Today, anyone can do a quick internet search for “Unit Trusts” (UT) and thousands of hits will appear. As we know, not all information on the internet is reliable, and there are many half-truths about investing in UT. Like every financial product, UT has its fair share of supporters and naysayers, I will like to attempt to dispel some of the common misperceptions from the general public and experienced UT investors, and offer the other side of the coin for the discerning investor to consider so that you may consider UTs in your investment portfolio to accumulate wealth and be more financially-free.

This article is extracted from my bestselling book Huat Ah! Building wealth in Singapore with Unit Trusts, now available at all good bookstores in Singapore.  I have shared 5 points out of the 8 points found in the book.

A. High UT fees reduces profit and increases loss

The upfront fees, annual management fees and other applicable fees are all costs to the investor and will certainly reduce his/her net profits. If costs are the greatest concern to the investor, he/she should buy UTs online, instead of meeting up with a representative of the distributor. He/she can also buy UTs that track the indices, examples of UTs in Singapore that track the indices are: Infinity European Stock Index, Infinity Global Stock Index and Infinity US 500 stock index. They are passively managed and feed into the Vanguard European Stock Index fund (tracks the MSCI Europe Index), Vanguard Global Stock Index fund (tracks the MSCI World Free Index) and Vanguard US 500 Stock Index Fund (tracks the Standard & Poor’s 500) respectively.

 

These three UTs from the Vanguard Group track and replicate the index and will thus have lower costs, compared to their active fund manager counterparts. Almost all UTs in Singapore are actively managed, making the three Infinity UTs the minority.

 

Most investors will not mind paying higher fees as long as the performance justifies it. An analogy can be found with gym users: there are always clients who would rather pay more to get a personal trainer to motivate and structure the training to see results faster. Buying UTs through a representative or actively managed UTs certainly entails higher upfront fees compared to the online purchase of UT and passively managed ETFs.

 

However, UTs are not long-term commitments compared to insurance plans and if after two to three years, the investor feels there is little benefit or the services of the representative does not meet expectations, he or she can easily transfer the holdings out to another platform with lower fees or to another rep to manage.

B. UT returns are too slow and too little

Most UTs hold over 30 securities/companies; this obviously leads to slower returns than individual stocks. However, as a result of holding many companies diversified across different sectors of the economy, most UTs typically drop less dramatically than individual stocks during a recession. Better managed UTs may drop less than their benchmark.

 

That UT returns are slow and too little is not entirely wrong. This is because, unlike other wealth instruments like FX (currency) or shares, etc., it is not possible to use leverage, margin trading or contra to invest in UTs in Singapore. The investor must pay the upfront sales charges in full to invest in UTs sold in Singapore, only when the monies are cleared can the fund manager make purchases. This makes UT less ‘sexy’ and more suitable for a medium-term investment of at least three years. However I have never heard of anyone in Singapore going into debt, becoming bankrupt or even committing suicide because of UT investments.

 

Investing in UT is boring; it hardly gives investors 5% returns in a single day, less common of 15% in a single week and rarely do any UTs in Singapore benefit from merger and acquisition news or stock buyback news to see their NAV soar over 50% in a single month. However, George Soros once said: “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.” The investor needs to be conscious of whether he/she is investing or speculating.

 

Many investors remember the Singapore penny stock crash saga in Oct 2013 when the share price of Blumont, Asiasons and LionGold tumbled almost 90% in a week, because of Blumont’s management’s inability to satisfy SGX enquiry of how they grew their market value over ten times in just 18 months. Blumont shares used to be 2 cents a share, with a single lot (1,000 shares) costing $200 in Mar 2012. On 1 Oct 2013, before the speculative bubble burst, it was $2.50 a share, and a single lot would cost $2,500 (an amazing growth of 12.5 times or doubling investors monies 3.5 times in only 1.5 years). Blumont’s share closed at 1.9 cents on 24 Dec 2014 and investors were back to square one. Greedy speculative investors with a punting mentality who bought many lots at more than $2 and held on until today are still badly burnt especially when the closing share price on 20 November 2015 is just $2 for 1 lot or a thousand shares (that is a drop of 1,250 times from its peak price). The gains from shares, especially penny stocks, can be very fast and tempting and is even more dangerous if leverage is used. I have never heard of any UT sold in Singapore with a peak and trough as dramatic as these penny stocks.

C. Fund managers are restricted by the UT’s investment objectives

The other criticism of traditional UTs is that fund managers must keep to the investment objectives even during recessions. For example, they have to stay invested even when the price of their companies free fall, cannot sell out, and are mostly not allowed to hold >10% in cash any point of time. The fund manager has to adhere strictly to the investment mandate and objectives at all time, otherwise the trustee has to report it to the regulators. There are two sides to every coin and the good thing about UT fund managers having to walk a tight rope and constantly being supervised by the trustee with regular audits is that it safeguards investor monies; otherwise many of the fund managers will have absolute power and liberty to invest in any company they desire. This certainly sounds like a red flag and I will urge investors to better stay clear of unregulated/low supervision investments.

 

To circumvent this restriction, the investor can first take advantage of the free switching offered by a wrap account or fund switching that all UT platforms have and switch out to Money Market (MM) or short duration high grade bond UT. MM UTs are known to preserve value and maintain high liquidity to give returns on par with SGD deposits. The investor can switch out of equity UTs entirely into MM UTs at any time to take shelter before or in the early days of the recession.

 

The other way to address this concern is to own a diversified portfolio of UTs with investment mandates that give the fund managers more room to invest so long as they maximise total returns in the long run. The investor will have to look carefully at the UT factsheet and study the UT objectives and holdings well, or they can consult their Reps. An example is the Hedge Fund UT that can make money for the investor even in a bearish market (Man AHL SGD Trend). Another example is a multi-asset UT like (Blackrock Global Allocation fund), where the investment objectives states there is no prescribed limits to the percentage of equities to bonds that the fund can hold as they adopt a flexible investment style. An observation about this UT as at end of September 2015, they were holding 22.8% of the total fund size of US$22 million in cash equivalents, an uncommonly high percentage for most Singapore UTs. Thus investors who want their monies to be managed by fund managers with greater autonomy with a more flexible mandate can choose UTs like the Blackrock Global Allocation fund.

D. Investors should buy UTs with bigger fund sizes

People tend to equate having more and being bigger as being more successful, for example, restaurants with more outlets must be more popular and have better food? However, does this hold true in the investing world? For big fund size UTs, with billions in Asset Under Management (AUM), there may be benefits associated with economies of scale, such as sharing of management fees, transactions costs, opportunities especially for bigger bond fund UTs (where certain MNCs or countries will prefer to borrow $500 million from one source versus $100 million from five different sources).

 

The question of whether a fund is big in its size is relative to the investment objectives and style of that particular UT. Some UTs investing in large cap companies (companies with a net market value above US$1 billion) may function better if they have a bigger fund size whereas UTs that specialise in buying small and medium cap companies may see performance suffer by having too big a fund size.

 

To give an example, two UT fund managers, one managing $100 million AUM and the other managing $500 million AUM, both decided to invest 10% of their AUM in a certain company. The fund manager about to invest $50 million may face more problems because the market value of small and medium cap companies is smaller, meaning $50 million will be more likely than $10 million to drive up the share price and create speculative problems.

 

Fund managers with bigger AUM investing in smaller and medium cap companies will thus have little choice but to spread their investments across more companies, some of which may not exactly be among the manager’s first choice. The UT managers will also not want to buy too much equity in single small-mid cap companies, which may result in them having a controlling stake, and hence management responsibilities, in the company.

 

Being small can be beautiful too, as fund managers can be more nimble and can afford to be more selective in buying companies as their resources are limited. For example, take Warren Buffett, who first started Buffett Associates Ltd with six other investors and approximately US$105,000 capital in May 1956. The first 20 years saw phenomenal growth of those pioneer investors’ funds. He famously lamented in 1999 that he could generate higher annualised returns if only he had lesser monies (he coined it the “fat wallet challenge”).

 

It is good to look at current fund size of the UT before investing and investors should be more concerned if there is a change in either direction of the fund size. Too rapid a drop in fund size would get the attention of most investors as it could signal an impending recession, or outflow to a competitor UT. Fewer investors are aware that too rapid a growth in fund size could spell trouble as well, especially for UTs with objectives that invest in small to medium companies as it may cause performance to be diluted.

 

More investment funds will pour in rapidly when the UT receives awards or gets mentioned by renowned analysts. Distributors will tell its sales force to sell that particular UT. This may cause the best years of the UT to be behind them and could be a signal for investors to switch to another UT because managing $20 million and aiming for a 6% annualized growth is certainly easier compared to managing $200 million and expecting the entire $200 million to also grow at 6%. Therefore, I will advice it is not size that matters but if the fund size is optimal for the category and investment style of UT; volatile investment inflows and outflows in their fund size may in fact disrupt the strategy of the fund manager. Hence big or small size funds have pros and cons, and it is more important for investors to keep a lookout, identify and monitor the UT’s fund size closely every two to three months.

E. UTs are always cheaper and more value for money at launch

Many investors ask me if they should buy new UTs at launch. I advise them to wait at least two to three months for the fund house to produce their first fund factsheet. Without this, investors do not have factual information on the UT’s top 10 holdings, track record and fund size, meaning they will not know the expense ratio, etc.

 

UT new launches are different from a company IPO (Initial Public Offering) because, unlike IPOs of companies where the number of ordinary shares to be offered is fixed as the valuation of the company was already done, UTs can issue an indefinite number of new units. Therefore it is rare and almost impossible for a new UT launch’s NAV/unit to rise to a premium on the first day, regardless of the buying or selling activity and level of over or under subscription to push up/down the NAV/unit.

 

In Sept 2014, the Ali Baba IPO closed higher by 38% at the end of its first trading day but I do not think many UTs will even close higher by 3.8% at the end of its first full week of inception. At the end of the first day, the UT portfolio is represented as 100% cash with no securities to have an appreciation in the NAV; moreover there are costs for the launch, management fees, etc.

 

There are pre-launch costs most UTs have to incur: marketing and advertising campaign to broadcast their launch, legal and regulation costs, printing costs, etc. These costs can exceed a few million dollars, which is amortised over a period of time as expenses of the UT and invariably will reduce the NAV/unit.

 

Another reason against buying new UTs at launch is that they are probably overpriced. Most new UTs are launched when markets are bullish on that particular theme or sector or region. It is easier to launch and market a UT at a time when the investment objective is ‘hot’ and ‘in’ so response to the launch will be good and the fund manager can raise more funds. This also means that the prices of the underlying companies in the UT holdings are more expensive since it is a bull market and these are current flavours of the market.

 

If the UT raised a big capital as its initial fund size, it may lead to bigger problems because most fund managers are restricted by the mandate to hold under 10% of the fund size in cash. Therefore he/she has to invest the initial large sum of cash in a rising market to purchase the companies, which at present could be overvalued especially if the UT was launched near to the peak of its market cycle.

 

Lastly, do not invest just because of the sales charge discount or vouchers that the distributor or the fund managers usually offer for newly launch UTs. Look at the fundamental objectives of the UT as well as look through the prospectus and background of the fund managers. The investor can proceed to invest if he has done all the research and feels that the UT launch is only at the start or middle of the recovery phase, and there is still plenty of future upside to the NAV of the fund, coupled with the promotions and other savings at launch.

 

The writer Derek Gue, is a financial strategist and can be contacted at bwutbook@gmail.com to give personalised advice on your UT portfolio. .