Introduction to Unit Trusts
Find out more about unit trusts investments, how you can benefit from investing in unit trusts, the various potential risks faced by investors, fees and charges involved as well as understanding some key performance measurements/ indicators.
1. What is a Unit Trust
A unit trust is a collective investment fund that pools the money of a large group of investors with similar investment objectives. It is managed by professional managers who invest this money in a diversified portfolio of equities, fixed income securities and other investments.
The organisation of a unit trust fund consists of a manager to manage the investment and operations of the fund, a trustee to protect the rights and interests of the Unit Holders and Unit Holders who are entitled to a proportionate interest of the assets of the fund. The obligations of these three parties are spelt out in the deed of the fund.
Click on image to zoom
2. The Regulatory Regime for Unit Trusts in Malaysia
The unit trust industry is governed by the SC, which was established under the Securities Commission Act 1993. The SC is empowered to require compliance with all legislations and guidelines under its ambit, which are, amongst others, the Capital Markets & Services Act 2007, the Securities Commission Act 1993 and the Securities Commission’s Guidelines on Unit Trust Funds. These securities laws and guidelines have been established to regulate and to facilitate the orderly development of the unit trust industry.
The appointment of the trustee, directors and CEO of the manager, investment committee members, Syariah committee members and external fund managers of the fund must receive the approval of the SC.
3. The Benefits of Investing in Unit Trusts
Unit trusts offer investors a simpler, relatively safer and less time-consuming way of investing in securities than investing directly in the stock market. Some of the advantages of investing in unit trusts are:
Professionally Managed - A team of experienced full-time managers, drawing upon their knowledge and experience in the capital markets, will be managing the investments. To perform their investment duties, they have access to various research materials and investment tools that might not be available to individual investor.
Diversification - Portfolio risk can be reduced by diversifying into stocks which are negatively correlated. However, this is not possible for investors with small capital. A unit trust fund pools together the resources of a large group of investors and spreads it over a diversified portfolio of investment thus minimising the risk of “putting all your eggs in one basket”.
Liquidity - Unlike fixed deposits, which have fixed maturing dates with early withdrawals resulting in forgoing interest earned, unit trust Fund can be redeemed on any Business Day. Affordable - An investor can choose to invest in unit trusts that fit his risk profile and financial requirement. As the minimum investment required is low, unit trust Fund make professional fund management services affordable and accessible to the general public.
4. Potential Risks
Prior to making an investment, prospective investors should consider the following risk factors carefully in addition to the other information set forth elsewhere in this Prospectus. Although unit trust management companies seek to minimize risks by investing in a diversified portfolio, investors should be warned that there are potential risks in investing in unit trusts. They include:
Market risk - Market risk cannot be eliminated by diversification. It stems from the fact that there are other economy-wide perils, which threaten all businesses. That is why investors are exposed to market uncertainties, regardless of numbers or types of investment held. Fluctuation in the market caused by uncertainties in the economy, political and social environment will affect the market price of unit trust Fund.
Equity investment risk - The value of equity investment is mainly determined by its potential growth in earnings, sound management etc. Failing to achieve the expected earnings would result in declining investment value which in turn affects the performance of the unit trust.
Fund management risk - The performance of any unit trust fund depends on the experience and expertise of the investment managers. Poor management of the unit trust may jeopardize its performance.
Performance risk - There is no guarantee on the investment returns or on the distribution to Unit Holders.
Inflation risk - A unit trust fund is subject to the risk of an investor’s investment not growing proportionately to the inflation rate making the investor’s purchasing power falls over time.
Liquidity risk - It is a risk that the investment cannot be sold at or near its actual value without taking a significant discount. This will result a lower NAV of the fund.
Loan financing risk - Investors should assess the inherent risk of investing with borrowed money which includes risk of increase in interest rates, risk of inability to provide additional collateral should the unit prices fall.
Credit/ default risk - Credit risk refers to the possibility that the issuer of a security will not be able to make timely payments of interest on the coupon payment date or principal repayment on the maturity date. This may lead to a default in the payment of principal and interest and ultimately a fall in the value of unit trust funds.
Interest rate risk - The level of interest rates has an impact on the value of investments and economic growth of a country. High interest rates dampen investments and aggregate demand leading to a slower economic activities. Both equity and debt securities of conventional as well as Syariah-based funds are affected by interest rates. The value of debt securities move in the opposite direction of interest rates, any increase in rates will lead to a fall in the value of debt securities, thus affecting the NAV of unit trust funds.
Currency risk - Currency risk is also known as foreign exchange risk. It is a risk associated with investments that are denominated in foreign currencies. When the foreign currencies fluctuate in an unfavourable movement against Ringgit Malaysia, the investments will face currency losses in addition to the capital gains/ losses. This will lead to a lower NAV of the fund.
Country risk - The foreign investment of the Fund may be affected by risk specific to the country which it invests. Such risks include changes in the country’s economic fundamentals, social and political stability, currency movements and foreign investment policies etc. They may have an adverse impact on the prices of securities of listed companies.
Risk of non-compliance - The risk that unit trust management companies and others associated with the fund do not follow the rules set out in the fund’s constitution, or the law that governs the fund, or will act fraudulently or dishonestly. It also includes the risk that unit trust management companies may not comply with internal control procedures. The non-compliance may expose the fund to higher risks which may result in a fall in the value of the unit trust funds.
5. Unit Trust Investment vs Other Alternative Investment Products
Investing in unit trust funds in general would potentially yield a higher return compared to return of deposits with the banks. However, the investment risk is higher for unit trust funds than that of the bank deposits.
On the other hand, unit trusts offer investors a relatively safer, well diversified, better managed and less time-consuming way of investing in securities. Investment in unit trust funds will in the overall minimise risks through diversifying investment exposure across different sectors and counters. Also, if an investor had invested into a security which is illiquid, one could face a situation where it is difficult to sell that security and find a willing buyer at the desired price. Unit trusts on the other hand provide liquidity because the manager of the fund is obliged to buy back units of the fund at NAV (with applicable redemption charge, if any).
6. Unit Trust Investor Profile in General
Unit trust investment is not suitable for short-term investors with investment horizon of less than a year or for speculators. It is targeted at medium to long-term investors and is suitable for investors who do not have the time and/ or the expertise to manage investments. A typical unit trust fund investors’ profile would also include persons who would like to have a well diversified investment portfolio that is liquid and easily redeemable.
8. Management Expense Ratio
The Management Expense Ratio (MER) indicates the costs that are incurred in the course of a fund administration. It is calculated by taking the fees and expenses paid out of a particular fund as a percentage of the average NAV of that fund determined on a daily basis over the financial period. The MER is an important ratio that investors can use to compare the costs incurred by a particular fund with other funds within the same category. A lower MER indicates the effectiveness of the manager in managing the costs of the fund.
9. Understanding the Performance Indicators/ Information
Fund performance is one of the criteria in choosing a fund. A simple way of measuring the performance of a fund is by calculating the total return of the fund. The total return of a fund represents the combined income received and capital growth from an investment. For easy calculation and comparing to performance of other unit trust funds or benchmarks, total return is usually expressed as a percentage of the initial fund value over the period of investment to obtain the average return.
The investors can then compare the return of the fund with other unit trust funds or benchmarks to assess the performance of the fund. However, a better performance measurement would be time weighted rate of return, which takes into consideration of each date that a cash flow moves into or out of the portfolio over the performance measurement period.
When analyzing a security or portfolio of securities, the investors need to know if its price behavior has been better or worse than that of the index benchmark they used for comparison. This gives a measure of its relative return and is a useful measure of the fund manager’s performance or ability to add value.
For an all equities portfolio, the most commonly used performance indicator or index benchmark in Malaysia is the Kuala Lumpur Composite Index (KLCI). For instance, should the KLCI register a negative return of 5% while the equities portfolio registers a negative return of 3%, the portfolio is said to have outperformed the KLCI by 2 percentage points. On the other hand, if the KLCI gained 10% during a defined period while the portfolio only registered a gain of 5%, the portfolio is said to have underperformed the benchmark.
Other performance indicators that can be used for equities portfolios include the broader FTSE Bursa Malaysia Emas Index (FBM-Emas), and for Syariah-approved equities portfolios, the FTSE Bursa Malaysia Emas Syariah Index (FBM-SHA). All these indices are published in newspapers or website of Bursa Malaysia.
The same concept applies to a fixed income or bonds portfolio. In Malaysia, the benchmarks for fixed income is not easily available to the public unlike that of (for instance) the KLCI or FBM-SHA. Pricing is not known to the public as bonds are generally traded over-the-counter and hence there is no public exchange in which bonds are traded. Nevertheless, there are benchmarks which are compiled by RAM and some bond dealers (e.g. merchant banks). These are based on the total returns of a portfolio of bonds. For instance, RAM compiles on a monthly basis its RAM-Quant Shop MGS Index which is based on the returns of Malaysian Government Securities. This is published in its monthly newsletter which is available by subscription only.
Some fixed income fund managers however prefer to adopt a more simple benchmark based on bank fixed deposit rates. Such benchmarks can be obtained from the banks or their websites.
Benchmarks may also be hybrid in nature i.e. a composition of two or more performance indicators. For instance, a balanced fund may choose to have as its benchmark a 50:50 composition of the KLCI and 12-month bank fixed deposit rate. An Islamic balanced fund on the other hand would use a composition of the FBM-SHA and Islamic deposit rates.