What is a unit trust?
It is a trust fund that pools the investments of a number of investors who shares a common financial goal. The funds collected are then invested in financial market instruments such as shares, government securities, corporate debt securities and any other interest-bearing investments.
The income earned through these investments and the capital appreciation realized, are shared by the investors (unit holders) in the fund in proportion to the number of units owned by them. Hence, unit trust is the most suitable investment for the common man as it offers an opportunity to invest in a diversified and professionally managed portfolio of securities at a relatively low cost. In a unit trust, there is a Fund Management Company (FMC) and a trustee who handles different roles in managing the trust.
The FMC is generally a private company with a minimum capital of Rs.25 million and it handles the marketing of units among the public and managing the investments of the fund. The trustee is generally a reputed financial institution and the main duty of the trustee is to look after the interests of the investors. All assets of the fund are under the custody of the trustee and the trustee monitors the entire operation of the trust fund.
What are the advantages of investing in unit trusts?
Professional management – Funds are managed by professional fund managers who have the necessary skills and expertise to manage your investments. The investor does not need to learn about the fund and monitor it as he would do when he directly invests in the equity market. It saves his time and brings about substantially high returns.
Less risky – Risk can never be eliminated but it is possible to manage it by spreading the risk. It should be noted that in unit trust, the investor’s risk is less, compared to directly investing in the equity market. On the one hand, risk could be minimized through diversification. As unit trusts are a pool of funds collected from several investors, the fund size is generally large and the fund manager is able to diversify the investment of the fund into different asset classes or spread out the investments even within a single asset class.
An investor with a small amount of money is unable to have a well-diversified investment portfolio on his own. Unit trust provides an opportunity for such investors to benefit from a well-diversified investment portfolio.
Convenient administration – Investing in a unit trust reduces paper work and helps to reduce many other problems as delayed payments and unnecessary follow up with brokers and companies.
Well regulated – As mentioned earlier, the main role of the trustee is to look after the interests of the investors in the fund. The trustee will monitor whether all investment decisions made by the fund manager are in conformity with the investment guidelines specified in the Unit Trust Code, the trust deed and the directives issued by the Securities and Exchange Commission (SEC).
Tax benefits – UTs are liable for income tax at 10 percent on its income and the income distributed to the investor and any capital gain realized by the investor are tax free in the hands of the investor.
Liquidity – Unit trusts are generally open-ended, that means investors can enter and exit from the fund at any time they wish. When an investor wants to exit from his/her investments he/she can sell the units they hold to the fund manager at any time. He will purchase it at the buying price, which is computed based on the net asset value (NAV) per unit of the fund.
Transparency – The operation of a unit trust is carried out in a very transparent manner, where the investors receive the financial statements of the unit trust on a semi-annual basis. An interim financial statement and the annual report are circulated to the investors or uploaded to the website of the FMC. All investments of the unit trusts are disclosed in the financial statements.
Return potential – A unit trust has the potential to provide higher returns over the medium term to long term as it invests in a diversified basket of securities.
Low cost – It is a relatively less expensive way to invest compared to directly investing in the capital market because the benefits of scale in brokerage, custodial and other fees translate into lower cost of investment.
Who can invest in unit trust?
* Approved provident funds and approved contributory pension schemes registered/incorporated in Sri Lanka
* Minors can invest with parents/guardians as joint applicants
* Citizens of Sri Lanka who are residents and are above 18 years
* Companies, corporations or institutions incorporated or established in Sri Lanka
Before investing in a unit trust, an investor needs to clearly understand his/her investment goals and the level of risk he/she is willing to bear.
There are different types of unit trust funds available in the industry catering to the diverse needs of the investors. Hence, the investor will have to first identify his/her requirement before making an investment.
Identifying personal requirements
Identify personal investment needs in consultation with an advisor who can understand your personal investment needs. Do I need a regular income from my investment in unit trust or do I want my capital to appreciate? You should also take into account your retirement plan and other financial commitments.
Risk tolerance level
Every investment has an element of risk and this varies according to the expected return. Higher the risks higher the expected return and lower the risk lower the expected return. Before investing, an investor needs to know the risk he/she is prepared to take in anticipation of the return he/she is expecting.
If you are a risk averse investor (i.e. you do not want to take any risk on your investment), then you need to select a fund that invests its assets in more secure type of instruments (such as Treasury bills and bank deposits). If you are an investor who is willing to take a higher risk in anticipation of higher returns, then you have the option of selecting an equity fund, which invests major portion of the investment in listed equity securities.
Investors must decide at the outset, for how long they are willing to keep their investment. If your investment horizon is short term (i.e. less than 12 months), it is advisable that you invest in a more liquid fixed income securities fund, such as money market fund or gilt-edged fund. Here the investor can expect a return comparable to the prevailing interest rates. If you are an investor who is expecting a growth in your investment, then you need to keep your investment for medium to long term (i.e. three to five years).
Different types of funds
Money market funds: The money market fund consists of short -term debt instruments mostly Treasury bills and other forms of safe debts having a maturity of less than one year. Such funds are generally identified as low risk and low return funds. However, generally returns are better than savings and short-term deposits.
Income fund: The fund invests in corporate and government debt. The primary objective is to give a steady income to the investors through regular dividends. These funds are likely to pay higher returns than money market investments.
Balanced funds: The objective is to provide a balanced mixture of safe income and capital appreciation. They invest in a combination of fixed income securities and shares.
Equity funds: The investment objective of equity funds are long-term capital growth with some income. The existences of varied types of equities resulted in introducing various forms of funds.
Global funds: A global fund invests overseas. This class of fund can achieve diversification by investing in many markets.
Sector funds: This is a separate category of funds that are not included in the above funds. This type of fund forgoes broad diversification to concentrate on certain segments of the economy.
Sharia funds: This is a special fund that invests in sharia compliant shares and instruments to encourage investments from investors who comply with the sharia principles when investing.
Index funds: This type of fund replicates the performance (market return) of a broad market index.
Now that we have a basic understanding of what a UT is, let us see how we can make an investment in the UT.
Step-by-step process of investing in a unit trust
* Once you have made the investment you can check the value of your investment regularly by monitoring the unit price that is published in the newspapers or the website of the FMC.
* Send the completed application form together with a copy of your National Identity Card (NIC) and the cheque to the FMC. Usually the cheques need to be drawn in favour of the FMC. However, in some funds cheques are drawn in favour of the trustee. The investors should communicate with the FMC and draw their cheques accordingly. Those investors who do not maintain a current account can deposit the funds to the collection account maintained in a bank by the FMC and forward the deposit receipt together with the application form and the NIC to the FMC.
* The next important factor that needs to be considered is the performance of the fund. You need to check the performance of the fund during the last couple of years and compare it with similar funds that are in operation.
* EMs are available on the website of the FMCs. If you have difficulty in understanding the provisions/clauses in the EM, you could ask the official of the FMC to explain it in detail.
* Before investing in the UT, the investor needs to read the Explanatory Memorandum (EM) and understand the objective and the risk-return profile of the fund.
* The next important item that needs to be checked is the fees. You should know the different types of fees and charges that are levied by the FMC and the trustee of the fund. Fees include the management fee, trustee fee, custodian fee, front-end fee (if any) and exit fee (if any). The management fee and trustee fee are usually charged based on the daily NAV of the fund and paid out on quarterly basis. The management fee and trustee fee together usually range between 0.50 percent to 2.00 percent p.a. based on the types of funds. Equity funds generally charge a higher management fee and trustee fee whilst the income funds charge a lower fee. The custodian fee is generally a fixed amount that is charged on the fund on a monthly basis. Some FMCs charge an entry fee when a new investor enters the fund. This is mainly charged to cover part of the distribution expenses. This fee is generally charged by the equity funds and it ranges from 2.00 percent to 5.00 percent. Similarly, some funds charge an exit fee when an investor wants to exit from the fund. Usually this is levied by the equity funds in order to discourage investors from leaving the fund early. Generally, the fund manager would have made the investments of the fund with a medium to long-term view and an early exit from the fund by an investor will put undue pressure on the fund manager to liquidate some of the investments before its true potential is realized.
* Once you have carried out the above process and identified a particular fund that suits your requirement, you need to contact the FMC, which manages the fund. You can request the FMC to send you an application form (generally these application forms can be downloaded from the website of the FMC).
* Upon receipt of your application form and the cheque, the FMC will prepare either a unit certificate or a transaction receipt in your name. This will have your name, address and the amount of your investment together with the number of units allocated. These unit certificates or transaction receipts are usually signed by the officials of the FMC and the trustee.
* Invest in unit trust regularly. The approach that works best is to invest a fixed amount at specific intervals (monthly or quarterly).
Future of unit trust industry
The SEC and the government have taken prudent measures to develop the unit trust industry with the objective of promoting unit trust as the vehicle for unsophisticated investors to access the stock market and the capital market as a whole. The SEC has included the development of unit trust to the ‘Ten Key Projects’ (a programme that is formulated to develop the capital market). They also facilitated in considering the gilt fund as a liquid asset. It encouraged licenced commercial banks and licenced specialized banks to invest in the fund. This increases liquidity and the market base.
Further on, last year’s budget proposed by the government had made several changes in order to develop the market. They are as follows:
* Unit trusts are allowed to structure funds in foreign currencies
* Tax applicable to profits and income were reduced to 10 percent for unit trust managing companies
* VAT waived on managing company’s services to unit trusts
* Foreign investors, Sri Lankans living overseas and Sri Lankans operating foreign currency accounts locally are permitted to invest in unit trusts without having to open a Securities Investment Account (SIA)
* Private pension funds and private provident funds can access capital market investments via unit trusts that invest exclusively in listed equities and listed corporate bonds (up to a 20 percent cap).
It is a very simple process to begin your investment in a UT, which is a pathway to enter and enjoy the returns of the capital market. You need not have a lump sum to begin your investment in unit trust.