A unit trust, also known as a mutual fund, is an investment managed by a professional fund manager. The manager combines money from different investors, known as unit holders, and invests it in a range of assets to achieve specific financial goals. According to the Capital Markets Authority (CMA), assets under unit trusts increased from Rs. 206.6 billion in September 2023 to Rs. 215 billion by December 2023. By 29 February 2024, annual effective returns ranged from 6.8% to 17.42%, with many schemes delivering returns above 10%.
If you want to grow your savings and investments, unit trusts can be a suitable option. This article explains the basics of unit trusts, including how they work, how fund managers operate them, and how investors earn returns. It also outlines the investment process, explains how dividends are paid, and highlights the advantages and disadvantages to help you make informed financial decisions.
What is a unit trust?
A unit trust is like a mutual fund where money from many investors is managed by a fund manager to make a certain return. The manager invests in bonds or shares, creates a portfolio, and splits it into units which investors buy.
Unit trusts are popular with people who want to invest in a mix of assets but don't have the time or knowledge required. The value of investments can go up or down, so you may end up with less money than you started with.
Key takeaways
A unit trust is a mutual fund where investors own units instead of shares in a company
- Unit owners are called unit-holders, holding rights to the trust's assets, with registrars serving as intermediaries
- The fund is managed by a professional and typically includes a variety of assets
- A unit trust's beneficiaries are the investor and the fund manager who oversees the trust's investments
How is a unit trust managed?
Unit trust fund management is overseen by fund managers who direct and manage the trust's portfolio. Trustees ensure that the fund manager follows the trust's investment goals, acting in the beneficiaries' best interests. Unit owners are called unit-holders, holding rights to the trust's assets, with registrars serving as intermediaries.
How do unit trusts make money?
Unit trusts generate income based on the total number of units multiplied by the unit price, minus fees and costs. The unit price is determined by dividing the fund's net asset value (NAV) by the total number of units. When money is added to the trust, more units are created at the current price. When units are withdrawn, assets are sold to match the current unit price.
Fund managers earn money from the difference between the buying price (offer price) and selling price (bid price), known as the bid-offer spread. This spread is influenced by the managed assets.
Where do unit trusts invest?
A fund manager uses a unit trust fund to invest in a variety of securities across different asset classes. These investments are usually grouped by asset type, geographical region, and industry sector.
Examples of asset classes include equities, fixed income, and property. Investments may also focus on specific regions such as the UK, Japan, the US, or global emerging markets. In addition, funds can be invested across industries including energy, real estate, utilities, and healthcare.
By spreading investments across different asset classes, regions, and sectors, fund managers aim to diversify the portfolio and reduce overall risk. This approach helps avoid concentrating all investments in one area, which may be more vulnerable to market changes. Diversification can improve the balance of the portfolio and provide greater stability over time. It is often described as avoiding putting all your investment eggs in one basket.
How can you invest in a unit trust?
Investing in unit trusts offers various avenues, such as acquiring income units or accumulation units. Income units furnish regular payouts to investors, whereas accumulation units reinvest earnings into the trust. The choice between these depends on individual and financial circumstances, along with the trust's dynamics. Assessing risk levels and return potentials across unit types is crucial. While unit purchases are available directly from fund management firms, consulting a broker or financial advisor for tailored guidance is advisable.
Are unit trusts low-risk?
Unit trust risk depends on the underlying investments the trust holds. Generally, diversified unit trusts that spread their holdings across different asset classes (stocks, bonds, commodities) tend to be less risky compared to investing in individual stocks. However, some unit trusts may focus on specific sectors or high-growth companies, which can be riskier but potentially offer higher returns.
How do dividends work in unit trust funds?
Unit trusts may distribute a portion of their profits to investors periodically (monthly, quarterly, or annually) as dividends. The amount you receive is based on two factors:
- Number of units held: The more units you own in the trust, the larger your share of the dividend payout will be.
- Declared dividend: The unit trust company determines the dividend amount based on their overall profitability.
How do you grow your wealth with unit trusts?
Unit trust growth comes from two potential sources:
- Capital appreciation: The underlying value of the assets held by the unit trust can increase over time. As the unit price reflects the combined value of these assets, an increase in their value leads to a rise in the unit price, potentially generating capital gains when you sell your units.
- Dividend income: Regular dividend payouts from the unit trust can provide a steady stream of income, contributing to your overall wealth growth.
Remember, unit trust investments are subject to market fluctuations. While diversification helps manage risk, there's no guarantee of profit. A long-term investment horizon and a well-diversified portfolio containing unit trusts suited to your risk tolerance are key factors for potentially growing your wealth over time.
Pros and Cons of a unit trust
A unit trust has advantages and disadvantages, just like any other type of investment.
| Advantages | Disadvantages |
| Mentored by a financial expert | The fund manager is responsible for the trust's performance |
| Investments in a diverse portfolio are included in one unit. | Fees for management |
| There is no commitment or set investment period needed. | The principal amount is not certain |
How do unit trusts differ from mutual funds?
A unit trust fund and a mutual fund are types of investment pools where people invest together in many different stocks, bonds, or securities. The big difference is how they are bought and sold.
A unit trust fund lets investors buy units in the fund, which go up or down based on the total value of the assets. The price is set once a day, and investors can trade units at that price.
A mutual fund lets investors buy and sell shares directly from the fund company at the end of each trading day. The price is based on the value of the assets. Mutual funds may have different types of shares with varying fees.
Both unit trust funds and mutual funds give diversification and professional management, but the main differences are in how they work and how they are traded.
Investment trusts vs Unit trusts
Investment trusts and unit trusts often invest in similar types of assets, but there is an important difference between the two. A unit trust is an “open-ended” investment, which means there is no limit to the number of units available. As more people invest, the fund increases in size. In contrast, an investment trust has a fixed number of shares. These shares can be bought and sold between investors, but no new shares are created.
Unit trusts are generally more flexible, but they can also experience greater fluctuations. This is because the fund may need to buy back units from investors who choose to leave, causing the fund size to reduce. Investment trusts tend to offer greater long-term stability because the number of shares remains fixed. Since shares are simply traded between investors, the overall structure of the fund stays more consistent over time.
Conclusion
In simple terms, when you invest in a unit trust, your money is combined with others to create a fund. The manager invests this money in different things, divides it into units, and you hope that the value of these units goes up over time. Finally, you can sell your units for a profit.
Unit trusts are generally good investment choices for beginners and experienced investors. They spread your money out over many different investments, so you face less risk. You can easily buy and sell units when you want.
However, as with any other type of investment, consider the risk involved with unit trusts. There are fees to pay for management, even if the fund doesn't do well. You have limited control over your investment, as it is managed by someone else. There is a chance that you could lose some or all of your initial investment. So, invest wisely and only after thorough research.
