Mon | Mar 8, 2021

Oran Hall | A close-up view of unit trusts

Published:Sunday | January 24, 2021 | 12:07 AM

I tend to recommend the unit trust to people who want to invest in securities for the first time, because the funds they offer are professionally managed, thereby relieving investors of the responsibility for researching specific securities, and they are diversified and units are easy to acquire and liquidate.

The tendency, though, is for prospective investors to ask about investing directly in the stock market.

Nothing is inherently wrong with investing directly in the stock market, but it requires time, an understanding of how it operates, knowledge of the companies, the ability to understand the performance of companies even at a basic level, and the willingness and capacity to take the risk associated with that type of investing.

I quite understand why investors want better returns, considering the very low nominal returns generated by interest-bearing securities, often below the rate of inflation, thus meaning a negative real return. Depending on others to advise what to buy, when to buy and when to sell without knowing why is not the best course to take.

Investing in unit trusts initially, and mutual funds, which have a different legal structure but operate in essentially the same way, is less risky and has several benefits.

The section in the Financial Gleaner, a supplement of the Friday issue of The Gleaner, which reports on the unitised funds, including unit trusts and mutual funds operating in Jamaica, has very good material for current and prospective investors.

These collective investment schemes comprise several investment portfolios, or funds, which provide investors with a wide range of options. Some funds invest in local securities and others in global securities. There are money market funds, bond funds, real estate funds, mixed funds, equity funds, the last three types being capital growth funds.

Investors interested in ordinary shares only have the opportunity to invest in any of the equity funds. In fact, they may invest in more than one such fund as a means for benefiting from the expertise of more than one fund manager. This is one form of risk management and diversification.

Such funds invest in a wide range of companies, so the prices of some may increase while others are decreasing, but unit prices will generally increase in favourable market conditions. It should not be surprising to see some fixed-income securities in these funds, because the managers need to keep the funds earning at all times. Investors will not receive dividends, as the funds re-invest them to contribute to the growth of the fund and the unit price.

An equity fund may outperform or underperform a particular stock, but that is to be expected. Nevertheless, the performance of such a diversified portfolio will tend to be more stable than that of a single stock or a small portfolio of stocks.

Whereas there are generally analysts to do research to inform buying and selling decisions, individual investors have to do their own research or read the research briefs that may be published by stockbrokers and other analysts.

Other than equity funds, investors interested in stocks may buy units, in the case of unit trusts, or shares, in the case of mutual funds, in mixed funds – also called blended funds. Such funds may include equities, real estate, money market securities and bonds. Their unit values do not vary as much as those of equity funds. They tend to underperform equity funds in a strong stock market, but outperform them in a weak stock market.

Money market funds and bond funds are best suited to investors who are not inclined to take high risk. Their returns are generally lower than the returns of the capital growth funds when the values of stocks and real estate are rising, but often better when they are declining.

The report in the Financial Gleaner gives the composition of the funds, the price of the units, the percentage change in the value of the units for the 12-month period to the date of the report, as well as the return from the beginning of the year up to the time of the report.

The reports are historical, so investors should not expect to get the same returns and should bear in mind that the returns they make should be computed from the time they invest to the point at which they are calculating their return.

In most cases, the report shows one price (for buying and selling) for the units of each fund. Where there are two, the selling price is what they would pay for the units and the buying price is what the unit trust or mutual fund would pay when the investment is being encashed.

When comparing funds, investors should compare a fund with one similar to it, a money market fund with a money market fund, for example. Similar funds will vary in their performance in the same conditions because of their policy and strategy, the securities they select, and what portion of their funds they place in particular securities and type of securities.

The report at the end of December 2020 shows negative returns for the capital growth funds but positive returns for the money market and bond funds. Expect the former to outperform the latter when the stock market changes course.

- Oran A. Hall, principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and