“Wrap fund” unit trusts – what are they about?

You may be surprised to find out that a wrap fund isn’t a fund at all. It’s often mentioned alongside unit trusts and investment managers might refer to it when discussing your portfolio.

We have a look at what a wrap fund is, who should consider making use of one, and what the pros and cons are of this kind of investment.

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What’s a “wrap fund”?

According to Andrew Bradley, CEO of Fiscal Private Client Services, what’s referred to as a “wrap fund” is actually a collection of unit trust funds.

“There’s no actual legal entity called a wrap fund. It’s an administrative creation which allows a Discretionary Fund Manager (DFM) to manage clients’ money on a discretionary basis, within a specific mandate to achieve an objective,” says Bradley.

He explains that a wrap fund is, therefore, given effect within a Linked Investment Service Provider (LISP), which provides the administrative infrastructure and service.

“Based on the agreed mandate, the DFM selects various unit trusts that meet their requirements. Over time, they have the authority to make changes and amend the allocations by buying and selling the unit trusts within the wrap fund collection of finances,” says Bradley.

He points out that a fund of funds, which is a unit trust fund that owns a number of other unit trust funds, is another mechanism to manage a collection of unit trusts.

“In essence, this serves the same purpose as a wrap fund, but does so through a registered unit trust fund. The wrap fund is an alternative to the fund of fund structure. There are now a number of DFMs who offer a collection of wrap funds or fund of funds, with different mandates and different objectives,” says Bradley.

Who should make use of wrap funds?

Bradley says that end clients and financial planners can best make use of wrap funds. They can be intimidating and confusing for lay investors.

“In South Africa and around the world, there are now more unit trusts than listed securities. This can make choosing one or more of them difficult,” he says.  

Bradley explains that while it may seem self-evident that a client can make use of a wrap fund, it’s not always clear why a financial planner would.  

“However, from a license perspective, a financial planner is not authorized to manage a portfolio of shares or unit trusts on behalf of a client. To do this they require a discretionary license, which most do not have. So, they make use of DFMs to do this on their behalf,” says Bradley.

He adds that financial planners can only make recommendations. It’s the client that makes the decision and takes the responsibility, and this is a completely different proposition.

What are the pros and cons of wrap funds?

Bradley says that wrap funds serve an important purpose: to proactively manage a client portfolio to a specific mandate and objective. He adds that it also ensures that this key job is professionally done.

“However, the disadvantage is that this can be done in a more cost- and tax-effective manner through the use of a fund of funds. These can do what a wrap fund does, as well as provide clients with significant additional benefits,” says Bradley.

He insists that it’s important to fully understand the additional administrative and/or investment management costs when using a wrap fund.

“Your money is in the hands and expertise of the DFM. Make sure that you are comfortable with their expertise and skill sets,” says Bradley.

“Conversely, if a financial planner tells you that you do not need a wrap fund and that they will select the unit trusts on your behalf, make sure you fully understand why they believe they have the skills and expertise to do so,” he adds.