UNDERSTANDING UNIT TRUST SCHEMES
What Are Unit Trusts?
Unit Trusts are a form of collective investment that allows investors with similar investment objectives to pool their funds to be invested in a portfolio of securities or other assets.
A professional fund manager then invests the pooled funds in a portfolio which may include the asset classes listed below:
- Bonds & Deposits
Unit holders do not own the securities in the portfolio directly. Ownership of the fund is divided into units of entitlement. As the fund increases or decreases in value, the value of each unit increases or decreases accordingly.The number of units held depends on the unit purchase price at the time of investment and the amount of money invested.
The return on investment of unit holders is usually in the form of income distribution and capital appreciation, derived from the pool of assets supporting the unit trust fund. Each unit earns an equal return, determined by the level of distribution and/or capital appreciation in any one period.
Unit trust investors are typically those with savings to invest, who neither have the time nor the inclination to hold portfolios of direct investments or shares. Rather, they prefer to invest in a secure, reputable investment vehicle which suits their purposes. Unit trusts allow investors to have easy access to a wide range of investments not normally available to them.
As investors seek to maximise returns on their financial resources, unit trusts provide an ideal way for them to gain exposure to investments that, in the long run, should produce returns superior to cash savings and fixed deposit investments.
The cost of these potentially higher returns is of course the risk that accompanies the investment. In the short term, the certainty of investment returns of most unit trust products is less than those offered by fixed deposits. However, in the medium to long term (i.e. 3-20 years), unit trust investments generally provide better returns at acceptable levels of risk.
History of Unit Trusts
Malaysia introduced the unit trust concept relatively early compared to its Asian neighbours, when, in 1959, a unit trust was first established by a company called Malayan Unit Trust Ltd.
The unit trust industry in Malaysia has therefore a history of more than four decades. The development of this industry can be presented in chronological order as follows.
The Formative Years: 1959 -1979
The first two decades in the history of the unit trust industry were characterised by slow growth in the sales of units and a lack of public interest in the new investment product.
Only five unit trust management companies were established, with a total of 18 funds introduced over that period. The industry was regulated by several parties including the Registrar of Companies, The Public Trustee of Malaysia, Bank Negara Malaysia and the Ministry of Domestic Trade and Consumer Affairs.
The 1970s also witnessed the emergence of state government sponsored unit trusts, in response to the Federal Government’s call to mobilise domestic household savings.
The Period from 1980 to 1990
This period marks the entry of government participation in the Unit Trust Industry and the formation of a Committee to regulate the unit trust industry, called the Informal Committee for Unit Trust Funds, comprising representatives from the Registrar of Companies (ROC), the Public Trustee of Malaysia, Bank Negara Malaysia (BNM) and the Capital Issues Committee (CIC).
The 1980s marked a significant development in the history of the industry when the Skim Amanah Saham Nasional (ASN) was launched by Permodalan Nasional Berhad (PNB) in 1981. Despite only 11 funds being launched during this period, the total units subscribed by the public swelled to an unprecedented level because of the overwhelming response to ASN.
The 1980s also witnessed the emergence of more unit trust management companies, which were subsidiaries of financial institutions. Their participation facilitated the marketing and distribution of unit trusts through bank’s branch network which widened investor reach.
The Period from 1991 to 1999
This period witnessed the fastest growth of the unit trust industry in terms of the number of new management companies established, and funds under management. The centralisation of industry regulation, with the establishment of the Securities Commission on 1 March 1993, coupled with the implementation of the Securities Commission (Unit Trust Scheme) Regulations in 1996 and extensive marketing strategies adopted by the ASN and ASB (Amanah Saham Bumiputera), played key roles in making unit trusts household products in Malaysia. Consequently, the total asset value of funds under management grew more than threefold from RM15.72 billion at the end of 1992 to RM59.95 billion at the end of 1996. The period also saw greater product innovation and deregulation of the industry.
Although the pace of growth of local unit trust funds has moderated since the financial crisis of 1997-1998, it has nevertheless maintained its upward trend.
The Period from 2000 to current
The unit trust industry has a very promising start to the 21st century. The industry recorded double digit growth for first 7 years, growing from RM43 billion in Net Asset Value(NAV) in Year 2000 to RM169 billion as at 31 December 2007. However, this strong growth has been punctuated by some extraordinary financial crisis in 2008, starting from the fallout of the subprime loans in the USA, bursting of the property bubble, the global credit crunch, the banking crisis and the rapidly falling share prices worldwide. As at 31 December 2008, the unit trust industry saw its NAV dropping to RM134 billion. While the industry NAV has dropped by 20% over the last 10 months, the industry Net Asset Value to Bursa Malaysia Market Capitalisation has increased from 15% to more than 20%. In relative terms, the unit trust industry drop is less severe than the fall in share prices in Bursa Malaysia due to the diverse nature of its assets.
3 MAJOR WAYS TO START INVESTING IN UNIT TRUSTS
Lump Sum Purchases
This is where an investor with a lump sum of monies invests into unit trusts. This may be the only investment the investor wishes to make. Over a period of time (3-20 years), the initial investment will increase as distribution and other income is earned by the fund. When redemption or sale of the units take place, the unit-selling price will reflect the accumulation and compounding of capital over the relevant periods. It is this compounding effect over time which makes accumulation type investments, such as unit trusts, so attractive to the investor.
For example, someone who has recently inherited a sum of money may wish to invest the funds into a unit trust and hold it for an extended period to save for some specific purpose. e.g. children’s education. At the end of the holding period, the proceeds of the sale of the units will be the initial investment plus the returns on that amount, accumulated over the period.
Some people invest in unit trusts by making regular (e.g. monthly) contributions to their fund. This is an ideal, disciplined and useful way to accumulate capital for a future need. By making regular contributions over a period of time, the sum accumulated at the end of the period will increase. This is commonly known as dollar cost averaging.
At the end of the period, the redemption (or sale) price of the units held will represent the accumulation of all contributions, plus returns generated from the total contributions since the first purchase was made. The effect is more noticeable the longer the holding and contribution period. This form of savings is the basis of most pension fund accumulation e.g. the Employees Provident Fund.
In addition to investing in unit trust by cash or through a regular savings plan, you can also invest using EPF Members’ Investment Scheme. The EPF will process a request to transfer an amount from a member’s Account 1 to approved unit trusts funds if:
- The Account 1 balance is not less than the required basic savings, details of which are enclosed in the table 1 as prescribed by the EPF for respective age of the EPF members.Table 1 – Basic Savings Amount in Account 1 (Effective from 1 January 2014)
YEAR (AGE) BASIC SAVINGS (RM) YEAR (AGE) BASIC SAVINGS (RM) 18 1,000 37 54,000 19 2,000 38 59,000 20 4,000 39 64,000 21 5,000 40 69,000 22 7,000 41 76,000 23 9,000 42 81,000 24 11,000 43 88,000 25 13,000 44 95,000 26 15,000 45 102,000 27 18,000 46 109,000 28 21,000 47 117,000 29 24,000 48 125,000 30 27,000 49 134,000 31 30,000 50 143,000 32 34,000 51 153,000 33 37,000 52 163,000 34 41,000 53 174,000 35 46,000 54 185,000 36 50,000 55 196,800
- The member is less than 55 years old
- An account in the approved Unit Trust Scheme has been opened into which the transfer can be processed
- No transfer has been made in the previous three (3) months from the EPF Members’ Investment Scheme
Transfers under the EPF Scheme is made at an intervals of three (3) months from the date of the last transfer, subject to the availability of the required balance in Account 1.
- The amount eligible for transfer is not less than RM1,000
The amount to be transferred is not more than 20% of the Account 1 balance remaining after deducting the required amount of basic savings prescribed by the EPF (subject to minimum of RM1,000)
BENEFITS OF UNIT TRUSTS INVESTING
For an individual to maintain his own portfolio of investments, he needs to keep up to date with market information and sentiments. In today’s sophisticated financial markets, this means having to embrace a wide range of information from a plethora of sources. For many individual investors, this is difficult, if not impossible and at times, very frustrating as they attempt to ” keep on top ” of the information pile.
Investing in unit trusts transfers most of the necessary ‘know-how’ of investing to those best equipped to handle it – the professional fund managers.There are a number of other substantial benefits of investing in unit trusts that should be noted.
Unit trusts are very affordable. Investors can start with an investment amount as low as RM100.
Rather than concentrating an investment portfolio of one or two investments or shares, a portfolio of market securities can be held. The wider the spread of investments, the less volatile (i.e. variable) the investment returns will be. In simple terms, investment into unit trusts means diversification of risk: “not putting all your eggs in one basket
Most investors prefer their investment to be liquid. That is, they can easily buy and sell without difficulties. Unit trusts provide this benefit, easily bought and sold. An excellent return that cannot be “cashed-in” (i.e. sold) does not necessarily mean a good investment as poor liquidity constitutes an additional risk factor for the investor.
Professional Fund Management
The people entrusted to manage unit trusts are approved professionals. Their training and background ensures that decision making is structured and according to sound investment principles. In the process, unit trust funds enjoy the depth of knowledge and experience that fund manager can bring. In the long term, it is this expertise that should generate above average investment returns for unit trust investors.
For the individual investor, it is sometimes difficult to gain exposure to a particular asset class. For instance, if an investor with RM5,000 wants to gain exposure to the Malaysian property market, global equity markets and the Malaysian bond market, it would be impossible to simultaneously hold a direct investment portfolio in all of these markets. With unit trust investments, it is possible to spread your money around to all of these asset classes at the same time, so that the investor can gain the investment exposure he requires.
Wholesale Investment Costs & Access to Other Asset Classes
When making direct investments in Bursa Malaysia, the investor faces costs and charges that are much higher. With unit trusts the economics of the transaction are more favorable i.e. the fees and charges/brokerage etc. per investment ringgit are likely to be less. As the fund managers invest in larger amounts, they are able to get access to wholesale yields and products which are impossible for the individual investor to obtain. For instance, unlike unit trust funds, most individual investors cannot have direct access to the Malaysian Government Security market because, amongst other reasons, the amount of each transaction could run into millions of Ringgit
The Comfort of Regulation
With the introduction of unit trusts in Malaysia came regulation from various regulators, especially the Securities Commission. The entire range of variables relating to the unit trust industry is governed by various legislations.The sole purpose of such regulations is to protect the interest of the investing public.
Regulations provide investors with a level of comfort that they are investing in a safe investment mechanism.
TYPE OF UNIT TRUSTS
An equity unit trust is the most common type of unit trust. The major portion of its assets are generally held in equities or securities of listed companies.
Equity unit trust funds are popular in Malaysia as they provide investors with exposure to the companies listed on Bursa Malaysia. The performance of the units is therefore linked to the performance of Bursa Malaysia. A rising market will normally give rise to an increase in the value of the unit and vice-versa.
There is a wide array of equity unit trusts, available in the market, ranging from funds with higher risk, higher returns to funds with lower risk, lower returns.
- Aggressive growth funds
These funds invest generally in companies with higher capital growth potential but with associated higher risk
- Index funds
These funds invest in a range of companies that closely match (or “track”) companies comprising a particular index.
- International equity funds
These funds invest primarily in overseas share markets.
These funds invest mainly in Malaysian Government Securities, corporate bonds, and money market instruments such as bankers acceptance and fixed deposits. The objective of a fixed income (or bond) funds is usually to provide regular income, with less emphasis on producing capital growth for investors. It is possible, however, for fixed income funds to generate both capital gains and losses during a period of volatile interest rate.
Money market funds operate in a similar way to a bank account-the unit price is normally set at a fixed amount. Money market funds invest in low risk money market instruments that are in effect short-term deposits(loans) to banks and other-low risk-financial institutions, and in short-term government securities.
REITs invest in real properties, usually prominent commercial (office) properties and provide the investor with an opportunity to participate in the property market in a way which is normally impossible to the small time investor. By acquiring units in a listed REITS, however, it is possible to invest a small amount to gain exposure to the property market and have diversification in your portfolio.
ETF is linked unit trust fund whose investment objective is to achieve the same return as a particular market index. ETF often have low expense ratios and can be bought and sold throughout the trading day through a stockbroker, on an exchange.
Some investors may wish to have an investment in all the major asset classes to reduce the risk of investing in a single asset class. A balanced unit trust fund generally has a portfolio comprising equities, fixed income securities, and cash.
The main objective of Syariah funds is to provide an alternative avenue for investors sensitive to Syariah requirements. Syariah funds will exclude those companies involved in activities, products or services related to conventional banking, insurance and financial services, gambling, alcoholic beverages and non-halal food products.
Any investment carries with it an element of risks. Therefore, prior to making any investment, prospective investors should consider the following risk factors:
Any purchase of securities will involve an element of risks. As unit trust funds principally invest in listed stocks, it may be prone to losses as a result of global, regional or national economic conditions, governmental policies or political developments. Market uncertainties and fluctuations in the market caused by these uncertainties will affect the net asset value (NAV) of unit trusts which may fall or rise, thus causing the income generated by the fund to fluctuate from funds with higher risk, higher returns to funds with lower risk, lower returns.
The various securities that are purchased by a fund may encounter liquidity risk. Liquidity risk relates to the fund’s ability to quickly and easily trade at a reasonable price, in and out of positions. Should a fund comprise a security that has become temporarily or permanently illiquid or difficult to sell, the fund manager may need to sell the security at a discount to its fair value, which eventually affects the fund’s value.
Performance of the fund depends on the experience, expertise, knowledge and investment techniques of the fund manager. Poor management of a fund can cause considerable losses to the fund, which in turn may affect the capital invested.
Ideally the purpose of any investment is to secure returns that are greater than the inflation rate. While a fund will constantly seek to maximize returns and exceed inflation rate, it may occasionally experience losses, which result in returns that will not keep pace with inflation in the short run.
Fixed income securities and bonds are particularly sensitive to movements in interest rates. When interest rates rise, the value of fixed income securities and bonds fall and vice versa, thus affecting the NAV of the fund. The general interest rate environment of the country may affect the value of the investment even if the fund(e.g Syariah Fund) does not invest in interest bearing instruments
UNDERSTANDING FEES AND CHARGES
Initial Service Charge
The first cost that an investor incurs in relation to investing in unit trusts is the initial service charge (sometimes called the service, sales, entry, or ‘up front’ charge). This is the cost to an investor investing in unit trusts and it is levied primarily to cover the marketing and distributing units and monitoring his investments by the unit trust consultant for the duration the unit trusts is held.
Sometimes referred as repurchase charge. This fee represents a deduction by the UTMC from the proceeds of disposal of an investor.
Annual Management Fee
Management expenses include expense for portfolio management, the manager’s fees, trustee and custody costs, audit fees, administrative charges like printing of annual reports, distribution cheques, postage and other services properly incurred in the administration of the fund. These costs are paid out of the fund’s assets.
Importance of Performance
Performance data is valuable to chart the progress of your investment. While performance is a key evaluator in identifying a suitable fund, it is not the only factor upon which you should base your decision. It is important to understand that unit trusts do not offer a fixed rate of return: your principal value will fluctuate, and the return on your investment is not guaranteed. The rates of return fluctuate with market conditions due to changes in valuation of the securities that a fund invests in, or other factors. For that reason, it is helpful to examine performance over various time periods.
It is important to keep in mind that performance is based on historical results and is not intended to project future performance of a fund. Ensure that the fund’s objectives as well as the manager’s investment style and strategy are aligned with yours. While yesterday’s data is no guarantee of future performance, the long-term track record is a useful barometer of the manager’s skill and expertise in managing different market cycles.
When comparing funds, it is best to focus on long-term performance because financial markets (and the economy) tend to go through cycles that can last for several years. For instance, small-company stocks (and funds) will at times outperform large-company stocks (and funds). At other times, the large-company stocks/funds will be the star performers. A common mistake investors make is to constantly “chase” the best-performing funds from the recent past. Unfortunately, last year’s “hot” sector of the financial market may be replaced this year by a different sector.
As historical data is never perfect, the additional information paves the way for investors to make more informed investment decisions. They should also remember that a top or winning fund may not necessarily be the most suitable fund for them.
If you are comparing the performance of several funds, be sure that you are making accurate comparisons: compare fund with the same investment objectives and fund policies before looking at the numbers.
The value of investment may fall as well as rise and investors may/may not get back the amount originally invested. Changes in the currency exchange rates may cause the value of the investment to increase or diminish if you are investing in an offshore fund
Measuring Fund Performance
A unit trust fund’s performance can be measured by its total return. A fund’s total return is the change in the value of an investment in the fund, taking into account any change in the fund’s unit price during the period and assuming the reinvestment of income and capital gains distributions.
Total return is commonly presented in two ways. One is called the fund’s cumulative total return, or total rise in the value of a fund’s investments over time, assuming that income and capital gains distributions were reinvested. The other is called average annual total return, which is the compounded total return, it would take each year to produce the fund’s cumulative total return. Seemingly modest annual returns can be converted, through the power of compounding, into impressive cumulative returns. For example, an average annual total return of 7% would, after ten years, amount to a cumulative total return of 97%.
When evaluating fund performance, a good approach is to compare its total return with the returns of similar funds or with the return of an appropriate market index or benchmark over the same time period. A stock fund should be compared with other similar stock funds – ones that invest in the same type of companies. A bond fund should be compared with bond funds that invest in bonds of similar maturities and credit quality (rating). You can usually find the name of the appropriate market index or benchmark on a fund’s prospectus or manager’s (annual and semi-annual) report
Absolute or total return tells the investor how much the distribution-adjusted net asset value of a fund has changed over a specific period. It only addresses the funds return for a certain period against its peers, without considering its risk.
In contrast, the information ratio is a reward-to-volatility (risk) ratio. It is calculated based on the fund’s returns earned in excess of a benchmark such as its peer group average, taking into consideration the fund’s risk as measured by the standard deviation in its relative returns over measurement period. The information ratio tells the investor how much better a fund performed in comparison with its peers from the reward/risk point of view.
The information ratio is one of the most important tools used to measure the performance of a fund’s portfolio management. It is a straightforward way to evaluate the relative returns that the fund managers achieve, given the relative risk they take on, against a benchmark. All investors, no matter what their aversion to risk is, will obviously seek the highest information ratio possible. The higher the ratio, the more consistent and greater the fund return.
- Three-year time period;
- Fund A monthly average returns = 15%; and
- Fund B monthly average returns = 12%.
Many investors who do not know risk analysis would say that the better performing fund would be Fund A with its 15 per cent returns. However, when you go through a risk-adjusted analysis using the data such as the information ratio (see tables below), investors will see a different picture:
TABLE A : Risk-adjusted analysis of Funds A1 and B1 (Scenario 1)
|FUNDS||MONTHLY AVG. RETURN||AVERAGE RETURNEXCESS||EXCESS RETURN STD. DEV.||INFORMATION RATIO|
TABLE B : Risk-adjusted analysis of Funds A2 and B2 (Scenario 2)
|FUNDS||MONTHLY AVG. RETURN||AVERAGE RETURNEXCESS||EXCESS RETURN STD. DEV.||INFORMATION RATIO|
In the scenarios above, Fund B would be considered to have performed better than Fund A in terms of rewards versus volatility relative to their peer group performance. This is because the information ratio for Fund B is higher, although Fund A recorded higher absolute returns.
A rather complicated mathematical formula is used to calculate the information ratio, so unless you have a financial calculator, you may want to simply refer to published unit trust fund performance rankings.
Unit Trusts Fund Performance Rankings
Unit trust fund rankings, ratings or other evaluations of fund performance enables you to compare your fund’s past performance with other funds. Unfortunately, investors often interpret these rankings as recommendations, or even as projections for future performance, which they clearly are not.
Your best protection is to be an informed investor. Request prospectus from the funds you are considering and read carefully to understand the goals, risk factors, performance record and procedures for buying and selling shares.
Professional ranking services, financial magazines and investment newsletters are the most common sources for this information, but there are others — and not all present the same information or use the same criteria for evaluating funds. As an investor, you should be aware of how these reports differ and how this information can be used by you in making sound investment choices.
Rankings or ratings provide another piece of important information that can be used in the selection of fund investments, but they should not be used as the only basis for your decisions. You still need to do your homework on the funds you are considering. Identify your goals and evaluate a fund’s ability to meet your goals within your investment timeframe and at the level of risk you are able to accept.
All performance rankings and ratings show how a fund has performed in the past but does not guarantee that it will continue to do so. Rankings are a good barometer, however, for determining if a fund has been well-managed over the years, or if it has consistently performed in a particular manner.
Fund Volatility Factors and Classification
|Fund Volatility Factors and Classification|