What You Should Know
About Unit Trusts

April 18, 2019

If you are new to investing, it can be very intimidating. Not everyone is schooled in finance or accountancy. Even for first-timers schooled in finance or accountancy, it can be confusing. Not everyone has the same gung-ho risk attitude. Yet there is a fear of losing out when you hear boasts from people who say how much money they made from investing.

Where to start?

First, don’t believe the people who talk about how much they made. Remember, people seldom tell you when they lose. People are driven by greed and fear. Hence, they tend to buy high and sell low. Not the best investing strategy.

Second, know your own risk attitude. How much can you afford to put at risk. Yes, investing is about taking risks. But it not the same way you take risks when betting or gambling. Sadly, most people who say they invest are really betting or worse, gambling. Read my previous blog to understand why.

Third, decide your investment time horizon. That is, for how long you are willing to put your money at risk. As I explained in my previous blog, time tends to smooth out volatility.

So where to invest?

The short answer is globally and in a diversified way.

How?

Before I tell you, let me highlight some challenges in the way that people currently claim to invest. Let’s segment the market into (i) those with little experience and knowledge; and (ii) those with more experience and knowledge.

Those with less experience and knowledge tend to put their money where people persuade them to. They tend to invest in unit trusts (or mutual funds) and investment-linked insurance products.

Those with more experience and knowledge tend to decide for themselves, with many buying and selling stocks and shares listed on the Singapore Exchange or even those listed overseas. Some even trade leveraged products such as Contracts for Differences or other derivatives, including foreign exchange, which means greater risks - where the losses and gains are magnified.

In this blog, I would like to address those with little or no experience and knowledge.

Did you ”buy” or were you “sold”?

Many of you are invested in unit trusts and investment-linked products. I am sure you have your reasons. But if your reasons are because you were approached or persuaded to invest, do sit down and think. Was is a sales person at a bank or a pop-up kiosk in a shopping centre, a person with a clipboard inviting you to do a survey at the subway escalator or simply, a friend or classmate you are “supporting”? Whatever your answer, the real question is whether you can recall the product features and why you needed it. If you can’t, chances are that you were sold a product, and you did not intend to buy it. And chances are, you were sold a unit trust or investment-linked product. How can that be good for you? In this blog, I will cover unit trusts.

What is popular isn’t necessarily good for you

Well, unit trusts are apparently very popular. In the USA, there are over 15,000 mutual funds compared to only 2,800 listed securities on the New York Stock Exchange which suggests that mutual funds must be a money spinner for fund managers and their distributors. In Singapore, unit trusts dominate the retail investment market. According to the 2017 Asset Management Survey by the Monetary Authority of Singapore (“MAS”), assets under management (“AUM”) in Retail Collective Investment Schemes (“CIS”) which includes unit trusts rose 24% to S$101 billion. Obviously, like in the USA, it is a lucrative market for those managing and selling unit trusts in Singapore.

What’s good about unit trusts

A unit trust has pre-determined investment objectives (the fund’s mandate) and pools money from different investors to be managed by a professional fund manager who decides what underlying investments to buy and sell based on experience and research to maximise the fund’s returns.

A fund manager typically invests in a basket of investments to mitigate risks. Hence, unit trusts can lower the cost of diversification for an individual because the money is pooled, and the underlying investments are shared in terms of units. Further, unit trusts can give an individual exposure to stocks and bonds which would require substantially much more money than the individual can afford. This diversification also allows the individual to get exposure to overseas markets and asset classes which may not be normally available to small individual investors.

Unit trusts are good for first time investors especially if the fund manager is reputable and has a good track record.

What’s not good about unit trusts

Unit trusts are manufactured to be overseen by trustees and managed by specific fund managers whose names brand these products. As they are typically not listed on exchanges, the fees and charges levied on the individual investor are higher than other investment instruments such as Exchange Traded Funds (“ETFs”). Unit trusts incur management, trustee, marketing, accounting, trading commissions and distribution costs. These add up to the Total Expense Ratio (TER), which can range from 1 per cent to 2.5 per cent of the AUM. Over time, these costs add up to erode returns. Worse, these fees are payable whether the unit trust makes money or not.

There is no real-time access to your share of the unit trust. You only get historical reports and only high-level breakdowns of the unit trust, usually on a quarterly basis.

Unit trusts typically need a minimum investment amount. Liquidity is limited as prices of units are only indicative. There is a time lag between your decision to redeem units and the actual money value of what you will get.

Unit trust managers tend to be relatively active in buying and selling the underlying investments to justify higher TER. Yet there is ample independent evidence to show that active managers do not necessarily add commensurate value for the fees charged over time. Studies show that over time, actively managed unit trusts are less likely to beat the market index, and variations in returns can be attributed to random chance.

ETFs – the new game in town

For some time, unit trusts brought more benefits than disadvantages. However, I would suggest that unit trusts are no longer the only game in town.

ETFs are investment funds traded on the stock exchange. While most of the ETFs were originally created to replicate the performance of specific market indices, ETFs have grown significantly since the original launch of SPY to track the S&P 500 Index in 1993. In just 25 years, ETFs are the most disruptive development in asset management. In 2018, the USA ETF market reached $3.5 trillion in AUM across 2,200 ETFs. If we include ETFs listed on non-USA exchanges, total ETF assets are a massive $4.6 trillion!

ETFs offer cheaper, simpler and direct exposure to asset classes across the world – across equity and fixed income, developed and emerging markets, currencies, metals, commodities, sectors and even specific investment strategies. For example, “smart beta” ETFs which diverge from broad, market-cap-weighted indices were first developed in 2003. Since then, the smart beta space has grown to 33% of the total number of ETFs and 20% of total assets. In 2008, ETF innovation saw the introduction of active and leveraged ETFs. Active ETFs are a developing trend, accounting for 11% of all existing ETFs.

Interestingly, ETFs are still largely ignored in Asia. Smart investors should take heed. The advantages of ETFs over mutual funds are, among other things, lower costs, the possibility of tracking the performance of the whole market rather than investing in single stocks, and potentially better investment results, as active fund managers tend to underperform the market.

So, should you still invest in a unit trust?

In my opinion, ETFs is the new game. They allow easy diversification for smaller minimum investment amounts than most unit trusts. Your portfolio would be easily globally diversified, at much lower expense ratios and with greater price or valuation transparency than unit trusts. Why? ETFs are exchange traded and there is a reference price set by the market. For unit trusts, there is at best, an indicative price (because of the time lag between closing markets and calculating unit prices). Liquidity of ETFs is much better than unit trusts, and money flows are more efficient and timely for ETFs.

So, why are all ETFs not well-known or widespread in Singapore?

It goes back to why you bought, or rather, were sold a unit trust in the first place. Unit trusts earn good fees for the managers and distributors compared to ETFs which are traded on an exchange for which only a small commission is charged.

The current market and dominant players simply have little incentive to earn less fees since you are so ever willing to pay high fees!

At SquirrelSave, we offer globally diversified ETF investment portfolios. Our machine learning AI does the selection and ongoing monitoring, making all the necessary asset allocation changes tailored for you, regardless of how much you invest. You see, our AI approach does not discriminate between a $50 account or a $50 million account. I will share more about why it’s time to use AI in place of the traditional human investment manager – and help you invest the right way. No need for knowledge, except to know your own risk capacity, risk aversion and time horizon. Check out my previous blog that talked about risk profiling.

SquirrelSave is part of a growing global movement to democratize the investment market and level it for the average man. At SquirrelSave, we hope to open market access for the un(der)served in Southeast Asia.

What about you?

If you have existing unit trust investments or you are new to investing, you have to decide if managing risks should come before chasing returns. If your answer is “yes”, SquirrelSave is your choice.

[1] “High fund expense ratios put Singapore retail investors in bind”, The Business Times, 13 Aug 2018
[2] “More evidence that it’s very hard to ‘beat the market’ over time, 95% of finance professionals can’t do it”, Mark Perry, American Enterprise Institute, 20 Mar 2018
[3] www.etftrends.com

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