Investing in Unit Trusts

Some points on how to approach your investment decisions. Please also refer to our Recommended Portfolios section, which provides an excellent breakdown on how our investment team assesses and chooses funds.

Choosing a Portfolio

• All investors have a risk profile which is a measure of their appetite for investment risk (refer to the PLANNING section for more details).
• Investors need to take risk in order to generate return. Investors who don't take risk may have their capital eroded through tax and inflation.
• The most important factors to take into account in determining a risk profile are age, health and the investor's emotional tolerance of investment volatility. Other factors include investment goals and the number and value of other investments.
• Historically, equity-based investment has enjoyed the greatest growth but also the greatest volatility over time. Winston Floquet, Chairman of Fleming Martin has compiled a thirty-year analysis of the performance of investments with different underlying assets. His study shows that between 1960 and 1998 equities have turned in annual performances ranging from a high of 91% in 1979 and a low of -26% in 1970. Bond-based investments have traded in a narrower range. Bonds enjoyed a positive return of 40% in 1993 and a low of -18% in 1994. Fixed interest investments have turned in the lowest variability with positive returns ranging from 19% to 4%. Click here for an illustration.

Traditional advice is that investors should move into safer, fixed interest investments as they get older. However, as people live longer and longer there is a real danger that they move into fixed interest investments too soon, thus depleting their reserves.

Seeking Returns

Sector rotation and stock picking

Traditional fund management is based on the assumption that qualified experienced fund managers have the ability to do better than the average performance of an index, like the JSE All Share index. For this service they charge an annual fee of 1% or so.

Investing in the index

Index funds are funds that seek to replicate an index. The fund manager of an index fund sets up a mathematical model that buys and sells shares according to their weighting in the selected index.. Index funds perform best in an "efficient" trading environment - no insider trading, free flow of information and so on. Investors who invest in index funds believe that it is more likely that they will outperform over time, given the compounded effects of the reduced fees of index funds. In South Africa, index funds that track the All Share index generally outperform during a commodity upswing.

Diversification

Diversification is undertaken to optimise the level of return for a given level of risk.

Over Diversifying

Some investors invest in too many equity funds. They get the benefit of diversification, without the benefit of lower annual charges levied by index funds.

Compounded Investment Risk

Investors should guard against the effects of compounding investment risk by selecting shares in similar sectors or sectors that follow the same cycle. Designers of wrap funds and multi-manager funds have to guard against compounding investment risk.

Switching

Switching investments between funds has its place and used intelligently can be an effective tool to preserve wealth during times of market volatility. Most investors make the mistake of switching funds that have been the market leaders over the recent past. Generally, these funds do not maintain their performance over the longer term, and investors switch again, eroding their capital.

Unit trust management companies are launching more and more theme funds or sector-specific funds, which will experience under, median or out performance relative to the All Share index according to the economic cycle. These funds are not designed for a "buy and hold" strategy.