Unit trusts are a well-established way for people to invest in the markets. They allow individuals access to bigger portfolios where they can enjoy the gains and cost savings associated with the size and scale of these portfolios.

This article is the first in a series on unit trusts and delves into the basics of unit trusts, how they work and their benefits.

What are unit trusts?

Unit trusts are Collective Investment Schemes (CIS) that pool the money of investors, which is then invested in financial instruments such as equities (shares of companies), bonds and property. This pool of money is divided into equal units that investors buy in proportion to the amount of money invested. Investors then share in the fund’s gains, losses, income, and expenses.

There are a variety of unit trust options available to investors, according to the risk associated with the underlying assets. For example, income-related unit trusts are lower risk, while equity-related unit trusts are higher risk.

How they work

A management company (MANCO) is responsible for the administration of a unit trust. A fund manager makes the investment decisions for the unit trust, researching financial instruments that have attractive return prospects and investing the funds into them. The fund manager ensures that the unit trust is invested in line with its mandate and has the appropriate risk characteristics, and is paid a management fee by the investors. The MANCO monitors the assets in the fund and notifies the manager if there is a breach of compliance within the fund.

Unit trusts can be actively or passively managed. The goal of active funds is to beat a benchmark (usually the market) through research that informs more frequent or short-term trading decisions. As such, active funds require more direct involvement by the fund manager. On the other hand, passive funds are set up to track the market’s performance through a portfolio that mirrors a market index. The passive fund manager does not trade frequently, and usually, rebalances the portfolio every quarter. The management and administration costs are therefore higher for an active fund than a passive fund, because of the greater involvement required from the fund manager.

Unit trusts invest in listed securities and can, therefore, be priced daily as they track the value of the underlying assets and this allows investors to invest/withdraw money on any trading day. Prospective investors will send an application form to the MANCO, which then opens an account and buys the units of the unit trust for the investor. Sharenet Investments offer unit trusts – find out about the Sharenet BCI Global Balanced FoF and download its latest fact sheet here.

Benefits of unit trusts

Your money is in safe hands. The fund manager makes the investment decisions, but can’t access your cash. Instead, a custodian (trust company or bank) is responsible for holding and safeguarding the securities owned within a unit trust.

Unit trusts are regulated by the Financial Services Board (FSB) – soon to be renamed the Financial Sector Conduct Authority (FCSA) – and the legal structure prevents anyone from taking your money.

Unit trusts spread your money across many instruments, which if done right lower investment risk. It is unlikely that you will see a negative return on a unit trust over an investment period of more than five years depending on the type of unit trusts you are invested in.

You can easily trade unit trusts. There is no lock-in period for your investment, giving you liquidity with one days’ notice for withdrawals.

It is easy to track the performance of your investment. Most MANCO’s give online access and monthly statements to their investors. You can also find unit trust performance tables published in the media, and the fund manager will provide monthly fact sheets containing information about the unit trust’s performance and holdings.

Unit trusts are not just for the wealthy, you can invest in any unit trust by starting with a small lump sum or even a monthly debit order. This empowers investors to gain exposure to large assets like shopping centers and blue-chip companies with a small investment.

Conclusion

Unit trusts are an accessible, flexible and straightforward investment, making them one of the easiest ways to grow wealth. You decide how much and how often to contribute to the investment through lump sum payments or regular debit orders, and you can withdraw the funds and receive the cash within days.

Do you have any questions on unit trusts and how you can start investing? Contact Sharenet’s fund team or your financial adviser today.

The fund manager of a property unit trust selects which property companies to include in the portfolio, raising the likelihood of realising attractive returns on the investment. A buy-to-let property, on the other hand, could be situated in a neighbourhood where there are low growth and few tenants.

2. Historic performance

The total return from listed property has exceeded residential property over the last 5, 10 and 15 years to 30 June 2017 (see below table). Total return includes price appreciation and income. For residential property, an income yield of 7% is assumed with the average buy-to-let property providing income of between 5% and 8% after fees.

Figures as at 30/06/2016. Source: Bloomberg, INET, Sharenet. Listed Property (FTSE/JSE Listed Property TR Index – J253T). Residential Property (BIR Residential Property Price Index plus 7% for the yield component).

3. Size

Adding property to your investment portfolio is a fantastic way to add diversification and potentially boost return. Most investors who buy a property to let will have to allocate a very large portion of their capital to the investment. This means you could risk a substantial portion of your portfolio on a poor investment decision. Unit trusts have much lower investment minimums. The Sharenet BCI Property Fund has a minimum lump sum investment of R25 000 (or R1 000 per month debit order). It allows the investor to only invest the amount that he/she is comfortable with.

4. Diversification

Diversifying your portfolio across multiple asset classes can boost return and improve the consistency of your return. The concept is the same for diversifying between different property sectors like shopping malls, office parks, warehouses and apartment blocks. Unit trusts give investors exposure to these sectors across multiple cities (geographic diversification). Compare this to one apartment in one location and you can start to see that the risk of investing in buy-to-let properties is higher.

5. Liquidity

Unit trusts are liquid investments, meaning you can withdraw your money and have it sitting in your bank account within days. Rental properties are not liquid and could take months (sometimes even years) to sell. Should you need to sell immediately, you may have to put the property up for sale at a much lower price and even then, it will be several weeks before you see the cash from the sale.

6. Costs

Unit trust fees include ongoing management, performance, admin and transaction fees. All these fees usually amount to less than 1.5% per annum for most property funds. Rental property fees dwarf that of unit trusts. To buy or sell a property will see fees associated with the transfer, agent, conveyancer, deeds and other admin fees. Ongoing costs will include insurance, taxes and levies. All these fees can cut a sizable chunk out of your property investment’s performance.

7. Risks

Rental properties carry a lot more risk than an investment in a unit trust. There is vacancy risk if you struggle to find a tenant or can’t get a tenant to pay, causing you to lose income. Listed property also has vacancies, but these are usually less than 10% of the property portfolio, meaning the bulk of the portfolio still delivers income each month.

Listed property is more volatile and your investment can fluctuate a lot more than rental property.

Rental property requires maintenance and something like a geyser bursting is a problem that needs immediate fixing.

8. Leverage

A good case for rental property is that you can take on leverage and use a loan to finance your property investment. Many investors don’t know that listed property companies can also take on leverage and can use clever ways to finance property investments (and at a lower interest rate than individuals can get).

9. Admin

Investing in a unit trust is very simple and can be done within a few minutes. To invest with Sharenet, visit our Investments website. Rental property on the other requires a lot more of your time. You need to screen tenants, run credit checks, set up and negotiate contracts, do viewings, collect rent and address complaints to name a few. You can get an agent to do all of this for you, but that is an additional cost that takes a bite out of your return.

10. Track performance

Unit trusts are priced daily and you can view the value of your portfolio online at any time. Fund managers are also required to provide a monthly fact sheet that shows how your money is invested. It is easier to track the performance of your investment than with rental property.

Conclusion

Property unit trusts hold all the cards relative to rental property. Listed property performance is historically higher than rental property. The risks associated with property unit trusts is less than with rental property and unit trusts are also far easier and less time to consume to invest in than rental property. There are benefits of owning your first property (including tax breaks and cheaper borrowing), but this article focuses on a buying-to-let property where the investor is looking for property exposure in addition to his/her primary residence.

It is easy to add property to your investment portfolio and now you can invest with Sharenet. Visit our Sharenet BCI Property Fund page to find out more.

Sources of Income for Funds

Income funds focus more on providing investors with strong levels of income rather than capital growth. The main source of income for income funds are interest and dividends. Interest income is usually received in the form of coupon payments received from bonds, debentures, notes, preference shares and money market instruments in the fund. The fund reinvests this income and then periodically distributes it to investors on pre-determined distribution dates that could be monthly, quarterly or semi-annually. These dates are available on the fund fact sheet (minimum disclosure document).

Income funds can also invest in property. Individuals often buy property as a source of income. The property is bought and then put up for rent to receive the monthly rental income. Income funds are no different and invest in property companies listed on the Johannesburg Stock Exchange. These listed property companies receive rental income from their property portfolios and also make profits from selling property. This income and profits are then paid out as dividends. Another group of property companies known as Real Estate Investment Trusts (REITs) have to pay out at least 75% of its income to shareholders. It’s important to note that the payments from REITs are taxed as income while dividends from listed property- and equity companies are subject to dividend withholding tax. Unit trusts will indicate how the income is split between interest and dividends.

Why Yield is Important

The yield of an investment is the rate at which you earn income on your investment. If you invested R10 000 in a fund and over one year the fund pays out a total of R1 000, then the yield of the fund is 10% (1 000 ÷ 10 000). Now why is it so important to know what your yield is on an investment?

The main objective of investments is to create wealth or at least to preserve it. The value of R100 today is certainly worth more than the value of R100 you will receive five years from now. That’s because money loses value or purchasing power over time due to inflation. A smart investor knows that to create wealth, you first need to beat inflation. The return on income funds is predominantly measured by its yield and this usually is an indicator of the income you can expect to receive from the fund over the next year. The yield of your investment should therefore be higher than inflation and this difference is known as the real return (or spread above inflation).

Investor Profile

Income funds are mostly used as the low-risk portion of a portfolio aimed at generating cash flow for the investor. Someone looking to cover day to day expenses with their investment should consider an income fund, as these funds generally pay out income monthly or quarterly.

Income funds offer investors a return that beats inflation (currently about 5.5%) with little variability in the return. Your money is also readily accessible and funds can be withdrawn within a couple of days, giving the investor liquidity in case of an emergency. This makes income funds an attractive alternative to bank savings accounts that normally offers lower returns, and fixed deposits that lock you in for a set term and offers lower returns. The time horizon for income funds is generally short term (shorter than three years) and longer term investors should consider adding growth assets to their portfolio to maximise return. If you are looking to save for a down payment on a house or that overseas holiday you have been promising yourself, then an income fund is a great option to consider.

The Sharenet Income Plus Fund offers investors the opportunity to invest in an income fund that has returned more than 9.40% over the past year to supplement your income or to help to make your dreams come true.

Fund of funds (FoF) are unit trusts that invest in other unit trusts managed by different fund managers. Fund of funds are often referred to as multi-manager funds due to the fund’s exposure to multiple fund managers. The manager of the FoF selects the underlying funds and manages the asset allocation of the FoF. Investors are often sceptic about the value added by FoF managers that can justify the extra layer of management fees on top of the management fees from the underlying investments. The reality is that an excellent FoF manager can add value in many areas.

Asset Allocation

The FoF manager monitors the asset allocation of the fund daily to ensure the fund is well positioned for prevailing market conditions. The manager will for instance increase exposure to equity when expecting the asset class to outperform. Not all FoF managers actively manage the asset allocation, but those that do are usually experts in moving capital across asset classes. FoF managers can also select the best fund managers within each asset class. An asset management company that is excellent in managing equity funds, may not have the same level of expertise in managing fixed income funds. Combining funds this way may be out of reach for certain investors due to high minimum investment amounts. An investor can hence access the best of breed managers in each asset class by investing in a FoF.

Manager Selection

FoF managers have systems and processes in place to conduct a thorough due diligence on fund managers considered for inclusion into the FoF. Analysing fund managers generally consists of two steps. The first being a quantitative analysis of the fund manager’s performance and investment style to determine if the fund is a viable option for inclusion into the FoF. The next step is an intensive due diligence into the fund manager and the investment team. This often includes a visit to the offices of the fund manager and completing a questionnaire on the company’s investment process. This should help the FoF manager make the best choice when comparing and selecting funds to invest in.

Investment Style Diversification

Adding multiple fund managers into a single fund provides diversification across asset classes and investment styles. Fund managers have unique investment styles that follow a certain approach/strategy. Differing strategies will respond differently to certain market conditions. That means an investment strategy (like value investing) might do well in one year but could underperform in the next due to changing market conditions. This is where diversification comes into play. By combining investment strategies, you can offset the negative impact of a certain kind of strategy during the different market cycles and increase the stability of your return.

Lower Underlying Manager Fees

Fund of funds has scale and a lot more assets under management than a retail investor. This means they are in a strong position to negotiate management fees of the underlying funds they invest in. Sometimes the fund that is being considered for inclusion into the FoF will have an institutional fee class that charges a lower management fee than the retail fee class. These institutional fee classes have high minimum investment amounts that are out of reach for retail investors. By utilising institutional fee classes, a fund of funds can significantly lower its cost (measured by the Total Expense Ratio or TER).

No Capital Gains Tax When Switching

Fund of funds can switch capital from one fund to another without triggering Capital Gains Tax (CGT). Retail investors, on the other hand, will need to pay CGT if they switch from one fund to another and there was a profit on the fund being sold. If the investor decides to rather invest in a fund of fund, then the only time the investor could be liable to pay CGT is when selling units of the fund of fund. That means you don’t have to be concerned about being in the wrong fund because switches within the fund of funds trigger no CGT. View our tax in unit trusts article for more details on the tax treatment of unit trusts.

Conclusion

Fund of funds can certainly add value to investors with the most prominent trade-off being the fees that are usually higher versus the increased stability of portfolio return. The scale that fund of funds has could reduce overall fees, meaning a smaller cost for all the additional benefits. Some of the benefits include diversification, especially for investors with a low investment amount, and strong selection that should deliver superior performance. There is also no capital gains tax for a FoF when switching between funds.

Sharenet Investments manages three fund of funds that are registered South African unit trusts. The Sharenet BCI Conservative FoF has low levels of equity for the conservative investor. The Sharenet BCI Moderate FoF has more exposure to equity than the Conservative fund and is suitable for investors with a moderate risk profile. For the more aggressive wealth seekers, there is the Sharenet BCI Aggressive FoF that can invest up to 75% in equity and aims to grow wealth over the long term.