The basics
A unit trust is a structure that allows investors access to
a wide range of underlying securities, via a single holding of units. A fund
manager, working on behalf of those investors, takes responsibility for all the
investment decisions made by the unit trust. The name “unit trust” derives from
the fact that a separate trustee becomes the legal owner of any securities
bought by the fund.
Why would I want to buy a unit trust?
The advantages of this structure include;
- The expertise of the fund manager in specific geographies and underlying investments
- The diversification that stems from the fact the fund will hold a wide range of securities
- The economies of scale that come from running a single mandate for many investors
- The light administrative burden placed on investors who only have to worry about units in a single fund rather than a broad portfolio of securities.
What sorts of investment do fund managers make?
The mandates, which set out what a fund is for and how it intends to invest, can be created to cover many different investment strategies. Some funds specialise in a particular area of the world (for example, emerging markets), while others may focus on a particular group of securities (say, UK growth stocks) or those which play to a particular theme (such as sustainable investing). Investors should make sure that they are clear on a fund’s mandate and, ideally, review its disclosure of the biggest holdings to understand how it is being executed.
What will this cost me?
Unit trusts can levy charges in a number of ways;
- One-off initial, or exit, charges
- Ongoing fees, typically a fixed percentage of the value of the assets under management
- Performance fees linked to the fund exceeding a certain target level of returns.
It is therefore important that investors find out about the level of fees before investing and understand the impact they may have on future returns.
How are units priced?
Units are not like shares, in that they do not trade in an open market such as the London Stock Exchange. Instead, investors deal directly with the fund itself – when they want to buy or sell units they do so to, or from, the fund.
Pricing is determined by the fund too. A valuation exercise is carried out, typically once or twice a day, to determine the value of the assets under management. Broadly speaking, this figure is then divided by the total number of units in issue to create a unit price. Until this exercise has been carried out, investors may experience a short delay when it comes to knowing what units are worth.
Another twist is that some funds are “single priced” – meaning investors can buy or sell units at the same unit price – whereas others are “dual priced” and operate a bid to offer spread. In the latter case, the price at which investors buy units will be above the price at which they can sell, a feature which adds to the overall cost of investing.
Gating
This one is a consequence of the pricing mechanism that links a fund’s unit values to its underlying net asset value (NAV), is the fact that if a lot of investors wish to sell units together, the fund manager will need to ensure that there is sufficient cash available to buy them back (or “redeem” them). Should these instructions to sell exceed the available cash, the fund manager may be forced to start liquidating investments within the trust to meet demand. Since this could create a downward spiral, as other market participants realise that a fund is having to dump investments quickly, sometimes a unit trust suspends trading in its units to facilitate this process. Such a move is known as “gating”. Whilst, in theory, a unit trust can later emerge from this process in a stronger position, having successfully managed redemptions.
Costs
As the earlier section above makes clear, there are quite a few ways for unit trusts to levy charges and not all of them are necessarily obvious. It is therefore important that investors are clear about these before investing as heavy costs can exert a considerable drag on returns.
Transparency
Another drawback with unit trusts is that investors may not have the full picture on what is held within the fund. Whilst certain disclosures are mandatory – such as the top holdings – fund managers argue that full disclosure of all holdings would weaken their competitive position. As such, investors need to have faith in the fund manager’s ability to stick with a specified mandate and avoid what is known in the industry as “style drift”.
What are the drawbacks?
Whilst unit trusts are well-established and remain a very commonly held style of fund, they are not perfect. Investors should be aware of some of the drawbacks, the first of which stems from their somewhat unique unitised structure
What are the alternatives to unit trusts?
These issues may lead some investors to consider another structure, called the investment trust. These may offer a very similar investment mandate but via a holding of openly tradeable shares in a listed investment trust company. These can be bought and sold in the same way as shares in any other company. This avoids the problem of gating mentioned above but comes with some other quirks, such as the fact that the shares owned by its investors may trade at a discount or premium to the fund’s underlying assets. Once again, investors also must remain alert to costs.
For other investors, another route is to invest in a portfolio of direct shares chosen by an Investment Manager. The advantages can include greater transparency and a better mandate “fit” when it comes to choosing the underlying investments. As to cost, this will depend on the size of the overall investment, with funds generally being more cost effective than direct portfolios for smaller amounts.
These differences are important and therefore well worth understanding and discussing before making an investment decision.
This short guide should be enough to get you started on the road to planning your family’s finances. Please fill out your details below to download a free PDF version or contact us at [email protected]
