Are unit trusts a good investment?

Without a background in finance, it’s difficult to decide where best to invest your savings. For this reason, many South Africans choose to rely on a fund manager when making these decisions.

Unit trusts 

Investing in a unit trust is one way of enlisting the support of a specialist, who will ensure you receive the best returns for your buck.

We have a look at how unit trusts work, whether passive investments perform as well as active investments, and whether historical performance is worth noting.

Tip: Increase your returns by joining a well-performing unit trust today.

How do unit trusts work?

According to Johan Esterhuizen, asset manager at Fedgroup, a unit trust is a portfolio of shares, bonds, and other asset classes, chosen and managed by professional fund managers.

“Investors’ funds are pooled, and the manager buys assets on behalf of the fund. The assets are split into equal units and sold to investors,” says Esterhuizen.

He explains that unit trusts are bought and sold directly from the management company, or through an investment platform. They’re not listed on a securities exchange, and trading and pricing happen once a day.

What are the advantages and disadvantages?

Considering the multitude of investment options available, it’s important to take note of the advantages and disadvantages of each.

When it comes to unit trusts, Esterhuizen believes the following are the most notable benefits:

• Decreased investment risk, owing to diversification.
• Investments are managed professionally.
• You can buy a range of individual securities, and access the stock exchange, without possessing a professional level of understanding.
• In the event of an emergency, you can access your savings within days.
• Unit trusts are highly regulated, and investors can be confident that, while they’re still subject to investment risks, they’re not likely to be victims of fraud.
• There’s a high level of transparency, as legislation requires disclosure about costs and details of the underlying portfolio.

On the other hand, Esterhuizen explains, these investments must be purchased directly from the management company, which could be seen as a disadvantage. Similarly, purchase pricing is not competitive, and this may also dissuade investors.

What about taxes, dividends, and fees? 

According to Esterhuizen, unit trusts are tax efficient, in that they offer tax exemptions on interest income and on capital gains.

“With a unit trust investment, you – the taxpayer – are the investor. This means that your individual tax rate will be used to calculate any tax,” says Esterhuizen.

“You can make use of your interest rebate and your annual capital gains tax exclusion if you’re in a unit trust,” he adds.

Investments usually earn investors dividends or interest. Esterhuizen points out that this is either reinvested or paid out. Investors share in the gains of the unit trust, but also the losses.

In terms of expense, fund managers need to be paid for their services. Their service fee generally includes an initial fee, an annual management fee, and administration and custodian fees.

“The combination of these fees varies from fund to fund, and investors should consider how the fees affect the returns. It’s important to weigh the fees up against investment performance,” says Esterhuizen.

The value of past performance

When selecting a unit trust, fund managers often use graphs to demonstrate how the fund has performed in the past. But is this a good indication of future performance?

According to Jako De Jager, head of retail portfolio solutions at Momentum Investments, when it comes to investing, historical performance isn’t necessarily a good predictor of future outcomes or expected performance.

“The majority of investment funds are philosophically aligned to a specific investment strategy or style. That style may have been rewarded in the past, but given changes in market structure and drivers of returns, there’s no guarantee that the same strategy will be rewarded over a specific time in the future,” De Jager says.

He adds that if the same style is rewarded, there’s no guarantee that the benefits will be of the same magnitude.