How to avoid common pitfalls when choosing a unit trust
15 Aug 2018: Johannesburg
– WARREN INGRAM
Unit trusts form a big part of our investment landscape in South Africa, and many people have money invested in these products. The range of options is bewildering, and often it is very hard to tell the difference between two funds.
Sadly, most investors (often with the "help" of their advisors) will select a unit trust purely on the most recent performance. It is a well-known trend that the best performing funds attract the largest amount of new investments. This is a terrible way to select a unit trust, as the top fund today is often the worst fund next year! I am regularly asked by investors how they should choose the right fund, so I decided to share some tips to help you decide on the right fund for you.
What should the unit trust do for you?
Time plays a massive role in determining the right type of funds for you. If you are only planning to invest the money for a short period of time, i.e. one month to two years, you have to select a very low-risk fund that has no money invested in shares or property. If you plan to invest for 10 years or longer, you can take a lot more risk and invest in a fund that only has shares and property.
Low-risk funds are typically money market or flexible income funds, and are ideal for short-term savings, e.g. to save for a deposit on a house or to go on holiday in a year.
If you have three to five years to invest, you might need a stable, moderate or conservative fund. These are funds that invest some money in shares, but still hold a large portion in cash and other low-risk investments.
If you are investing for a period of 5 to 10 years, you can invest in a balanced fund, as these funds have a large allocation to shares, with a smaller allocation to cash and low-risk investments.
If you are investing for your young child’s university, you should invest in a fund that mainly owns shares and property. These are typically called General Equity or REIT funds. It is important to understand how much money you could lose in your selected fund if the stock markets crashes. It is pointless investing everything in an equity fund which might lose half your money in a big crash, if you know that you hate short-term losses.
It has been proven many times that funds with the lowest costs are often near the top of the rankings over longer periods of time. Costs can be a drag on performance. This means a well-run higher-cost fund can still do well for you, but the costs are always a disadvantage. The lowest-cost funds are not always going to be best performers, but they do have a better chance, as they carry less baggage (fees).
Index or active
History shows that only eight out of 10 fund managers can beat the market after costs. This is a scary statistic for fund managers, but the two out of 10 who do beat the market achieve significantly better growth – and therefore it is hard to ignore the performance potential of active funds. I feel it is better to combine your investments if possible – an active fund with one index fund.
The problem with investing, based on performance alone, is that the best performer today could be the worst performer next year. Property unit trusts provide a notable example. A year ago the top-ranked fund was dominating the sector; it was number one over nearly every period from one month to 10 years. However, as of the end of April, this fund is last in the rankings over one year – the worst performance out of 41 funds! It lost investors 9% over the year. The number one fund in April made investors 11% and was ranked in the top 10 a year ago. Be wary of always selecting the top fund as your main criterion.
Focus - investment company or generic product provider?
Is the provider of the unit trust a focused investment company, or is it a generic product provider that offers all types of financial products e.g. insurance, banking and investments? I like focused investment companies. However, some large product providers have recognised that they are not good at retaining the best fund managers themselves, so they make use of small, focused investment businesses on an outsourced basis.
Size and age of the fund management business
I prefer to follow fund managers for three years before I start considering them. A new fund management company might be brilliant, but the team will need time to learn how to manage money over different cycles. I am happier to invest with more established managers that have the necessary experience.
Each of these factors are relevant to your selection process, but they are not deal-breakers. For example, if a fund meets most of my selection criteria but is weak in one or two categories, I might still use it if I feel it is the best option.
Warren Ingram is a wealth manager at Galileo Capital. Views expressed are his own. Contact him on @warreningram.
About the Financial Planning Institute of Southern Africa
The Financial Planning Institute of Southern Africa (FPI), a South African Qualifications Authority (SAQA) recognised professional body for financial planners, which serves the public by ensuring that people who carry the CFP®
designation are qualified, experienced and professional. FPI has recently been approved by the South Africa Revenue Services (SARS) as a Recognised Controlling Body (RCB).
The Institute is also recognised internationally and is a founding, and a current affiliate member, of the international Financial Planning Standards Board Ltd (FPSB)
based in the USA, along with 25 other affiliate member countries who offer CFP®
certification, the highest recognised professional designation worldwide for a financial planning professional.
In 2012, FPI was highly commended by FPSB and awarded Tier 1 Affiliate Status for receiving 96% in the global assessment. This is the highest achievement any affiliate has ever received. For more, visit www.fpi.co.za
or follow @FPISANews.