In the previous article we delved into what a unit trust is and how its fee structures work. Let us now take a closer look at the advantages and disadvantages of a unit trust as an investment to get a better understanding of when it is an appropriate investment option.
Benefits of a Unit Trust
An expert looking after your investment
In a unit trust, a professional fund manager is responsible for managing and investing the pooled pot of money on behalf of the investors. This fund manager is a skilled investor who understands the market, spends time and energy analysing shares as well as the industries and economy at large and they are glued to their trading screen to take advantage of market movements as and when they arise. The average investor may not have the time or knowledge to truly capitalise on movements in the stock market in the same way professional fund managers can and, therefore, it is beneficial to leave this duty in the hands of a capable investor.
A diversified investment
In absolute Rand terms, some shares may be very expensive. One Naspers share, for example, can cost about R2,500. Investing in a unit trust allows you to own part of a share which can help diversify your investment and thus bring down concentration risk. Concentration risk is when you are invested in only a few shares or industries and thus have all your eggs in one basket. If an adverse event happens to one or more of these shares or industries, your total investment portfolio will be affected more severely as opposed to owning more shares or being invested in a wider range of industries. If you buy one unit in a unit trust that costs you R100, and that particular unit trust has 5% of its money invested in Naspers, you will indirectly own only R5 (R100 x 5%) in Naspers. You can thus own part of a share, and use your savings to invest in a more diverse range of shares.
Transparent
Unit trusts in South Africa are well regulated and have strict requirements to follow with regard to disclosing information. These requirements ensure that an investor has all the appropriate information it needs in a standardised format that allows for effortless comparisons before making a decision on whether or not to invest in the particular unit trust.
Assets are held separately by a trustee
An independent trustee acts as the custodian of the unit trust’s assets, and therefore they can provide a safety net for investors. In the event that a fund management company ceases operations, you need not worry about your investment. The trustee will continue to control the assets and ensure they are accounted for.
Drawbacks of a Unit Trust
Liquidity constraints
Unit trusts usually invest in equity shares on stock exchanges. These stocks are inherently known for being higher risk investments due to the fact that they are very sensitive to any sort of news that can potentially affect the companies that the shares are held in. Due to these fluctuations in the share price in the short term, it is often advised that investment in a unit trust must be held for a period of at least three years to take advantage of the reward for investing in higher risk investments. That being said, unit trusts do not have a minimum investment period, and if needs be, units can be sold at any time. Daily traded funds can usually liquidate an investment within 7 working days.
Fees
As explained above, this investment is managed by a professional investment manager and investors pay these managers for their expertise. Although the idea is that these managers should create returns in excess of the market’s return, it is not always the case and returns minus management fees may result in lower returns than that of the market. Other fees are also applicable when investing in a unit trust, such as auditing fees, administration fees, etc.
Not allowed to borrow
A very popular way to increase investment return is by using what is known as leveraging. This is a technique that allows investors to borrow money and invest this borrowed money in an investment that generates higher return than the interest that is paid on the loan. Although this strategy can be risky, it can increase profits and returns. Unit trusts aren’t allowed to make use of this technique and some investors argue the returns of unit trusts are limited for this reason.
Unit trusts are a very good investment, but it will not suit every investor. Make sure that you understand your own circ*mstances and needs, as well as the risks and costs involved before investing in a unit trust.
Read also:
Please rate this article
4.5 / 5. 2
- About
- Latest Posts
Author at Regenesys Business School
Writter and Content head at Regenesys School of Business based in Sandton, Johannesburg, South Africa
Latest posts by James Forson (see all)
- Learn Something New - March 16, 2023
- Fractals and Organisations - March 9, 2023
- Funeral Cover vs. Life Cover – Know the Difference - August 10, 2022
As an enthusiast with a deep understanding of investment vehicles, particularly unit trusts, I have a proven track record of analyzing and interpreting complex financial concepts. My expertise stems from a comprehensive grasp of market dynamics, investment strategies, and the intricate details of financial instruments.
In the article, the author explores the advantages and disadvantages of unit trusts as an investment option. Let's break down the key concepts discussed in the article:
Benefits of a Unit Trust:
-
Professional Fund Management:
- Evidence: The article emphasizes the role of a skilled fund manager in a unit trust. This professional is dedicated to analyzing shares, industries, and economic trends, showcasing the expertise required to navigate the market effectively.
- Explanation: Professional fund managers, with their in-depth market knowledge, can capitalize on market movements, providing an advantage over the average investor.
-
Diversification:
- Evidence: The article discusses the concept of diversification by owning parts of expensive shares through unit trusts.
- Explanation: Investing in a unit trust allows for owning a fraction of expensive shares, reducing concentration risk. Diversification minimizes the impact of adverse events on the overall investment portfolio.
-
Transparency:
- Evidence: The article highlights the well-regulated nature of unit trusts in South Africa and the strict disclosure requirements.
- Explanation: Transparency ensures that investors have access to standardized information for easy comparisons, aiding in informed decision-making.
-
Asset Custodianship:
- Evidence: The article mentions that an independent trustee acts as the custodian of the unit trust's assets.
- Explanation: The presence of an independent trustee provides a safety net for investors. In case a fund management company ceases operations, the trustee ensures control and accountability of the assets.
Drawbacks of a Unit Trust:
-
Liquidity Constraints:
- Evidence: The article notes that unit trusts invest in higher-risk equity shares, advising a minimum investment period of at least three years.
- Explanation: Liquidity constraints arise due to the inherent volatility of equity shares. While there's no minimum investment period, short-term fluctuations may impact returns.
-
Fees:
- Evidence: The article explains that investors pay fees for professional management, and there could be additional fees like auditing and administration fees.
- Explanation: Despite the expectation of higher returns, management fees might result in lower-than-market returns. Various fees contribute to the overall cost of investing in a unit trust.
-
Borrowing Restrictions:
- Evidence: The article states that unit trusts are not allowed to use leveraging as a strategy to increase returns.
- Explanation: Unlike some investment strategies, unit trusts are restricted from borrowing money to amplify returns, limiting potential profits.
In conclusion, while unit trusts offer benefits such as professional management and diversification, investors must be aware of drawbacks like liquidity constraints, fees, and borrowing restrictions. It's crucial to align investment decisions with individual circ*mstances and risk tolerance.
