Ins and outs of unit trust investing

HANNA ZIADY:  We are taking a look this evening at the ins and outs of unit trusts. Gary Booysen, who is portfolio manager at RandSwiss joins is in the studio for this discussion. Good evening, Gary, and welcome.

GARY BOOYSEN:  Hi, Hanna. It’s good to be here.

HANNA ZIADY:  It’s good to have you with us. Gary, let’s start with a very straightforward question. When we talk about unit trusts, what do we mean?

GARY BOOYSEN:  It’s interesting. Thanks for having me on the show. If you look at my background, I’m actually a stockbroker, so I’m going to come at unit trusts with a very different point of view, probably, than the average financial planner.

HANNA ZIADY:  Which we welcome.

GARY BOOYSEN:  Which you can welcome but I’m probably not going to be as kind to unit trusts as a unit trust manager would be.

A unit trust essentially is a CIS structure, which is a collective investment scheme, where investors club together, they pool their funds and then using that almost economy of scale can use those funds to go and buy a diversified portfolio. That can be across asset classes as well. So it could be a stock portfolio, it could be a combination of stocks and bonds, it could have a money-market component, it can have property in it as well. And obviously there is a huge variety of unit trusts out there.

I think unit trusts originally came about because that was trying to make investment simpler for people. They didn’t want to do complex stock analysis and they didn’t want to go and have to understand the balance sheet of a company and the future prospects of it. So they handed it over to a professional manager. I think we now have more unit trusts in our market than we have stocks.

HANNA ZIADY:  Maybe 1 500 unit trusts – 1 480 I think.

GARY BOOYSEN:  There are between 300 and 400 stocks listed on the JSE, of which the liquidity that these guys can invest in is probably only the top 150.

HANNA ZIADY:  Something’s gone wrong.

GARY BOOYSEN:  Maybe it has gone wrong but it’s a very saturated market I think in South Africa. Again, it is a very handy tool for investors to go into, but what this has spawned as well is now the fund of fund managers, who are people who go and say the unit trust has become such a complicated product in itself, you need to use us, as an intelligent investor, to help you select the right fund manager so that we can put a basket of funds to target the right risk profile.

The stockbroker in me is saying this is just adding various layers of fees to your investment and what you essentially want, as the end-user of a financial product, is your exposure to the asset that’s generating the income that you are either going to receive via capital appreciation or via an income distribution.

So for me I would still say that with a personal share portfolio, by entering the stock market directly if you are buying blue-chip stocks or perhaps looking at some of the passive products which have cut the fees down dramatically, you will probably end up saving a lot of money just by removing the fees.

HANNA ZIADY:  We are going to get to fees and passive products in a minute – very important things to consider. Give us a few examples of fund of fund managers. You mentioned that they are the experts that are going to help you choose the right unit trust. Just give us an idea of who those would be – what sort of companies

GARY BOOYSEN:  I could give you an exhaustive list. But there are all sorts of fund of fund managers. Sygnia, for example, is a known multimanager. Again, it depends very much. I’ve just sort of tarred and feathered fund of fund managers.

HANNA ZIADY:  If you are a fund of fund manager and you are listening and you’d like to phone and defend yourself–

GARY BOOYSEN:  Just complain, that’s fine. I think there are a lot, especially when you move into the hedge fund space or more complex products. If you look at someone like Tower, for example, there is definitely a place for the fund of fund manager when you get into very complex structures. And a simple…retail investor is not going to be able to read that fact sheet and understand quite the products that they are investing in and the level of risk that the fund manager is taking. So there definitely is a place for fund of fund managers – but, like anything, I think it can be abused.

HANNA ZIADY:  Let’s assume I don’t want to invest directly on the stock market, I don’t feel confident enough to have my own personal share portfolio, I’m not au fait with company balance sheets, I can’t decide which stock to choose, presumably then unit trusts would offer some benefits. And on what basis would you choose a unit trust?

GARY BOOYSEN:  Don’t get me wrong. I’m quite negative on the unit trust industry, but there are a lot of pros.

The one is the economy of scale. So when you do club together in a unit trust, you are going to get far lower trading costs.

The other obvious benefit of a unit trust is that you have far lower entry criteria. If we were doing a personal share portfolio for someone, you really have to start with about R250 000 in your portfolio because we need to get optimum diversification in a balanced stock portfolio. You are probably looking at picking up between 15 and 20 stocks. If you are looking at a minimum trade size of R10 000 to R20 000, because costs have come down, you run out of money very quickly.

So ja, looking at how to select a unit trust, the first thing you need to look at is probably your time horizon. So you need to understand what asset allocation is inside the unit trust – are you going for something with a heavy stock allocation, are you going for something with a combination of stocks and bonds, what is the money market component? You want to look at the geographic diversification of the fund as well. So you want to see how much they are investing in the local market and how much is invested offshore. Most of that information can be found on the fact sheet on the website of the fund that you’re looking at.

HANNA ZIADY:  A very important fact that you raise is I think in terms of the money you have to invest. Some unit trusts will enable you to invest as little as R300 or R500 a month, which is great if you are starting out and you don’t have R250 000 to put into a stock portfolio.

You mentioned fees. Because we know that fees have a massive impact on the long-term value of your investment eventually, how do you decipher what the fees actually are, what it is that you are actually paying for the unit trust?

GARY BOOYSEN:  Regulation of the unit-trust industry has increased dramatically. If you are looking at a unit-trust manager, the basic fee they are going to be charging you is the management fee. That historically could have been as high as 2 to 3%. So if you look at an investment over 20 years, the compound effect of losing, say, 2% a year is significant. I did some calculations earlier. If you invest R250 000 into a unit trust, if you just drop your performance by 2% over 10 years you are probably going to earn about 30% less gross. So it’s significant.

But looking at the fees again, within that you’ve got your management fee, you’ve also got to look at the type of performance fee your fund manager is going to charge you. But all of that is wrapped up into a nice ratio for you called the total expense ratio. Again, that will be reported on the fact sheet. You need to look at these things, because it can be excessive.

Again, because I’m a stockbroker, I’m going to have to go back to managed stock portfolios. In a managed stock portfolio you will probably pay and all-in 1% fee and you’ll have perfect transparency on your transactional cost as well. Now that is maybe a little more opaque than some of the  structures that collective investment schemes use.

HANNA ZIADY:  Now let’s look at active versus passive. Gary has already warned me that he is going to defend active managers, but I will challenge that. We carried an article on the Moneyweb site earlier this week which effectively showed that index-tracking funds, which are passive funds that simply track an index, actually often beat actively managed funds. And this is despite the fact that actively managed funds tend to charge more. That’s certainly true over a sustained period of time. So why do we insist, Gary, on giving our money to active fund managers?

GARY BOOYSEN:  [Chuckling] An interesting question. I suppose we insist because we feel that there is a human making these selections, which I think is a valid concern. If you look at it, this is creating a vast pool of zombie money in the global economy. To allocate capital to businesses based on the sight of their market cap, for example, is not a valid allocation of capital. You need active managers. There is a role for active managers, there is no question.

HANNA ZIADY:  But those humans are charging us lots of money.

GARY BOOYSEN:  Absolutely, and I think that is the problem. If you look at it, you said we allocate capital to active management, strangely, in spite of the fees. But really I think it is those fees that cause them to underperform in the long run as well. If you look at some of the fee structures, they are excessive. If you consider what our market does, 13, 14% on average over the past ten years compounded, there are not many managers that are outperforming that. I think one in five is the stat on managers that outperform. But a lot of that I think is because you are not getting the transparency on the product and you probably are paying a lot more fees. Again, if I look at it in the context of trading portfolios and I look at it in the context of personal share portfolios, we regularly see investors outperforming benchmarks.

HANNA ZIADY:  Retail investors.

GARY BOOYSEN:  Retail investors. And it’s based on very simple trading premises as well – good diversification, low churn rates where you hold on to the buy-and-hold strategy, that kind of thing, which just reduces your costs. You can outperform passive investments. And again, it’s easy to say a passive investment outperforms an active investment. What did the market do if you were in Satrix 40 last year – 5%. Active managers were outperforming well last year.

HANNA ZIADY:  In times of volatility they certainly do come into their own.

GARY BOOYSEN:  At the same time there is a vast array of different passive strategies, so it’s also easy to pick and choose and say this active manager didn’t outperform that passive strategy. But if you start looking at some of the more complex passive strategies, like Satrix Rafi, for example, there is almost an active component underlying that. So it is a debate and I’m valiantly defending active management.

But also, we do use passive products constantly. There are core and explore strategies and they are fantastic products, especially to get simple entry. The one thing that I can also mention is that passive products aren’t free either. A lot of these passive products you actually have to look at; there are various different passive products that you can buy on the local market to get Top 40 exposure. Each one has a different total expense ratio as well. You have to be aware. Each one has a different tracking area as well. So you have to be aware of the product that you are buying. But again, you can find that on the fund fact sheet.

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