QUESTION: Please explain unit trusts, how they operate and the risks and rewards of such investments.
PFA: A unit trust is an investment trust that issues and sells units to the public and invests the money so derived in investment instruments for the benefit of the unit holders, who become the joint owners of the pool of investment assets; they do not have a claim to individual investments.
Units are created and sold to new investors and redeemed when the unit trust buys back units from existing unit holders.
The unit trust is governed by a trust deed, which is a legal document made between the managers of the trust and the trustee for the benefit of the unit holders. It spells out how the manager and trustee should act in operating the unit trust thus protecting the investors or unit holders.
The trustee is a corporate body which is independent of the managers, acts as the custodian of the investments, cash and income of the unit trust and holds ownership of the investments in trust for the unit holders.
A management company is responsible for the day-to-day management of the unit trust. It is separate from the unit trust and has its own board of directors.
It earns income by charging management fees to the unit trust. Its functions include investing the funds of the trust, selling and redeeming units, valuing units, managing the financial and accounting affairs of the trust and promoting the trust.
It does not, however, own the investments of the unit trust and unit prices are not determined by the market but by the net asset value of the fund divided by the number of units, except in the case where a sales charge is added.
A unit trust generally sets up several investment funds. This allows it to invest the funds in ways which are suitable to the needs of the unit holders, whose reasons for investing are many and varied.
There are capital growth funds, equity funds, money market funds, blended funds, fixed income funds, to name a few.
These meet the different investment objectives of investors, who may also invest in more than one type of fund if, by so doing, they can structure their investments in the way that best enables them to realise their investment goals.
Investors may also buy units in more than one unit trust to capitalise on the varying investment styles and expertise of managers and as a means of managing risk.
Capital growth funds invest for capital appreciation so most of the investments they make tend to be in stock and real estate due to their ability to increase in value. But they are also liable to fall in value depending on market conditions.
Equity funds invest primarily in ordinary stock but, like capital growth funds, they may also invest in interest-bearing securities to earn some income and give stability to the fund.
Money market funds invest in short-term interest-earning securities. Fixed income funds invest mostly in medium to long-term interest-earning securities.
Blended, balanced, or mixed funds are generally highly diversified as they invest in a wide range of instruments including stock, real estate and long-term and short-term interest-earning securities.
They tend to be suitable for investors with a medium risk profile as opposed to investors in money market and fixed income funds who, are low risk takers, and investors in equity and capital growth funds, who are high risk takers.
Investors benefit from investing in unit trusts in several ways. Unit trusts are liquid; they can be converted to cash easily. They are described as open-ended because they are constantly issuing and redeeming units.
Unit holders redeeming units can receive payment the same day, though they may have to wait longer if the sum involved is high.
Unit trusts make managing investments easy for investors. The funds are managed by professional managers who do the required research and make the buy-sell decisions. Investors do not, therefore, need to worry about such matters.
Unit trusts make it easy for investors to diversify their investments as many of their funds are diversified, and in-vestors may also invest in more than one fund.
In many instances, investors are able to benefit from investment instruments that they would not have been able to invest in, due to them not having sufficient funds to make those investments.
In most cases, the minimum sum required to purchase units is small enough to facilitate even small investors, who get the same return as much larger investors.
Investors have easy access to how their investment is doing as unit prices are published in the national newspapers regularly and the managers themselves give such information upon request.
Investing in unit trusts is costly. In addition to the regular costs paid to brokers, for instance, the funds pay management fees to the managers and, in some cases, a charge is payable at the time units are purchased or, in other cases, when they are redeemed.
Although there are four unit trusts in Jamaica, generally, units tend not to be as readily available outside of Kingston as they are in Kingston.
Unit trusts are suitable for large and small investors, busy people, high-risk and low-risk investors, persons with little knowledge of investments and, though being liquid, are ideal long-term investments.Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of 'The Handbook of Personal Financial Planning', offers free counsel and advice on personal financial firstname.lastname@example.org