Investing in Unit Trusts

The secret to financial success

(Part 1)

This series of articles will provide sound financial advice that stands the test of time on how to protect and grow your wealth in simple language for anyone to understand and reach financial freedom and security.

Banks and finance companies can go bankrupt, stock markets can go up as well as down but the strategies explained in the articles will give financial literacy for you to take control of your finances away from institutions. In the first article we said that the secret to financial success lies in striking a balance between the present and the future and living within your means.

In the second article we described how to save by setting a financial goal and having a written financial plan and getting your money to work for you.This article discusses investing in unit trusts.

What is a Unit Trust?

For a retail investor, or for a seasoned investor, unit trusts offer a simple and effective way of saving money - they are also the perfect way to build a balanced and diversified investment portfolio, particularly if you do not have a substantial amount of money to invest. These are legal vehicles established to protect investors who pool their cash in a fund.The fund, in turn, uses this money to buy a portfolio of assets.

What is the difference between a 'closed-ended' fund and an 'open-ended' fund?Open-ended funds are allowed to issue new units and existing units can be redeemed on demand. As there is no limit to the fund size, they just become bigger to accommodate demand.

On the flip side, if there are more sellers than buyers, the fund will become smaller. The price is dependent on the value of the fund's underlying assets. In Sri Lanka, most unit trusts are open-ended funds.

Closed-ended funds have a ?xed number of issued units and do not issue new units after the closure of the Initial Public Offer.

Closed-ended funds are traded on an exchange to provide an exit and entry mechanism for investors who wish to redeem their investment and enter into the investment respectively.

The traded price of the closed-ended fund will rise and fall depending on supply and demand for the units, like shares of listed companies fluctuate with demand and supply, as the supply of units is limited.

Closed-ended funds generally trade around their net asset value or at a slight discount to the net asset value (NAV) until close to the maturity of the fund when the trading price begins to converge with the net asset value of the fund

Operating structure

The operating structure of a unit trust has been designed to safeguard your money. The Securities Exchange Commission of Sri Lanka (SEC) regulates unit trusts and requires fund managers to ensure that their investments are sufficiently liquid and diversified.

The regulations relating to disclosures in prospectuses also require fund managers to give true and adequate information about the unit trust to enable investors to make an informed decision about its merits and risks.

Approval by SEC does not guarantee the quality or pro?tability of the fund. Investors must do their own homework and assess for themselves the merits and risks of the unit trust before investing. Although a fund manager makes decisions on your behalf, they do not have access to your funds. In Sri Lanka, unit trusts are established by a trust deed. The trust deed is a legal document that sets out the working arrangement between investors, the fund manager and the trustee.

It spells out the investment objectives of the unit trust, and the responsibilities of the fund manager and trustee.

The trustee is always independent of the fund manager and acts as the custodian of the fund assets and ensures that the unit trust is managed according to the guidelines laid out in the trust deed to minimize the risk of mismanagement by the fund manager.

All unit trusts have a similar operating structure (see Figure 1) and therefore, there is no difference between a bank-owned unit trust and others. There has been no record of any unit trust fund defaulting payments in the 24-year history of the unit trust industry in Sri Lanka.

(To be continued next week)

The writer is the Group Director/CEO of the Candor Group and can be reached at [email protected]