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Finding your way through the unit trusts in South Africa

25 May 2011 Nedgroup Investments

With over 900 individual unit trusts on offer in South Africa, one of the biggest challenges facing local investors is how to select one that will provide them with the best chance of meeting their long-term financial goals.

Anil Jugmohan, CFA, Investment Analyst at Nedgroup Investments, says that while there is no magic formula for choosing a unit trust that will meet your expectations, there are certain criteria worth taking into account. “The most important consideration when analysing a specific unit trust is to ascertain whether or not the fund is suitable for their individual needs and objectives. You need to consider your short- and long-term investment goals and your risk profile, while evaluating the unit trust in that context,” he says.

In order to do this, Jugmohan says it is crucial to understand the long term historic performance characteristics of the unit trust itself along with the asset classes underlying it. He warns that this assessment should be relative the fund’s benchmark as well as in absolute terms. A sound understanding of the potential risk/return outcomes is necessary, and this should be based on a thorough analysis of market valuations.

“Do not be tempted to react to short-term fluctuations as this will not give a true representation of long-term performance. Properly understanding the reasons for poor performance is critical. One needs to establish if it is of a short-term or permanent nature.”

He adds that it is also important to consider the reputation of the institution that is managing the fund along with their attitude towards Stewardship of clients’ capital. He advises potential investors to do as much research as possible about the specific product that will be used and to ensure that, prior to investing; they have thorough knowledge and understanding of the product.

“Investors should also be mindful of the tax implications of a particular investment strategy in the context of their overall financial plan. Your financial advisor should be able to assist you here,” he says.

When it comes to choosing a fund, Jugmohan says size does matter in that a unit trust can be too big or too small.” A unit trust that is too small will not benefit from economies of scale and may find it difficult to cost-effectively trade in shares and other instruments on the exchange.

“Unless costs are subsidised until the fund reaches critical mass, a very small unit trust will be unfairly disadvantaged by certain mandatory fixed costs that are incurred in the management of the portfolio and which effectively decrease portfolio performance.”

However, he explains that a unit trust that is too large, could find it difficult to be nimble. “A very large unit trust will find it difficult to invest in the majority of less liquid companies which could be offering good value. Therefore there are fewer opportunities for outperformance going forward.”

As a general guideline, Jugmohan says that a good unit trust should have the following characteristics:

- Managed by a good, reputable fund manager

- Reasonable fees to the client

- Transparency

- Appropriate benchmark

- Adequate levels of disclosure

- Widespread availability of appropriate investment-related information

- Regular dealing times (daily is the generally accepted standard)

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