The Wide World of Unit Trusts - What is a unit trust?

Unit trusts have grown in popularity in recent years. It's not hard to figure out why. Unit trusts are the small investor's answer to achieving wide investment diversification without having to come out with prohibitive sums of money. And the benefits do not end at that.

But first, what is a unit trust? A unit trust fund is an investment scheme that pools money from many investors who share the same financial objectives. In exchange for the money, the fund issues units to the investors who are known as unit holders. Unit holders can sell (known as redeeming) their units back to the fund, or buy (and sell) further units.

Managing the fund

Meantime the fund is managed by a group of professional managers (known as the unit trust company) who will invest the pooled money in a portfolio of securities such as shares, bonds and money market instruments or other authorised securities to achieve the objectives of the fund. Because of the large sums collected, the fund manager is able to diversify among various investments in such range and diversity that the risks of investing are minimised.

Income earned

The total assets of the fund determine the value of the fund and the price paid by unit holders or the amount received when they redeem their units. The unit trust fund earns income from its varied investments in the form of dividends, interest income and capital gains. This income is then distributed to the unit holders in proportion to the units they hold, in the form of dividends or bonus units.

Protection for unit holder

As a unit holder, your protection within a unit trust is ensured in the way unit trusts are structured. Unit trusts are actually trusts. The protection is enshrined within the unit trust deed which spells out the respective duties, responsibilities and expectations of the three parties in the unit trust who are namely:
-The unit holders who provide the funds for investing;
-The unit trust company providing investment, administrative and marketing services; and
-The trustee company which holds the assets of the trust on behalf of the unit holders.
-There are three sources of information that you must examine when selecting a fund. These are the fund's prospectus, the trust deed and the financial statements comprising the annual and interim reports which are available for inspection, free of charge, at the premise of the fund manager.

Read the prospectus

The prospectus is a very important document as it sets out the fund's goals, investment strategies and policies and the risk-reward position it takes. It may be hard reading being full of legalese, but you must go through the fine print to ascertain that your goals and expectations match that of the fund. The financial accounts will show if the fund is sticking to its game plan and how well it is performing within the plan. Hence as an investor, you should consider the following factors when selecting a fund:
-Investment objective - it must be clearly stated or it gives leeway for the fund manager not to carry out your intentions of choosing the fund.
-Investment policies - the types of authorised investment and strategies should match your own convictions.
-Size of fund and growth trends.
-Any investment restriction, like minimum investment required.
-Level of risks with its investments - unit trusts don't completely eliminate risks.
-Types and amount of fees - understand them so that you will be left with no surprises.
-Historical performance on total returns on an annual basis, NAV (net asset value which is essentially the worth of each unit), expense ratios, and particularly the distribution of income to investors and growth of assets - so that you can gauge how well the fund has performed over time.
-Latest investment portfolio - so that you know the percentage of holdings in each kind of asset.
-Information on Board of Directors, key management team (especially the fund manager, auditor and trustee.