Deciding between a unit trust or an ETF

I recently wrote about how a R200 a month investment became worth R35 000 by just investing investing in Satrix 40, an index-tracking exchange traded fund.

I mentioned that the returns could have been even better if I had selected one of the top performing unit-trust funds.

A reader asked why I didn’t just switch the investment to the top unit-trust company. The catch is knowing in advance which unit trust will be the top performer.

It’s not surprising that investors have become dissatisfied about unit-trust returns and costs, when over the last five years only five out of 47 general equity unit-trust funds have beaten the Satrix 40 ETF. In fact general equity unit trusts in aggregate have underperformed the all-share index (J203) over the last five years by an average of 2,3% per annum.

So yes, if you had selected one of the five funds that outperformed (see table below), you would have done well, but otherwise Satrix 40 delivered a decent return without worrying about fund manager selection.

Why some unit trusts under-perform

Cash holdings
Nick Brummer of Investonline.co.za explains that a general equity unit trust will underperform a strong bull-market because it is required by legislation to hold cash to meet redemptions and this cash holding will reduce performance.

Resource boom
Over the last five years, resources outperformed the market by 20%. Brummer says unit trust fund managers have historically always been on average underweight resources. This is because resources companies by nature are cyclical and hence riskier and commodity prices are difficult to predict.

New guys on the block
Brummer says the underperformance is largely due to the proliferation of new unit trusts increasing to 913 from 550, of which general equity unit trusts increased to 82 from 44. The significance of this is that many of these new unit trusts have untested processes and limited experience, leading to their underperformance and dragging down the sector as a whole. In addition, some of these unit trusts have a more conservative investment strategy resulting in them underperforming in a bull market.

The sad truth is that the majority of general equity funds just track the index and at a higher cost than an index-tracking fund. But this is not a reason to ignore all unit trusts, just a reason to do your homework before investing and to understand when a unit trust can better meet your needs.

Brummer’s research shows that the top five “premium brand” unit trusts over the last ten years outperformed the Satrix 40 by 4,1% a year which meant that investing R10 000 in November 2000 into “premium branded” unit trusts would now be worth R58 141, verses R41 907 invested in the Satrix ETF, which is 38,7% more in value. But past performance is not a guareentee of future performance.

How to decide between a unit trust and an ETF

How much do you have to invest?

The “premium” brand fund managers tend to have high minimum investments of at least R500 a month. The Satrix range of ETF’s have a minimum of R300 per month. Most of the banks offer unit trusts for as low as R200 a month but the cost are high and these funds are not “premium” brands. If you are investing R2nbsp;000 a month you may want to diversify your investment across several fund managers through a platform such as Investonline.co.za

If you are investing a lump sum a fund manager that can protect your capital during more volatile markets may help you sleep better at night than an investment tracking the all-share index.

Do you want to research unit trusts?

If you just want a simple, no fuss R300 a month investment that will grow with the market and you don’t want to have to worry about which fund manager is top of pops, then an ETF which gives you the performance of the JSE all-share index is a good option.

You can get market outperformance by investing in ETF’s which track the Rafi (Research Affiliates Fundamental Index) like Satrix Rafi or Absa eRafi. This in an index made up of companies that are based on valuation rather than the size of the company.

Do you want more protection during market corrections?

With the high levels of volatility in our market, many investors do not have the stomach for the wild movements of the stock market. This tends to affect lump sum investments more than monthly debit-order investments.

A unit trust fund manager can follow a more defensive strategy than an index tracking fund.

Allan Gray, Nedbank’s Rainmaker Fund and Investec Value fund are good examples of this and they tend to outperform in weak markets. If you invest in a flexible unit trust or a balanced unit trust, the fund manager can move out of equities and protect your capital.

Although many people say they are long-term investors, if you need access to your investment during a market crisis, and had no defensive strategy you could lose a significant amount of money. You will also have exposure to other asset classes such as bonds and property which do outperform over certain periods.

The best performers

Average annual performance of five premium brands from November 2000 to April 2010

Nedbank Rainmaker: 22,2% p.a.
Allan Gray Equity: 21,7% p.a.
Coronation Top 20: 21,6% p.a.
Prudential Equity: 18,7% p.a.
Investec Equity: 18,1% p.a.
Average of top five 20,5% p.a

What is an ETF?

An exchange traded fund (ETF) is an investment vehicle which provides an investor with direct access to a basket of shares traded on stock exchanges such as the Johannesburg Stock Exchange (JSE) with the convenience of trading in a single security. Most ETFs track an index, such as the FTSE/JSE Top 40. ETFs are attractive as investments because of their low costs (total expense ratio TER) and the ability to purchase them like a normal exchange listed security. An ETF combines the diversified portfolio of a unit trust investment with the tradability features of a listed security allowing it to be bought or sold at the end of each trading day at the market ruling price.

Further information: www.etfsa.co.za

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