-ended and are divided into units with different prices. An open-ended fund allows that new contributions to the pool can be made and that withdrawals from the pool are possible too.
These prices directly influence the value of the fund’s total asset value. Whenever money is added to the trust as an investment, more units are made to match the current unit buying price. In the same way, whenever units are taken, assets are sold to match the current unit selling price.
Fund managers make money through the difference between the price of the unit when bought – the offer price, and the price of the unit when sold – the bid price. This is called the bid-offer spread and varies according to the kind of assets managed.
How to buy and sell
An investor can buy units in a fund from a unit trust management company at a price calculated at the end of each day and usually published by newspapers.
There are two prices, the unit trust buyer’s price (the price at which one buys units from a unit trust company) and the seller’s price (the price at which you can sell units back to the unit trust company).
To buy units is as easy as opening a bank account. You can invest a lump sum, a cheque, or cash, accompanied by an application form to a chosen unit trust company. If you prefer regular monthly investments, a debit order form, along with the application form, will be all you need to purchase units.
Benefits of Unit Trusts
The main advantages of investing in Unit Trust funds are the reduction in investment risk through diversification and having approved professional investment managers managing the funds.
As unit trusts are a collective investment scheme, investors can start with a low investment amount.
Investors are investing in a diversified portfolio of investments; hence the risk is spread out better.
Most investors prefer investment to be liquid, which means being converted back to cash easily, a feature that unit trusts provide. Some funds can even return an investment to cash within the same day.
Professional Fund Management
Unit trusts fund managers are approved professionals in a highly regulated industry, with their license, background, and expertise ensuring structured decision-making according to sound investment principles.
In the long term, this expertise should generate above-average investment returns for unit trust investors.
Individual investors may find it difficult to get exposure to particular asset classes, but with unit trust investments, it is possible to spread money around several asset classes concurrently.
Reduced Costs and Access to Asset Classes
Pooling money with that of other investors gives the advantage of buying in bulk, making dealing costs an insignificant part of an investment.
While fund managers invest in larger amounts, they can get access to wholesale yields and products, which are impossible for individual investors.
With the introduction of units, trusts came regulation from various regulators. The variables relating to the unit trust industry are governed by various legislations to protect the interest of the investing public.
Are Unit Trusts for You?
If you consider investing in unit trusts, the following is important to know:
- Your investment objectives – Why are you investing? Is it for retirement income, a bond, or a holiday home? The answer will determine which funds are suitable for you.
- Your time horizon – Do you need access to your capital in six years or six months? You need to choose a fund that matches your time horizon.
- Protection from inflation – Do you want to protect your capital from being eroded by the cost of living? If so, you need to choose a fund that will produce returns well above inflation over the long term.
- Market timing – Since the average investor finds it difficult to time the market, you may consider phasing in your investment over time.
Unit trusts are unincorporated mutual funds that pass profits directly to investors rather than reinvesting in the fund.
Whereas mutual funds are investments made up of pooled money from investors who hold various securities, such as bonds and equities, a unit trust differs in that it is established under a trust deed and the investor is effectively the beneficiary of the trust.
Fund managers run the unit trust and trustees are often assigned to ensure that the fund is run according to its goals and objectives.
Pros and Cons
|Both small and substantial amounts can be invested||You are not able to choose the exact assets or ethical investments|
|Your assets are managed for you||You must pay fees, even if a fund performs badly|
|It helps you diversify your portfolio to hedge against market volatility||There is still the potential to lose out if markets perform badly|
|You can usually sell your units at any time||The money you make will depend on the fund manager’s decisions|
|Due to the legal structure of a trust, assets are held by a trustee and are safe if the firm goes bankrupt|
What is a unit trust?
It is a pool of funds contributed to by investors, put into an investment scheme managed by a unit trust company, and invested on behalf of the contributors.
How do I invest successfully?
The golden rules are:
- Do not invest borrowed money.
- Only use money that can be invested for longer than three years, preferably five.
- Spread your investments in an unstable market.
- Do not let short-term fluctuations discourage you.
- Start selling units gradually when your planned investment term ends.
For what can you use unit trusts?
For financing a house or car, supplementing pension plans, endowment assurance, deferred compensation, estate costs, income tax relief, and buying out of interests in the company.
Will I lose money if I become unemployed and cannot continue to invest?
You can cancel regular monthly investments and repurchase your total unit trust investment to date or you can cancel the regular monthly investments and leave the unit trust investment to grow as it is.
Must I invest in monthly amounts?
No, you can also invest in lump sums whenever you wish.
Should I invest monthly or make lump sum investments?
Lump sums can take advantage of times when the stock market is low, or inexpensive but monthly investments take advantage of cost averaging and may be more affordable.
Can an investor switch between funds and is there a cost?
You can change between funds if you think one fund is going to out-perform but must be requested in writing. There will be a charge of between 0 and 1,5%, depending on the unit trust company.
What is the difference between high growth and high income?
High growth aims to provide a large lump sum at the end of the ideal investment period, say five years, with smaller twice yearly or quarterly dividend payments.
High income aims to pay out large twice yearly or quarterly dividend sums instead of aiming for a large lump sum at the end of an investment period. Income payments can be reinvested though.
Why are there so many distinct types of trusts?
Many investors believe that one sector will outperform another. You are not restricted and may invest in all of them.
How do you buy unit trusts?
Payment will usually take place by either delivering the amount physically to your nearest branch or by arranging a debit order with your bank.
Is an investment in unit trusts protected?
Yes. The Act stipulates how the portfolio must be spread, thus reducing the investment risk. The Act also stipulates that the money must be kept in trust, thus protecting investors against fraud.
How does an investor sell his units?
The written notice must be given and a repurchase form is usually available for this purpose. The units will be repurchased at the ruling price on the day the instruction is received.
Are there tax benefits for investors?
Yes, at present an investor can benefit in the following ways:
- Capital growth – normally tax-free, provided you are not classified as a dealer in shares.
- Dividends are tax-free.
- Interest is fully taxable after the maximum amount allowed is deducted from your total interest income.
What happens when an investor dies?
As with any other asset, an investment in a unit trust may be bequeathed. It has the added advantage that it can be divided on an absolutely equitable basis amongst more beneficiaries in a will.
May an investor invest in somebody else’s name?
Yes, you are free to invest for example in your wife/husband’s name, or on behalf of your children or grandchildren.
What is a buyer’s and seller’s price?
The buyer’s price is the price at which you buy units from the unit trust company, that is every time you invest money in unit trusts.
The seller’s price is the price at which you sell your units back to the unit trust company.
Who can invest in unit trusts?
If you consider investing in unit trusts, you should ask yourself the following:
- Am I prepared to invest my money for a minimum term of about five years?
- Do I have adequate life assurance?
- Do I have a savings account?
If you have answered “yes” to all of these questions, unit trusts are probably right for you.