Q & A about unit trusts

We sat down with the Apio wealth team to find out about unit trusts as an investment.

Are unit trusts a good investment?

In the investment space it is unlikely to find one solution that fulfills the needs and goals of all investors. With that in mind unit trusts have their place in the market, like most other investment vehicles. For investors looking for a diverse portfolio with high liquidity and an investment time horizon of at least three to five years a unit trust can be a fantastic investment vehicle.

How does a unit trust work?

For people who do not want to worry about picking underlying assets(i.e. stocks, bonds, property, etc..) and building a diversified portfolio they will most likely consider investing through a fund manager whose job it is to pick the underlying’s that will be in most in line with the specific goals of the fund. If one were to buy and pick all the underlying’s in their own capacity it could become quite costly and time consuming. A unit trust pools the resources of multiple investors who have entrusted their money to the fund manager who then buys and manages the underlying assets on behalf of the investors. The trust does not distribute the actual underlying’s to the investor, instead it combines all shares purchased into a portfolio/fund and then divides the fund into an equal number of units. The investor then purchases these units. This is where the name unit trust comes from.

What are good alternatives to unit trusts?

Exchange – traded funds (ETFs) are a good alternative to unit trusts. Although the two often get mixed up due to their similarities, there are some fundamental differences which could influence the investors decision. An ETF is an also known as a passively managed fund as they target market tracking performance, their goal is to mimic market movements. Whereas unit trusts usually have active managers whose primary goal is to beat their target benchmark generating greater return to their investors. Unit trust with active managers are more expensive and whether they offer better after fees performance is still up for debate. The key differences to know to make an informed decision are:

  1. ETF’s are market tracking, with a goal of mimicking market movements not outperforming. Unit trusts goal is generally to outperform their benchmark.
  2. ETF’s are considerably cheaper than Unit trusts.
  3. ETF’s offer greater liquidity as they can be traded like stocks. Units trusts are priced and traded only once daily.

What are the advantages and disadvantages of unit trusts?

Advantages:

  • You have access to professional management making all investment decisions.
  • There is a large investment universe with many units trusts to chose from.
  • Pooling resources with other investors allow smaller investors an opportunity to invest in diverse range of assets at a low cost.
  • High levels of regulation around unit trusts.
  • Investors can choose their monthly contribution amounts, with low minimums.
  • Offers high liquidity.

Disadvantages:

  • Returns are not guaranteed.
  • To realize the benefit of investing in a unit trust, investors need to look at a minimum investment horizon between three to five years.
  • The large choice of funds can also be a disadvantage as it can confuse unqualified investors, furthermore, they could easily pick a fund that does not meet their required needs, goals or risk tolerances.

What about taxes, dividends and fees?

Unit trusts will be subject to the following taxes depending on the underlying’s in the fund:

  • Local Dividends: Taxed at 20% dividend withholding tax for south African residents.
  • Local interest: taxed according to income tax table at investors marginal tax rate and is subject to a local interest exemption.
  • Foreign interest: Taxed according to income tax table at investors marginal tax rate.
  • Capital gains tax: can lie anywhere between 0% and 18%. The capital inclusion rate of 40% is multiplied by the investors marginal tax rate to get an effective tax rate on capital gains.

Unit trust fees are dependent on the platform and funds chosen. Both platform fees and fund manager fees vary widely, so it is always wise to do some comparatives between platforms and funds before making your investment decision. It is important to note that a cheaper fund does not guarantee better after fees performance.