Understanding Unit Trusts
The first ‘unit trust’ was launched in the United Kingdom in 1931 to rival American mutual funds. Since then, it has evolved and flourished throughout the globe. Singapore alone has over a thousand unit trusts for investors to choose from.
What is a unit trust?
First of all, let us clarify that the definition of ‘unit trust’ varies from region to region. In the USA, a unit trust has different properties from a mutual fund. But in the United Kingdom, both have the same meaning. Similarly, in Asia, the term is used interchangeably with ‘mutual fund’.
Going by the Asian definition, a unit trust is basically a fund where your money is pooled with other investors’ money. This fund is then used to invest in a portfolio of assets according to the fund’s investment objective and approach. That explains why ‘unit trust’ is sometimes just called ‘fund’ in short.
The portion of funds owned by investors are given proportional numerical values called ‘unit’. The profit from investments made under the fund then go directly to the investors – the ‘beneficiaries’ of the fund.
How did the term ‘trust’ come about then? The pool of investors’ money is managed by a fund manager. The investors entrust this fund manager, which can be an individual or a firm, to generate returns for them.
Most unit trusts adopt a trust structure but not all of them. A traditional fund commonly invests in bonds, equities and properties. Alternative funds arose in the recent past and these hold assets other than the aforementioned asset classes.
How does unit trust in Singapore work?
Both local and foreign funds offered in Singapore are regulated as a Collective Investment Scheme (CIS). These are generally open to anyone. Fund managers are appointed to manage funds or unit trusts. In return, they are paid a management fee from the fund based on a percentage of the assets managed.
Some unit trusts are more complicated and are categorised as Specified Investment Products (SIPs). Investors must be certified to have the relevant knowledge and investment experience before they can participate in SIPs.
How unit trusts make money
A fund is divided into units. Each unit is valued at a price via a set formula. Investors purchase units based on this price.
Fund Managers will purchase or sell the underlying assets represented by the unit trust and attempt to make a profitable return. This movement in the value of the underlying assets corresponds to the value of the units in the unit trust.
When the Fund Manager executes a successful (profitable) transaction, the total value of the assets that he is managing appreciates in value. This increases the value of each unit of the unit trust, and investors (subscribers of the units of the unit trust) would then have made a profit.
How is the price of unit trust determined?
The price fluctuates depending on the market value of a fund’s investments. Generally, the price of each unit is calculated by dividing the fund’s Net Asset Value (NAV) with the number of units outstanding.
The NAV is the market value of the fund’s net assets. If the prices of investments held by this fund change, the NAV changes accordingly. ‘Number of outstanding units’ refers to the total number of units allotted so far in this fund.
Funds are priced either by the “bid and offer pricing” method or the “single pricing” method. Details of the pricing method is provided in the prospectus and product highlights sheet.
The bid price is the price at which investors sell or ‘redeem’ their units. The offer price is the price at which investors buy or ‘subscribe to’ units. Both instances will occur charges issued by the fund manager.
Bid and offer pricing
In this method, the subscription charge is added to the NAV per unit, while the redemption charge is deducted from the NAV per unit.
The fund provides a single quote that reflects the NAV per unit. Then the subscription charges are deducted from the amount invested before the units are allocated. Redemption charges will be deducted from the redemption proceeds.
Comparison of the two pricing methods
The following is an example showing how a $1,000 investment is calculated for bid and offer versus single pricing.
|Scenario||Bid and offer pricing||Single pricing|
|Buying with $1,000 investment
· Initial 5% subscription charge
· NAV of $1.00 per unit
|Offer price per unit
= NAV of $1.00 + initial sales charge of 5%
Number of units bought
= $1,000 ÷ $1.05
= 952.38 units
With $1,000, you can buy:
952.38 units valued at $952.38
|Buy price per unit
= NAV of $1.00 per unit
Number of units bought
= $950 (5% sales charge deducted from $1,000) ÷ $1.00
= 950 units
With $1,000, you can buy: 950 units valued at $950
|Selling when NAV has increased to $1.15
· 1% redemption charge at sale
· NAV has increased to $1.15 per unit
|Bid price per unit
= NAV of $1.15 – redemption charge of 1%
= $1.138 × 952.38 units
If you sell your investment of 952.38 units, you receive $1,083.80.
This is less than the NAV of $1,047.62 ($1.10 × 952.38 units).
|Sell price per unit
= NAV of $1.15
= ($1.15 × 950 units) × 99% (Less redemption charge of 1%)
If you sell your investment of 950 units, you receive $1,081.57.
This is less than the NAV of $1,045 ($1.10 × 950 units).
Fees and charges
Unit trusts incur various costs which are then passed on to the clients as ‘fees and charges’.
Like any other investment, fees can reduce the returns from your investment. Furthermore, there are certain types of fees that are charged regardless of how well the fund is performing.
For your fund to grow in value, the returns must be greater than the fees and charges incurred. The Net Asset Value (NAV) of Unit Trusts reflects the fund value net of fees (i.e. fees have already been factored in deriving the NAV).
There are two broad categories of fees:
1) One-off fees and charges
2) Recurrent fees and charges
1. One-off fees and charges
If the fund has these charges, they will be charged once per transaction when you buy or sell your units:
a. Subscription fee or initial sales charge
- Also known as ‘front-end load’
- Ranges from 0% – 5% of your investment
- Payable to the fund manager or the distributor or agent when you buy units
b. Redemption fee or realisation charge
- Also known as ‘back-end load’
- Ranges from 0% – 5% of your investment
- Payable to the fund manager or distributor or agent whenever you sell your units
- Some funds progressively reduce the redemption fee if you hold your investment over a longer period.
c. Switching fee
- Usually about 1% of your investment
- Payable to the fund manager or agent when you switch from one fund to another that is managed by the same fund manager (if you are charged a switching fee, typically you would not be charged initial sales charges for that transaction)
d. Upfront charges
- Only applicable if you sign up for a wrap account with the distributor
- Ranges about 2% – 3% of new monies
- Payable to the distributor whenever you place new monies with the distributor (normally you would not need to incur initial sales charges, redemption fees or switching fees for transactions if you are on a wrap account)
2. Recurrent fees and charges
These are paid by the fund and include management fees, trustee fees and other fees. There are two types of recurring fees:
a. Fees that are payable by you
b. Fees that are charged to the fund
a. Fees that are payable by you
Included in this sub-category are platform fees and wrap fees.
- Incurred if you buy funds through a fund platform or financial adviser who uses a fund platform
- Ranges from 0 – 0.3% per annum of the total value of fund holdings
- Payable to the fund platform provider
Platform fees will be deducted from the cash holdings placed with the fund platform. If you do not have cash holdings placed with the fund platform, some of your fund holdings would be sold off to pay the platform fees.
- Incurred if you sign up for a wrap account
- Approximately 1% per annum of the total value of assets under the advice of the distributor
- Payable to the distributor
b. Fees charged to the fund
These are lumped under management fees and other fees.
Management fees or trailer fee
- Ranges from 0% – 2% per annum of the fund’s NAV
- Payable to the fund manager
- A portion of the management fees may be paid by the fund manager to the distributor to provide investors ongoing advice/service
- Starts from 0% – 50% of the fund’s performance
- Payable to the fund manager
- Also known as ‘profit sharing’, where the interest of the investors are aligned with the fund managers as the fund manager only earns Performance Fees should there be a positive return
- Typically paired with a High Watermark feature, where Performance Fees are only charged above the previous highest NAV value, ensuring investors are only charged once on profits earned
These are payable to the fund’s service provider such as the trustee, administrator, custodian, accounting and valuation provider and auditor.
The fees charged to a fund make up the total expense ratio (TER), which should be disclosed in the fund’s factsheet. The TER is usually between 1.0% and 2.5% of a fund’s NAV.
Types of unit trusts in Singapore
- Equity Funds – investments solely in stocks or shares of a company
- Fixed Income Funds – solely invested in bonds (loans to an entity to earn a fixed or variable interest for a set period
- Balanced Funds – a mix of stocks and bonds
- Real Estate Funds – investments with a focus in Real Estate
- Thematic Funds – investments with a focus on specific themes such as sustainability or technology
- Alternative Investment Funds – investments in alternative investment asset classes such as the Salzworth Global Currency Fund, which focuses on FX spot trading in G10 currencies.
Returns from unit trusts
Returns can be derived from two forms:
- Capital gain when the price of the unit is higher than the price you paid for
- Dividends that may be distributed by the fund each year
Will I lose money?
Your principal invested amount is not guaranteed. It is possible to “lose money” if your total value of redeemed units is lower than the initial investment.
Why invest in unit trusts
The answer to this: diversification of assets and risks. A unit trust gives you access to assets or markets that may be difficult or expensive for you to invest in directly. It is managed by a professional who is trained to buy and sell investments on your behalf, according to your level of risk appetite and investment objective.
How do I choose a unit trust?
Consider the following when making your choice:
1. What assets the fund invests in
Most funds in the market are broadly divided into five main categories: equities, bonds, thematic, balanced and alternative investments. Depending on the type of funds, some of them can also invest in assets or a combination of assets such as financial derivatives, money market instruments, eligible deposits and units in other funds.
2. Investment strategy or approach
Are you comfortable with the strategy or approach employed by the fund manager for this unit trust? The fund may be vested in certain countries, regions, sectors and so on. Different underlying risks are associated with these factors.
3. Risk and return profile
Different types of funds are suited to investors of different risk tolerance. One metric to consider is the largest drawdown; in other words, the biggest drop in value the fund has incurred since inception.
4. Passively or actively managed
Funds that are passively managed usually invest in assets of a benchmark index. This type requires less time investment by the fund manager. Actively managed funds require more active investment decisions by the fund manager, and tend to attract more fees and charges.
An alternative fund structure to unit trusts: VCC
The Variable Capital Company (VCC) framework launched in 2019 offers both investors and fund managers more investment options. The VCC enables alternative fund structures to be set up and to be re-domiciled in Singapore with more flexibility.
A few features of the framework may be of interest to investors:
- A Variable Capital Company can be used for different fund strategies, including open-ended funds, close-ended funds, retail funds and funds for Accredited Investors.
- It can also be used to hold multiple sub-funds with segregated assets and liabilities.
Unit trusts can be rewarding provided they are purchased with the correct understanding and expectations. Aside from all the other factors mentioned in the article, the timing of entry and exit of the funds also play a critical role in your profitability. One should invest in Unit Trusts with a longer horizon and not attempt to time the market.
Co-Founder, Managing Director
John has over 20 years of experience in providing multi-tiered services in the areas of fiduciary, tax, accounting, trust and asset management. His network includes ultra-high net worth individuals and families, corporations and conglomerates from ASEAN countries.
As a trained lawyer, John has been intimately involved in the set-up and implementation of his clients’ structures, often being able to value add beyond the original mandate.
John’s pride is seeing many working relationships with clients transforming into close friendships. Sharing the same vision with his partners and teammates, he aims to bring safe investments with good alpha returns to investors.