Investing in the stock market may sound like a smart thing to do; much more trendy than investing in unit trusts.
If you have the money and the expertise to do it, investing directly in shares on the JSE can be very rewarding, but if you are able to invest only small amounts, and/or you have little time to research where and how to invest, the good advice has always been to choose a multi-asset unit trust fund. This type of fund offers you access to a diversified range of shares and/or other securities selected by a professional fund manager at a relatively low cost.
However, in recent years, changes brought about by the lower costs of online stockbrokers and the rise of exchange traded funds (ETFs) may have made this traditional advice a little less relevant.
ETFs are listed on the stock exchange, but represent a basket of shares in line with a preselected share, bond or money market index, such as the FTSE/JSE All Share Top 40 Index, so they offer diversification across a range of shares for the price of buying a single share. Now, too, some banks offer pre-selected share portfolios to their online banking customers with smaller amounts to invest.
The JSE says it has seen an increase in the number of individual investors accessing shares and ETFs directly through a stockbroker or investment plan as a result of improved awareness and understanding of markets, the rise of ETFs, the launch of the JSE’s Tax Free Savings Account (TFSA) for ETFs, increased use of online stock-broking platforms, the rise of share incentive schemes, and the growth in the South African middle class.
In just over a year, individuals have opened more than 25 000 tax-free savings accounts with stockbrokers and have invested R250 million in them.
However, there are still some good reasons for certain investors to invest in a unit trust, particularly if they:
• Are investing for retirement,
• Want greater diversification across the asset classes;
• Are looking for a fund that is managed in a way that reduces exposure to the ups and downs or volatility of the market;
• Want a low-risk, short-term investment, such as a money market fund or an income fund; or
• Want to be sure they can sell their investments quickly when they need to.
Nerina Visser, ETF strategist and adviser at etfSA, an investment platform for ETFs, says there are many factors to consider when choosing how to invest, and you should not consider only costs, but also what other existing investments you have (if any) and your investment needs.
Before you take the plunge into owning shares directly, rather than through a unit trust fund, consider the issues discussed below.
In order to achieve diversification that will ensure you earn a reasonable return under most, if not the most extreme, market circumstances, you need to own between 12 and 20 shares.
This may be difficult to achieve if you are a smaller investor investing directly in individual shares, and it is the reason why many smaller investors have traditionally chosen unit trust funds that pool smaller amounts to buy a number of shares and offer them as units.
It is also possible now to get diversification across shares by investing directly on the JSE via an ETF or share plan.
One online platform, EasyEquities, enables you to invest in fractions of shares, which gives you access to a more diverse range of shares for less. However, you don’t actually own the shares; instead you have a contract for difference (CFD), which gives you the right to benefit from increases in the share price and to receive dividends.
Be aware that CFDs are leveraged investments and are not regulated by the JSE or the Financial Services Board, according to Ann Mackeurtan, the chief executive of stockbroker Momentum SP Reid Securities. You may therefore be exposed to greater risks than when investing in shares or ETFs.
Most unit trust funds invest in a range of at least 20 shares, if they are what is known as high-conviction fund managers, and up to 80 shares in the case of managers who take smaller bets against an index.
Across asset classes
Unit trust funds that are what is known as multi-asset funds give you the ability to invest across the different asset classes of shares, bonds, cash and listed property. This gives you additional diversification, which should result in your investment being subject to less volatility, or ups and downs, than a portfolio of shares only.
Some unit trust funds move their asset allocation in line with their expectations of what will happen in the market. If, for example, they believe shares are expensive now and will perform particularly well in the future, they may sell some shares and invest the cash until the prospects for shares are better. This is known as tactical asset management.
Across investment styles
Unit trust fund and retirement fund managers have different investment styles. Many South African fund managers are value, or valuation fund, managers who invest in shares that are undervalued and that they expect will return to fair value, delivering a better return on your investment than you might earn from the mar ket as a whole.
Some managers have been very successful over long periods by sticking to their particular styles, but investment styles can also under-perform – at times for long periods. One recent case of this was the under-performance of deep value managers, who invest in very undervalued shares.
When you invest in a unit trust fund, you get the benefit of a professional investment manager managing your money. He or she is backed by a team of analysts who analyse different shares – and/or bonds, cash and listed property if the fund invests these asset classes.
A key strength of active fund managers is that they can select shares and allocate across asset classes based on their perceptions of the opportunities ahead, Lara Warburton, the managing director of financial advisory practice Integral Wealth, says.
You can use a professional stockbroker to choose and manage your share portfolio, with the help of a back-up team, but this will cost you more than operating without support, or having access to only some online research about shares. Mackeurtan says the relationship with a broker is the main reason why some investors prefer share portfolios to ETFs or unit trusts.
In the case of a pre-selected share portfolio offered by the likes of First National Bank (FNB), you are relying on the bank’s stockbrokers to select the right shares and you will typically only have exposure to equities.
ETFs typically track an index, so the need for an investment professional’s skills is limited.
When you invest in an ETF that is based on indices made of shares or bonds in line with their market capitalisation, it is a bit like investing using your rear-view mirror: the index weighting is highest in the stocks that have already performed well, but are not always the stocks that will perform well in the future, Warburton says.
Some ETFs track what are known as enhanced indices, designed to harness the returns from a certain type of shares – for example, the Satrix Divi is aimed at harnessing the returns of high dividend-paying shares.
If you invest through a stockbroker or online stockbroker, the minimum number of shares you can buy is one share and the price of shares ranges from more than R2 300 for the likes of a share like Naspers to a few cents a share. ETFs, such as the Satrix40, which tracks the top 40 shares on the JSE, and the S&P Givi (Global Intrinsic Value Index) SA, were trading at about R47 and R48 this week.
However, it is not cost-effective to buy only one share because of the costs involved – brokers generally advise you to buy shares in lots of 50 or 100.
The deciding factor remains the transaction amount, Mackeurtan says.
In addition to holding a sizeable number of each share, ideally you should buy a broad range of shares to ensure that your share portfolio is diversified. This means that, unless you are buying an ETF, you need even more money to invest.
Most stockbrokers will only open an account for you if you have at least R5 000. If you have less than this to invest, you will need to consider the pre-selected share portfolios offered by the likes of FNB and Standard Bank, or an ETF investment platform.
FNB’s Sharesave is available from R300 a month or a lump sum of R1 000. It gives you access to the Ashburton Top40 ETF and the Ashburton MidCap ETF. Standard Bank’s Autoshare Invest gives you access to 200 shares, with a minimum investment of R500 a month in each share you select.
Many unit trusts funds have investment minimums of R500 a month or a R10 000 lump sum, but there are a few that will take R200 a month or a R1 000 lump sum.
The rare exceptions, such as Standard Bank’s Equity Fund, are available for as little as R50 a month or a R500 lump sum.
Some boutique managers will accept only lump sums of R100 000.
When you buy shares or ETFs on the JSE you need to open an account with a stockbroker, who will charge anything from 0.32 percent to 1.7 percent of the value of the transaction, depending on whether there is a flat fee for transactions or fees are pegged to the size of transactions, and depending whether you take a full brokerage service, or one without the research. Most brokerage firms also charge a monthly administration fee.
The brokerage cost of buying fractional shares through EasyEquities is 0.25 percent.
You should also be aware that if you want to reinvest the dividends paid on shares held in a stockbroking account, you will incur additional transaction fees. If your dividends amount to only a small rand amount, it may not be cost-effective to reinvest them.
Unit trust funds will reinvest your dividends without cost, as will the ETF investment plans such as Satrix and etfSA. The costs of creating new units for your dividends will, however, have a cost within the fund.
Fees and levies
You also need to pay a Strate settlement and administration cost of 0.005787 percent of your investment, with a minimum of R11.58 and a maximum of R57.87, plus VAT.
An investor protection levy of 0.0002 percent of your transaction value is also payable, to protect you against insider trading and other harmful practices.
Some of these charges may be reduced if you invest through a tax-free savings account, or you buy CFDs through EasyEquities.
When you buy individual shares you have to pay Securities Transfer Tax (STT) of 0.25 percent, but if you buy an ETF or CFD, there is no STT, Visser says.
ETFs through investment plans
You can buy ETFs through investment plans offered by Satrix and etfSA.
They both have an annual fee of between 0.46 percent and 0.74 percent (with VAT) of your investment.
Recently, Satrix’s investments became available through SatrixNOW, at no platform fee and a transaction fee of just 0.29 percent (with VAT) per trade.
You also pay Strate fees and an investor protection levy, but these costs are shared between all investors on the day, as transactions are bulked by the administrator.
If you buy ETFs through a stockbroker, you have to pay the full fees yourself.
Unit trust costs
Most unit trust funds have no initial fees, but there is an ongoing annual management fee of between 0.5 percent and two percent. Sometimes there is a lower base fee combined with a performance fee on performance above a particular hurdle or benchmark. If you use a financial adviser, there could be an additional advice fee.
If you invest through a linked investment service provider, an investment platform that gives you access to a number of unit trust funds and the ease of switching between them, there will be a platform administration fee and possibly charges for switching investments. However, the charges on the unit trust fund may be lower than those you would pay as a direct investor.
Unless you invest in a tax-free savings account or in a retirement annuity (RA) fund, your investments will incur tax.
The interest earned by cash investments in unit trust funds have to be declared annually and if this amount, together with any other interest you earn, exceeds the interest exemptions (R23 800 for under-65s and R34 500 for over-65s), it will be taxed at your income tax rate.
Dividends tax, at a flat rate of 15 percent, will apply to any dividends paid on shares within a unit trust, or on shares held directly. The tax on dividends is a withholding tax, which means that the fund manager, in the case of a unit trust, or the company secretary of the company that issued the shares in the case of shares held directly, deducts the tax and remits it to the South African Revenue Service on your behalf. In other words, the amount you receive is net of tax.
When you sell a unit trust fund, you pay capital gains tax (CGT) on any gains you make on the investment that exceed the annual exemption (R40 000 a year). The gain is calculated from the purchase date (as long as that was not before the introduction of CGT in October 2001) to the date of sale.
You will also pay CGT on your shares held for more than three years, but you will generate CGT each time you buy and sell a share, unlike a unit trust, where CGT is payable only when you sell the fund, and not when the fund manager buys and sells shares.
If you are regarded as a trader, who buys and sells shares often, you may have to pay income tax on the shares. Income tax is generally higher than CGT, because capital gains are only included in your income after the exemption and then only one third of the gain is included and taxed at your income tax rate.
Note: You can only invest in shares in an RA on some investment platforms, because an RA needs to comply with regulation 28 of the Pension Funds Act. Certain unit trust funds are what is known as regulation 28-compliant for this reason.
Contributions to an RA are tax exempt and, as a result, saving pre-tax contributions into such a fund is likely to result in a better investment return overall than investing in an investment that has no tax incentives.
You can sell unit trust funds at any time and have the money in your bank account within 48 hours – often less. The unit trust company is obliged to buy the units back from you and may only, under very exceptional circumstances, refuse to pay you out.
Share portfolios can be slightly more difficult to liquidate, Mackeurtan says. The time it takes to sell the shares depends on the time it takes to find a buyer.
There is also a settlement period on the JSE of three days, which means that, once your trade has been completed, it will be three days before the money is paid to you.
ETFs have to be able to buy the ETFs from you, which gives you liquidity in these listed instruments.