IN LAST week's focus on unit trusts, also known as mutual funds in the United States, we discussed the merits and drawbacks of the investment instrument.
While they are more affordable than blue chip stocks or property, investors must bear in mind that a slice of their capital sum has to be shaved off for the fees incurred. This is just like the commissions and clearing fees one has to pay when buying and selling shares.
According to Franklin Templeton's regional sales trainer Chris Tse, there are typically four types of fees in unit trusts.
All other things being equal, the higher the costs of the fund, technically known as the expense ratio (all fees and expenses expressed as a percentage of the fund's average net assets), then the higher the returns required before the fund starts making money that goes into your pocket.
The first is the sales charge. This is the initial sum, usually up to 5 per cent of your capital, incurred for the purchase. But unlike stock purchases, where one usually has to make an upfront payment on top of the capital invested, sales charges for unit trusts are typically deducted from the capital.
Fund managers also charge an annual management fee for looking after the assets in the fund, so that investors can be relieved of monitoring them themselves. This is deducted on a daily basis and already computed into the price of the fund, but can range between 0.5-2.25 per cent on an annual basis.
The sales charge and the annual management fees are the typical costs of unit trusts. Some funds and distributors are known to also charge service, maintenance, or performance fees, depending on the nature of the fund and whether advisory is required.
All other things being equal, the higher the costs of the fund, technically known as the expense ratio (all fees and expenses expressed as a percentage of the fund's average net assets), then the higher the returns required before the fund starts making money that goes into your pocket.
For a clearer illustration, Young Investors' Forum asks Franklin Templeton's Mr Tse to explain the calculations of returns and fees in the examples below.
Assumptions
Principal sum = $1,000
Sales charge = 5 per cent
Annual management fee= 1.5 per cent
(After deducting the sales charge of 5 per cent, the initial investment = $950)
If the price per unit of the unit trust is $1, then the investor will end up with 950 units of the fund, after accounting for the sales charge. Similarly, if the price per unit is 95 cents, then the investor will have 1,000 units.
Assuming that the unit trust makes money from the first year onwards, Table 1 shows what the performance could potentially look like.
However, not all unit trusts make money from their first year. As seen in Table 2, even if the returns is 5 per cent in the first year, the investor is still $2.50 short from his initial principal of $1,000.
If he does not take profit and continues to leave his money in the fund, he could still make money over a period of time).
Yet there are also funds that consistently underperform and do not make money for the investor for a period of time. Take for example, a fund that generates a return of 5.3 per cent for the first year (which will grow the investment to the principal sum value), and then returns 0 per cent for the next four years. The value of the investor's holding will then just hover around his capital amount of $1,000.
Hence, like every other type of investment, the performance of unit trusts is not uniform. Apart from costs, one should also pay attention to the risk levels, trends on the sector or region of the fund, the philosophy and style of the fund manager, against your own investment appetite.
