What are Unit Trusts?

Stokvels, mutual funds, equity funds, unit trusts - to thousands of South African investors all of these are more or less the same thing. To a certain extent they are quite right. Many individuals cannot accumulate large enough pools of money to give them access to an expensive service or product. In the case of Stokvels - the original term was probably "stock fairs" - the individual then uses the pooled money to buy goods in bulk at a lower price, or to negotiate better returns or loans at low rate of interest.

Unit trusts work in very much the same way. They obtain something that is almost impossible for individuals - blue chip shares. Shares are the main commodity traded by the Johannesburg Stock Exchange. Some types of shares - known as blue chip shares - are in demand and are therefore expensive. Examples of blue chips are Driefontein gold mines, Suncrush and South African Breweries. Daily newspapers publish the prices of these shares and many others on their financial pages.

The high prices of some shares have been as effective as a Yale lock and an iron bar in prohibiting investors from purchasing them. A golden key to unlocking these riches is now in the hands of even the most modest investor. That key - unit trusts - is available to everybody.

Unit trusts are not insurance products. Many insurance companies who market life assurance, retirement annuities and other related products, also act as management companies for unit trusts. Along with life assurance, retirement annuities, etc., unit trusts fulfill a very important role in the individual's portfolio.

How do they work?

Unit trusts are the pooled resources of thousands of investors who have entrusted their money to a management company.

The management company buys shares on the Johannesburg Stock Exchange on behalf of the investors. The trust does not give the shares to the investor, but combines them in a portfolio. The management then divides the portfolio into many equal "units." The investor receives a certain number of units for the money he has entrusted to the company that manages the unit trust.

The Johannesburg Stock Exchange represents the main sectors of the economy. These are gold, other mining, mining houses and industry. The unit trusts represent each of these four sectors in their units. A fifth sector - liquid assets or cash - completes the contents of a unit trust portfolio.

Anyone can buy units by investing a single lump sum or by investing on a regular monthly basis. In most equity or share investments there is always an element of risk. Fluctuations of share prices on the JSE cause this risk and are also responsible for their increase or decrease in value.

However, the fluctuations in unit trusts are often not so severe. Shares that show a stable or better performance cushion the drop in price of other shares. This is especially the case with the general unit trusts, where risks are lower than in the specialist trusts because the general unit trusts gain exposure to more sectors.

A barometer of the country's economic health is the Johannesburg Stock Exchange. Share prices generally rise in a healthy economy. In an ailing economy, prices will fall and subsequently so will the price of units in a unit trust. That is the bad news!

Bad news becomes good news

Unit trusts utilize the bad news to create good opportunities for investors. In simple terms, the drop in share prices means that more units can be purchased on behalf of the investor for the same amount of capital.

When the downturn cycles (bear markets) are over, the share prices will be lower. The trusts will be able to purchase more units with the same amount of investors' money. The larger number of units purchased then offer a bigger opportunity for growth in an upturn of the market.

This is also why unit trusts are not usually a short-term investment. They are able take advantage of both the downturns and the upturns. Therefore the reasoning is that, the longer the period of investment, the lower the risk.

What are their advantages?

The most obvious advantage of unit trusts is the direct access investors get to wealth creation and profits of the Johannesburg Stock Exchange. Everyone, regardless of occupation, qualifications, sex or age, can share in this industry that opens the door to every sector of the South African economy.

The beauty of unit trusts is that the investor needs no expert knowledge. The individual doesn't require experience in buying or selling or a knowledge of shares. Teams of professional economic and market analysts will invest on the investor's behalf to ensure the maximum capital and income growth.

With a small regular monthly amount (between R20-R50 depending on the company) or a low single lump sum (between R100-R500 depending on the company), you can share in the biggest and best the economy has to offer investors.

Clearly you don't need to be a millionaire to share in the advantages unit trusts have to offer. Protecting one's buying power has become a major problem, especially in a country with a high inflation rate. Unit trusts are consistently proving their worth by beating inflation over the medium to long term, while giving capital growth.

For example, when the inflation rate was well over 14% in 1990/1991, the compound annual growth of unit trusts was above 20% on average and, in certain unit trusts, as high as 25% and even more!

Because of their proven track record, unit trusts have become an ideal way of providing for medium-term needs. Investing in unit trusts can meet your needs for a deposit on a home, an education for your child or owning your own car. Unit trusts are therefore medium to long-term investment avenues (five years and longer). For short-term needs such as buying clothes or groceries, paying rent and those unexpected emergencies that we all have to deal with, a savings account will do.

The Receiver of Revenue is also a hazard that investors have to cope with when ensuring the best returns for their money. In the case of unit trusts the advantages are on par with the returns. The total interest income from all sources up to R2 000 is tax free, as is dividend income, while capital growth is normally totally tax free.

With retirement annuities, life policies and fixed deposits, investors must meet particular requirements before they can turn their investment to cash. With unit trusts you have direct access to the money invested. On receiving a written instruction, the management company will immediately sell the investor's units at the prevailing price.

The investor will receive his money shortly afterwards - usually within three to five working days. The advantage this has for taking care of a sudden financial crisis, is obvious. In addition, you can invest for as long as you like. You do not sign a contract committing you to invest for a certain period.

These investments are extremely flexible and one can change from a single lump sum to regular monthly investments. One can increase or decrease the amount according to one's individual needs. Few other investments are as accessible and flexible as unit trusts!

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