INTRODUCTION TO A UNIT TRUST FUND
What Is A Unit Trust Fund?
A unit trust is a collective investment scheme that pools money from many investors who share the same financial objective. The fund is managed by a group of professional managers who invest the pooled money in a portfolio of securities such as shares, bonds and money market instruments or other authorised securities to achieve the objective of the fund.
A unit trust is a collective investment scheme that pools money from many investors who share the same financial objective. The fund is managed by a group of professional managers who invest the pooled money in a portfolio of securities such as shares, bonds and money market instruments or other authorised securities to achieve the objective of the fund.
The Unit Trust Framework
The diagram below illustrates the basic framework of unit trust in Malaysia.
The Regulatory Framework Of A Unit Trust Fund
The SC is responsible for the regulation of all matters relating to unit trust funds under the Securities Commission Act, 1993. It has a set of guidelines for unit trust funds designed to safeguard the interests of the investing public and to facilitate the orderly development of the industry. Appointments of key participants to a unit trust fund, such as the appointment of management company, board of directors, chief executive officer, investment committee members and Shariah adviser, also comes within the regulatory purview of the SC.
Benefits And Risk Management
Investing in a unit trust fund enables the investors to enjoy the benefits and advantage of diversifying their investment and assets. All investments carry risks and investing in unit trust funds is not an exception. The value of the unit trust fund’s underlying investments changes from day to day, which in turn affects the value of the unit trust fund. As a result of the changing value of the underlying investments, the value of your investment in a unit trust fund can go up or down over time.
* Benefits
Professional Management
By investing in a unit trust fund, investors are able to benefit from the expertise of professional investment managers who in turn are able to draw upon specialised research, market information and the expertise of a variety of third party investment analyst whose services would not normally be available to individual investors.
Diversification Opportunities & Minimisation of risks
Due to the large pool of funds available, a unit trust fund has more financial muscle compared to a direct investment in the stock market by an individual investor as he is therefore able to diversify more effectively (i.e. investments could be spread out more widely amongst a broad spectrum of securities than would have otherwise been available to an individual). This broad exposure helps spread and reduce risk. Minimisation of risk is achieved by investing in different types of asset classes, securities or sectors so that losses in one asset class or some securities or sectors will probably be offset by gains in other stocks.
Liquidity
It is more convenient to buy and sell units in a unit trust fund rather than investing directly in shares of companies where prices and opportunities to transact depend on the supply and demand at that material time.
Ease of Transaction
A unit trust fund provides investors with simple, convenient and a less time consuming way of investing in securities than investing directly.
* Risks
General Risk
Management Company Risk
The performance of a unit trust fund depends on the experience, knowledge and expertise of the investment manager and the investment strategies adopted. The risk remains that the securities which the investment manager has selected will not perform as expected and this could cause the fund’s returns to lag behind similar funds’ returns.
Liquidity Risk
Liquidity risk refers to the ease with which a security can be sold at or near its fair value depending on the volume traded on the market. The unit trust fund may have no choice but to sell that security below its fair value due to low trading volume which in turn could cause the fund’s portfolio to decline in value.
Results Not Guaranteed
As a result of risk elements described herein, the returns from unit trust funds are not guaranteed. Investment returns and the principal value will vary when sold, an investment may be worth more or less than when purchased.
Loan Financing Risk
Investors must be aware of the inherent risk involved with loan financing of a unit trust fund, which should include the ability to pay the loan instalments, which may be affected by unforeseen circumstances such as an increase in interest rate and the ability to provide additional collateral should the value of investment fall below a certain level.
Risk Of Non-Compliance
The unit trust fund’s objective may be affected should the management company and the investment managers not adhere to the fund’s investment mandate. To maintain the fund’s integrity, sufficient internal policies, controls and monitoring must be in place to protect the interests of Unit holders.
Inflation/Purchasing Power Risk
Inflation reduces the purchasing power of money i.e. it is the risk that your investment return fails to keep pace with the inflation rate. Therefore, to maintain an investment’s purchasing power, its total return must keep pace with inflation rate. In an inflationary environment, fixed rate securities are exposed to higher inflation risk than inflation-linked securities.
* Investment Risk
Interest Rate Risk
This risk relates to unforeseen movements in the direction of interest rates. Generally, interest rates and fixed income securities value are inversely related; as interest rates rise, the resale value of fixed income securities falls, and vice versa. Generally, bonds are more vulnerable to this risk than other types of investments. Rise in interest rates could cause the bond market and individual securities in the fund’s portfolio to decline in value. Unit trust funds that hold such securities could then experience a decline in their net asset value. Interest rate risk is a general economic indicator that will have an impact on the management of the unit trust funds regardless of whether it is a Shariah-based unit trust fund or otherwise. This does not in any way suggest that Shariah-based unit trust funds will invest in fixed income securities, which are not approved by the Shariah. All investments for Shariah-based unit trust funds will be in accordance with Shariah requirements.
Credit/Default Risk
Credit risk arises when there is a possibility that the issuer is unable to pay interest due and/or the principal amount on time. The value of the fixed income securities will decline if there is a default by the issuer or there is deterioration in the credit quality of the issuer. This could then affect the investment performance and net asset value per unit of the unit trust fund.
Market Risk
This is a class of risk that inherently exists in an economy and cannot be avoided by any business or company. It is usually due to changes in the economic outlook and affects broad market confidence. Market risk cannot be removed from an investment portfolio by diversification. Investors should, therefore, note that the performance of a unit trust fund might go up or down in accordance with the prevailing market risk.
Specific Risk
This class of risk represents the risk unique to a particular company due to company-specific factors such as capital structure, quality of management, nature of business and others. These factors could cause the appreciation or depreciation of the securities issued by that company. The net asset value of the unit trust fund with significant exposure to that company could be expected to fluctuate. This risk may be greatly reduced through diversification.
Currency Risk
A risk that a business operations or an investment value will be affected by changes in exchange rates. For example, if money must be converted into a different currency to make certain investment, changes in the value of the currency relative to the Malaysian Ringgit will affect the total loss or gain on the investment when the money is converted back.
Country Risk
It relates to the likelihood that changes in the business environment will occur that reduce the profitability of doing business in a country. These changes can adversely affect operating profit as well as the value of the assets.
Alternative Savings/Investment Vehicles
Alternative investment products to unit trusts are deposits in financial institution, equities, derivatives and property investment. Unlike direct purchases in individual stocks, unit trust fund products provide investors the opportunity to pool their savings for the purchases of diversified portfolios of permitted investments. This will enable investors to invest in different types of investment instruments (such as stocks and bonds), thus enabling them to reduce risk. Fixed deposits, on the other hand, are generally safer with guaranteed returns though the returns may stand a higher risk of significant erosion from inflation as compared to investment products.
Fees And Charges Imposed On You
Sales Charge/Entry Fee
You may be imposed with sales charge/entry fee when you invest in unit trust funds. Some fund such as bond funds may not impose any sales charge/entry fee.
Exit Fee
Some funds may have an exit fee which is incurred when you liquidate your investment.
Switching Fee
Switching fee is an administrative fee which is imposed on all switches between equity and non-equity funds.
Transfer Fee
Transfer fee is an administrative fee which is imposed on the transfer of units to another beneficiary and between accounts of the same beneficiary.
Operating Expenses
Operating expenses, which are paid from the funds’ assets, include annual management fee and trustee fee for its services, audit and other professional fees, commissions paid to brokers in effecting the investment transactions of the funds, tax and duties imposed by the authorities, fees for the valuation of any investment of the fund by independent valuers for the benefit of the fund, costs incurred for the modification of the deed of the fund other than those for the benefit of the Management Company or trustee as well as cost of convening meetings of Unit holders other than those convened by or for the benefit of the Management Company or trustee.
Understanding Performance Indicators/Benchmarks And Management Expense Ratio
The performance indicators, such as total return and average annual total return, serve to help investors evaluate the potential risk and reward of investing in unit trust funds by noting changes in the unit trust funds’ performance from year to year. Total return measures the change in the price of a unit trust fund, assuming that all distributions are reinvested and should be evaluated in light of the fund’s particular investment objectives and policies, as well as general market conditions during the reported time periods.
Benchmarks are adopted to measure the performance of unit trust funds. For instance, an equity fund that focuses on Malaysian equities can adopt the Kuala Lumpur Composite Index (KLCI) or FTSE Bursa Malaysia 100 index while Shariah based equity fund typically adopts the Kuala Lumpur Shariah Index (KLSI). Bond funds may utilize fixed deposit rate as the benchmark. In the case of a balanced fund, it is a norm to use composite benchmark, for example 50% of the composite is calculated based on the percentage change of the KLCI while another 50% of the composite is calculated based on fixed deposit rate.
The Management Expense Ratio (MER) is a useful way to compare the costs of investing in a fund with the cost of other similar investments. MER is the ratio of the total of all the fees incurred in a financial year and deducted directly from the fund (including annual management fee, the annual trustee fee, the auditor’s fee and other professional fees) and all the expenses recovered from and/or charged to the fund (including cost of printing, stationery and postage) expressed as a percentage of the average value of the fund.
Typical Profile Of A Unit Trust Investor
An investor of a unit trust fund typically:
- wants to accumulate wealth over the medium to longer term in meeting financial objectives such as retirement or education funds;
- seeks diversification as a means to manage risks associated with different types of investments;
- has insufficient time or access to material to conduct research on the various types of investment and assets available to him/her;and
- wants investment professional to manage his/her money.
The Various Types Of Unit Trusts
What Is Bond and Fixed Income?
A bond is a debt security issued by a borrower who intends to raise funds . A holder of this debt is thefore owed the amount that binds the borrower to it with several variations of collateral or conditions that are specified to be met by the borrower.
In Malaysia, bonds are issued by the Malaysian Government, Corporations, financial institutions, goverment agencies or sometimes specifically structured vehicles.
The features of a bond include its nominal amount, price, its issue date, maturity date and a fixed or floating coupon if there is. Other examples of optional features may include but not limited to a guarantee (explicit or implicit), collaterals, charges, financial conditions and a rating.
These bonds or fixed income securities (a term commonly used inter changeably) are traded in the Malaysian financial system amongst banks, corporations, other financial institutions like insurance companies, government agencies like pension funds and unit trust companies. The underlying purpose is to invest in an instrument that provides a given yield for a given period of time based on interest rates, credit , liquidity and economic conditions to meet the objectives of the investor.