JOHANNESBURG - A unit trust is a type of investment that provides you with easy and affordable access to financial markets.
Your money is combined with the money of other investors who have similar investment goals.
Investment managers use the pool of money to buy underlying investments to build a portfolio, which is split into equal portions called “units”. Units are allocated to you according to the amount of money you invest and the price of the units on the day you buy them.
How a unit is priced
A unit in a unit trust fund is priced according to a simple equation: price = (assets - operating expenses)/number of units.
The assets of the unit trust are the shares, bonds, cash and/or property that the fund owns on behalf of investors. The value of these assets is generally updated daily, but sometimes weekly, depending on the fund.
The operating expenses comprise fund management fees, operating costs - which include trustee and custodian fees, audit fees or their service fee, and bank charges - transactional costs for buying and selling shares, and VAT.
Once operating expenses are subtracted from assets, this sum is divided by the total number of units bought by investors.
The problem with exclusively using unit prices to compare unit trusts is that it says nothing about the value of the unit trust as a whole. If we have two unit trusts both with assets of R1000, but one has 50 units and the other five, their prices would be R20 and R200 respectively. An investor would be mistaken in thinking that one is 10 times more valuable than the other by virtue of its price.
Unit trusts are priced differently to shares
Investors also often make the mistake of thinking unit trust prices are analogous to share prices. But there is a vast difference. The share price of a stock is the price that buyers and sellers agree to at a given time, which usually has a wavering relationship with the actual value of the business behind the stock.
Sometimes the share price is based on sentiment, mood and herd behaviour. The price of a unit trust comes from the actual value of the investments within it. Sentiment and mood play no direct role.
Put another way: if stock market investors fall in love with a stock and buy it in excess, the price of that stock will be driven up, but if unit trust investors love a unit trust and buy lots of its units, it will do nothing to influence the unit price.
What changes the price of a unit trust fund?
The variables that move a unit trust’s price are the value of the assets within it and its operating expenses. When the shares inside an equity unit trust do well, then the pool of assets of the unit trust increases in value and the price of an individual unit increases as well. The same happens when your unit trust manager lowers any part of operating expenses: Lower expenses lead to a bigger pool of assets being divided between unit holders.
Investors are sometimes tempted to try to take advantage of this price movement by attempting to time the market - buying when the price is low and selling when the price is high, just as some traders do with shares.
But, as with shares, timing unit trust purchases is difficult. In fact, trying to time the exact right moment to buy or sell a unit trust might be even more difficult because it involves not just one investment, but a large number of investments, and the price of each investment might move independently of one another.
Most unit trusts are not designed to be traded frequently, and doing so will probably result in a lower return. Their strength is in the accumulation of wealth over time, as time smooths out the rough-and-tumble of volatile price movements.
How should you compare unit trusts?
Looking at price is a simple but misleading heuristic for comparing unit trusts. The correct way to assess a unit trust is to:
* See how the price per unit has grown over time; this will give you an indication of the track record that the investment manager has for creating wealth. You can obtain the same information by looking at the performance over different periods on fund factsheets.
* Examine the operating expenses to see that these are not excessive. Typically, investment management fees should be fair relative to the performance delivered.
In addition to these hard measures related to costs and performance, you should:
* Think about what you need from your investment and the risk you are comfortable with;
* Find an investment manager whose philosophy resonates with you.
* Assess the manager’s performance over a long enough time frame, through different market cycles.
* Ensure that you understand the mandate of the unit trust and that it aligns with your needs.
It’s easier to just look at price, but being thorough before you invest generally leads to better outcomes.
Monitoring a unit trust
Watching the unit price daily, weekly or even monthly is fun to do but almost meaningless to a long-term investor. It is akin to watching the rev meter on your dashboard to see whether you are getting closer to your destination.
Instead, you should review your investments at reasonably set intervals to see whether they still meet your needs, and to check that they are performing as they should.
Most unit trust management companies include prices on their websites and they are also quoted on various financial news websites. Prices are typically quoted in cents.
Ray Mhere is the Johannesburg regional manager of Allan Gray.