An introduction to unit trust investments

Unit Trust investments enable everyone, including first-time investors, to build a balanced and diversified investment portfolio, with exposure to the stock exchange. They work by allowing a large group of people to pool their capital for investment in the equity, bond and money markets.

What is a Unit Trust Investment?

Unit Trusts, or collective investments, are popular investments in which investors’ funds are pooled and managed by professional managers.

Investing in shares has traditionally yielded good returns, offering investors the opportunity to build real wealth. But the large amounts of money required to buy shares are often out of reach of smaller investors. Pooling everyone’s funds in a collective investment enables fund managers to build a portfolio of securities or shares and to then offer cost-effective access to financial markets.

There are two main sources of income for Unit Trust funds: interest from interest-bearing investments, such as money-market instruments and bonds, and dividends from shares.

There are around 1 500 locally managed Unit Trust funds available to investors in South Africa. Even if you haven’t specifically invested in a Unit Trust, it’s likely that your retirement annuity and other investments are invested in Unit Trusts to earn the highest return.

The pros of a Unit Trust Investment

1. Well regulated

Unit Trusts are strictly regulated by the Financial Services Board (FSB), the Association of Collective Investments, and each collective investment scheme manager's trustee or custodian. You’ll enjoy wholly transparent fees, charges and investment performances.

2. Low investment risk

A Unit Trust spreads your money across many investments, reducing the chances of you suddenly losing large amounts of money should the markets change. For example, if one of the companies in which you have invested suffers a severe setback, only a small percentage of your investment will be affected as it is spread across multiple companies.

3. Know your investment status

It is easy to monitor the performance of Unit Trusts. You can access your statement online or receive regular updates from your fund manager.  You can also track the performance of your Unit Trust fund on a daily basis on investment websites or via the press.

4. Start with a small investment

You don’t need a large amount to start investing. On average monthly debit orders usually start at around R500. By investing a little more every month, you can start to grow your investment steadily. The reason Unit Trust funds exist is to make it easy for anyone to invest in any part of the economy they choose to and to benefit from professional fund management.

The cons of a Unit Trust Investment

1. Spoilt for choice

Investors looking into Unit Trusts will find a multitude of options available in the South African market, making it difficult to choose. If you are not conversant with investments or Unit Trusts, it’s worth making use of a registered financial advisor to assist you.

2. No guarantees

Unit Trust funds are invested across a range of different investments, over various geographical regions, providing different risk with various financial institutions. There is no guaranteed return or a guarantee that you will not lose money. However, with an investment term over at least a five-year period, a return is generally achievable and probable, with the correct investment strategy.

How is income earned in an Unit Trust Investment?

Investors earn interest and/or dividends from your Unit Trusts, depending on the type of fund you’ve invested in.

Interest is what you earn on your money by lending it. Dividends are a share of profits that you get as a part owner of a company when you purchase its stock. It is your portion of the company’s earnings. Unit Trust fund managers may declare these earnings monthly, quarterly or every six months.

When you earn interest and/or dividends the default option is for them to be automatically reinvested, increasing the number of units you own. Alternatively, you could opt to have dividends paid out to you instead of being reinvested, but this will have an impact on future growth.

What fees will I be charged?

There are fees that you need to be aware of when investing in Unit Trusts. These fees will be deducted as a percentage of your investment. There are two distinct types of fees:

1. Upfront fees

These fees are deducted on the first day of your new investment. This is a once-off fee, which usually ranges as follows:

• Unit Trust management company initial fee: ranges from: 0.25% – 2.00%
• Financial advisor initial fee: ranges from: 1.00% – 3.00%

VAT is levied on top of this fee.

2. Ongoing fees

Ongoing annual fees are deducted over the lifetime of the investment. This is shown as a percentage, which will be deducted monthly over 12 months. Ongoing fees usually range as follows:

• Unit Trust management company fee: ranges from 0.50% – 1.75% p.a.
• Financial advisor fee: ranges from 0.50% – 1.25% p.a.
• Unit Trust platform admin fee: ranges from 0.25% – 0.95% p.a.

How will I be taxed on a Unit Trust Investement?

Unit Trusts are subject to two types of taxes:

1. Tax income earned in the form of interest and dividends

At the end of the tax year, your investment company will issue you with an ITB3 certificate, a certificate produced annually for every account that has received credit interest. It states how much interest was earned during the tax year. If an account earns interest above the prescribed threshold, you are liable for declaring it on your annual tax return.

2. Capital Gains Tax

If you sell any of your Unit Trusts, or if you switch from one Unit Trust to another, you’ll be disposing of assets and are subject to Capital Gains Tax. This is why it’s important to do the research and ensure you are satisfied with your choice of fund.