“Those who fail to plan, plan to fail” – This quote is so famous, it has permeated every nook and cranny. However, not everyone has truly realised and integrated such understanding into their lives, especially when it comes to financial planning.
The areas of financial planning include cash management, risk management, investment planning, tax planning, retirement planning and lastly, estate planning. This article will focus on Unit Trust as an investment planning option and will discuss basic concepts of what it entails.
What Are Unit Trust Schemes (UTS)?
Unit Trust (also termed as Mutual Fund in the United States) is defined as an unincorporated mutual fund structure that allows funds to hold assets and provide profits that go straight to individual unit owners through increased redemption price when the units are redeemed after a period or through dividends.
In simple terms, it is an investment scheme that pools money from many investors; which is then managed collectively by professional fund managers who invest the pooled money into a portfolio of various investment instruments of varying performance, such as but not limited to securities (shares and bonds), properties, commodities and cash equivalents. One of the main benefits of UTS which interests beginner investors is its diversified portfolio which brings upon minimal risks. This will be delved into further in the article.
How does UTS Operate and who are the parties involved?
A tripartite relationship exists in a UTS structure; between (1) the Investors or Owners of Unit Trusts (Unit Holders), (2) the Unit Trust Management Company (UTMC) or the Fund Manager, and (3) the Trustee (bank or insurance company).
Unit Holders who allocate money or invest in a Unit Trust Fund would be naturally concerned about their investments. That is why a UTS is constituted under or governed by a trust deed (be registered with the Securities Commission) entered between a Trustee and the Manager. The trustee holds the assets of the unit trust fund, ensuring that the UTMC invest the assets of the unit trust in line with the terms of the deed and prospectus of the fund, thus safeguarding the interests of the Unit Holders. The UTMC will thus, focus primarily on administering the operations of the UTS through a diversified portfolio of authorised investments. With that in place, Unit Holders are bestowed with comfort and confidence in their investments.
Unit Holders despite holding the rights to the trusts’ assets, do not directly purchase or own the securities in the portfolio. They buy units of the trust fund, not the securities themselves. So, ownership of the fund is divided into units of entitlement. The number of these units are never fixed in a unit trust. When investors open more accounts and invest more in the trust, more units will be created to meet such demands.
If the underlying securities of the trust perform well, the value of the fund increases and the value of each unit increases accordingly; likewise, if the securities do not perform, the fund value and unit value decreases. Thus, the number of units held is dependent on the money invested and the unit purchase price at the time of investment.
Each unit trust has an individual price called the Net Asset Value (NAV) which reflects the value of the overall unit trusts’ assets, like the investments the fund manager has made with the fund. The Net Asset Value can be calculated by dividing the value of the unit trust assets by the number of units issued.
The return on investing in unit trust comes in the form of capital appreciation and distribution, from the pool of assets supporting the unit trust fund. Capital distribution arises from dividends, which if any, will be distributed based on the total units held at the end of the fund’s financial year. Capital appreciation is the increase in the value of the assets of the portfolio. By selling the units at a price higher than initial purchased price, unitholders will profit; if lower, then there will be a loss. Each unit will earn an equal return, which is determined by the amount of distribution together with capital appreciation.
Advantages and Disadvantages of Unit Trust
1. Professional Management v Loss of Control
One of the benefits of UTS is that it is run by experts. Professional fund managers carry out a fund’s investment objectives and strategies and take care of their portfolio trading activities. Not only do they have access to a huge dimension of resource and information, but they have also undergone training in handling investment operations. With experience and comprehensive knowledge in market motion, they can identify potential high yield avenues and predict future performance based on past results. Unitholders can rest assured that the investment of fund assets will abide by fundamental investment principles. This is promising for first-time or amateur investors who lack the time, knowledge and expertise to manage their investments.
On the flip side of the coin, abdicating management of investments and delegating such task to fund managers spells consequences. Unitholders will have no say and no control over the investment decisions of the fund manager. Should the investor have differing opinions about the style of management, he can neither influence nor alter the manager’s decisions.
What can be done by investors is to critically evaluate whether the fund manager is equipped with the resources, experience and skills to properly manage the fund. Investors should also adopt a more hands-on approach and attempt to fully understand the type of funds in the first place such as studying fund prospectus and reports themselves.
2. Diversification v Risk
“Do not put all your eggs in one basket” is one golden rule every investment guru preaches when coming to diversification as a conservative or defensive investment strategy. By diversifying through a broad-based portfolio under unit trusts, the “portfolio effect” comes into play. As assets are diverse, when there is a fluctuation of economic performance, some assets perform better, some not so, all moving in different directions; this reduces if not evens out the losses incurred by assets that perform unsatisfactorily. In contrast, if investors concentrate their capital under only one kind of investment, if adverse events occur, they will be laden with a tragic amount of loss. Basically, as the number and diversity of investment in the portfolio increases, the portfolio’s balance and stability increase, minimising risks of loss, leading to less volatile returns. This acts as one of the most attractive aspects of UTS.
But like a shadow, risks tag along under any form of investments. And those incurred by investing in UTS includes currency risks, market risks, liquidity risks, inflation risks, interest rate risk, risk of legislation change, management risk etc. Notwithstanding that the diversifying character of UTS is capable of drawing in the highest return with the lowest risk, it is still unable to extinguish all possible risks. In such a case, unitholders should often keep an eye on the fund’s performance so that it meets their financial expectations and targets.
3. Investment Costs
Under direct investments, generally, the smaller investor is met with higher investment costs relative to large institutional investors including UTMC fund managers. As fund managers invest in large amounts, costs advantages are reaped through economies of scale. Moreover, large investments open access to high and exclusive institutional rates of return. Small investors are limited from such lucrative opportunities, such as the Malaysian Government Securities market, in which transactions are made in the millions. Access to wholesome yields with low investment cost, this forms part of the reason why investors jump on the bandwagon of investing in unit trust funds.
However, it is to note that the professional expertise and services provided by UTMC are not without costs. Fees can reduce the return of investors and might hamper investor’s motivation for investing in UTS. After considering the annual management and trustee fees, unit trust funds must still generate returns high enough to beat the interest rate of Fixed Deposits and EPF dividends to be a prospective form of investment. This is however contingent on how investors construct their investment plans and strategies to lower costs.
CEO of Berkshire Hathaway, Warren Buffet once said: “If you aren’t thinking about owning a stock for 10 years, don’t even think about owning it for 10 minutes”. For those who echo his sentiment that investing is about minimising risk to engender wealth in the long run rather than generating short-term profits, then UTS which notably sprouts the same principle is an investment option worth exploring.
Writer: Reuben Chong
Reviewer: Vikky Beh
Editor: Bryan Wong