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Selecting unit trusts one of the biggest challenges for local investors

27 September 2012 Anil Jugmohan, CFA, Investment Analyst at Nedgroup Investments
Anil Jugmohan, CFA, Investment Analyst at Nedgroup Investments

Anil Jugmohan, CFA, Investment Analyst at Nedgroup Investments

There are hundreds of unit trust options available to South African investors - however not every unit trust is suited to every investor – making the selection of a unit trust one of the biggest challenges facing local investors, ie how to select one th

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 one’s individual needs and objectives,” 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 to 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 understanding of market valuations as well as the manager’s philosophy and process.

“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 planner should be able to assist you here,” he says.

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

- Managed by a reputable fund manager

- Reasonable fees to the client

- Transparency

- Appropriate benchmark

- Adequate levels of disclosure

- Widespread availability of appropriate investment-related information

“When it comes to choosing a fund management firm, Jugmohan adds that size does matter in that the firm can be too big or too small.” A firm 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, as well as to access premium research reports.

“Unless costs are subsidised until their funds reach a suitable size, a very small unit trust portfolio will be disadvantaged by certain mandatory fixed costs that are incurred in the management of the portfolio and which effectively decrease portfolio performance.”

However, Jugmohan also explains that a fund management firm that is too large could find it difficult to be nimble. “A very large firm will find it difficult to invest in the smaller, less liquid companies which could be offering good value. Therefore there are fewer opportunities for outperformance going forward,” he adds.

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