3 Factors To Consider When Evaluating Unit Trusts [TFC 95]
What do regular savings plans, investment linked policies (ILPs) and robo-advisors have in common? They are essentially different ways of putting your money into unit trusts. Do you have unit trusts as part of your investment portfolio, or are you looking at investing in one? If so, then you definitely need to listen to this week’s TFC episode as we explore some factors to consider when evaluating unit trusts!
Fret not if you are unfamiliar with unit trusts as Reggie will explain in detail how unit trusts work and what exactly happens to your money as it goes through the 3 main phases in unit trusts: capital injection, investment process and withdrawal process.
Because of the ease of investing in a unit trust (you no longer have to pick stocks anymore!), it is vital that you take some time and effort evaluating them before making your decision. Does it matter if the unit trust is a passive investment through an index or an actively managed fund? What constitutes active management and how do you evaluate that? Why do the fees matter, and is there a difference between one-off charges and recurring charges? Why are some unit trusts more complex than others, and which one do I choose? Find the answers to these questions in Episode 95 of The Financial Coconut.
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Reggie: Hey Coconuts! Recently, I know you’re seeing ads like 6.88% per annum return or 8% per annum return. You’re seeing all that and you’re wondering… hey is it a scam? Not scam! It’s all financial institutions, big financial institutions promising you returns that you might think… why are they doing all these now? Is it too good to be true? What are they actually doing?
Actually, all of them are still selling you unit trusts, but they have a different structure behind it. The products are different, the instruments they’re using are different and all that stuff. And we are at TFC contemplating to do a review segment where we’ll talk about different products unique to each and every instrument. If you are looking at certain financial products, drop in our Telegram group, drop in our Instagram, let us know what you want us to review and we will look into that. But today specifically, I’m going to consolidate all the learnings that we have so far to come to you with one episode to evaluate unit trusts.
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Good morning everyone. I welcome you to another day with The Financial Coconut. In our podcasts, we will be debunking financial myths, discovering best financial practices and discussing financial strategies that fit our unique life. You get it, ultimately empowering us to create a life we love while managing our finances well. Today we’re going to spend some time to learn how to evaluate unit trusts.
So, many months ago, I did an episode, Episode 46, about why I do not buy unit trusts. Some people feedback to me to say, “Hey, actually, if you think about it, robo-advisors are also selling unit trust.” When I thought about that, I think they have a point.
I’m going to define what is a trust. A trust is actually just a legal structure where one party known as trustor, in this case you, you’re the trustor because you are putting your money or your assets, you trust someone. You are the trustor and you give all these assets to another party, which is the trustee. The trustee then has the rights to hold the assets, to do what they want to do for the benefit of a third party which is the beneficiary. In most cases, the beneficiary is you. So if you think about it, as long as you pass your money, or pass your assets, your property, what have you to another party, which is the trustee, then they invest, they make all the decisions. You don’t get to decide. At the end they give the money to you or they give the money to the beneficiary. That is really very much a trust structure.
While robo-advisors want to make it feel like you actually have a choice, if you think about it, it is still very structured. There is a certain portfolio that they’re pushing and you can decide how much to put into the portfolio, you can decide between a few portfolios. But actually, you still put your money with them into a custodian account, they are your trustee, and they will manage it accordingly.
If we define it that way, then yes, I can say that I agree with these people to say that robo-advisors are also really selling unit trusts. But of course, unit trust has a very bad name so far, they don’t want to call themselves unit trust reseller, or like digital unit trust. It’s not smart from a marketing standpoint. So they will call themselves a robo-advisory and even a lot of these financial companies, financial institutions, like the banks or insurance providers and all that, they are trying to sell it in a different fashion. “Regular Savings Plan” or a “Multi Asset Portfolio” or “Investment Linked Plan”. Investment linked plan also very smelly these days… you get the idea. Everybody’s just trying to market it in a different fashion and they use all sorts of terms to try to market themselves differently. They want to stand out, but the reality is all of them are really just selling unit trusts.
So then what is a unit trust? Now that you know a trust structure, where you put your money to a trustee, the trustee manages it and if they make money they will give it to the beneficiary which is usually you. When you are a unit holder of the trust, that means you buy a portion of this overall trust… that’s why it’s called unit trust, you own a portion of this trust, a unit of this trust, simple as that.
What usually happens is in Singapore, the trustee will then take the money they’ve gathered from all these unit trust holders to pass to a third-party fund management company. They don’t actually manage themselves, they engage a third party to manage your fund management company. Which is why sometimes it gets a little bit messy when you are interacting with unit trusts as a retail investor, because you usually have to interact with the distributor, the trustee and the fund manager. There are three different groups that you have to talk to, or at least three different groups that your money interacts with, but maybe you only talk to the distributor, which are your banks, your insurance agents, your robo-advisors and what have you. They’re the ones selling you the unit trust, then the trust, then the fund management company which the trust appoint. Which is why in contract, sometimes it’s very messy and they all look like the same name… Maybank. You know why? Because you buy from Maybank retail, and the Maybank Trust that is set up for the unit trusts and there’s a Maybank investment arm… let’s say something like that.
Although it looks like you’re buying from one guy, actually it’s quite separated. Why is it important to recognize that there are multiple entities that your money is actually interacting with? Because that will directly tie into the funding and the fee structure. Who pays who, what is the percent, all that jazz will then come in.
To elaborate a little bit more about the investor journey for a unit trust buyer, there’s usually three parts as to how the money moves. The first part is the capital injection into the trust. So how do you put your money into the trust? There are many ways… regular savings plan, ILPs (Investment Linked Policies), robo-advisors. They are all different ways to put your money into the trust.
Now you see the link? Everybody’s really just selling unit trusts, but they name it differently. Regular savings plan, this is a very common term you hear from a lot of brokers, they do that. Banks, they do that. ILP is not uncommon, insurance agents sell that. Robo-advisors of course not uncommon these days also.
When you think about it, they’re all just doing different ways of injecting capital into the trust. This is phase one, capital injection. The second phase where the money moves into is the investment process, which is the part where it’s interesting. When they put the money, where do they invest in, how do they invest in and all that jazz. Number three is then the withdrawal process. The withdrawal process is also very interesting because these days, a lot of companies are promising you 6.88% per annum, 8% per annum, all that jazz. All these will then be factored into the withdrawal process. So as a retail investor, when you invest your money into a unit trust structure, there’s really just three parts: capital injection, investment process and withdrawal process. These are the three processes.
I’m not saying a regular savings plan is ILP, is robo-advisor… no it’s not, they are not the same. But it’s really just different distributors selling the same thing with their own spin. If you specifically look at ILPs, they are being sold by insurance agents or financial planners. What happens is it is unit trust plus insurance, so unit trust plus insurance sold to you as ILPs. Of course the structure can be a little bit more complex depending on what is within the ILP structure, but generally that’s the idea. Why they do that? Of course because insurance is a very high margin business and they do make more money from that. With that, they will sell you what they are good at. So it’s not surprising.
Your brokers, your banks, they will sell you regular savings plan which is the same thing of unit trust, but sold differently with their own spin. Not exactly the same, but relatively similar. You get the idea.
With all that out of the way, from definition to understanding what is a unit trust, who are the entities involved, where does your money move, how is this whole user journey or investor journey for unit trust buyers… now, let us talk about how do you evaluate a unit trust. There are multiple ways but to me, there are few core principles. The first one is… whether is this a passive investment through an index or is it an actively managed fund?
Important. Very different. I’m sure you guys have heard this already… passive investment aka rules-based investing. Whatever name they call it, similar idea. Index investing means they are trying to set up a fund to copy the index, they’re trying to emulate the index. We’ve talked about this in Episode 33: Basic Pointers when Choosing Your Index ETF (Exchange Traded Fund).
The idea is… ETF is when the fund can trade on an exchange. That means you can buy, sell on your app immediately, it can transact like that. Immediate. But a lot of unit trust, they actually put their money in non-trading funds which are just traditional funds. They are not trading in the exchange. In other words, they have a very traditional clearing process. If the investor wants to take back the money or they want to switch a fund and all that, they have to fill up forms, send it through their clearing department and then go through this whole process which ends up taking two to three days. Which is why a lot of times, you want to liquidate traditional unit trust, ends up quite a while, because once again… multiple parties. You talk to a distributor, the distributor talks to the trustee, the trustee talks to the fund. As long as structures get very complicated and very long, it usually takes longer and this is what happens in a lot of traditional unit trusts whereas ETFs, click of a button, it gets sold. That’s a lot easier, a lot faster.
At its core, as long as this investment idea is around passive index investing, then you just really got to look out for as low a tracking difference compared to the index that it’s trying to emulate because that’s the whole idea. The S&P 500, that is an index. The Straits Times is an index. So based on the index, the index have their own idea what they’re looking for and you cannot actually buy the index. So you buy the fund and the fund is trying to emulate the index. If the fund is trying to emulate the index, then the definition of a good index fund is that the tracking difference is very low, that means it is the same, the value is the same. But it’s rarely the case, especially if you’re trying to go for theme funds and all that because of fee structures. Because all these fund managers they charge, your trustee they charge, they got management fee and all that. Usually the tracking difference is the fees. Please listen to Episode 30 for more clarity, but the core idea is here… as long as passive investing, trying to emulate index, the epitome of a great index investor is 100% emulate the index. As long as the tracking difference is very low, then that’s good.
The interesting part is the active management side of things. For a long time, active management was quite a serious thing. What is active management? Active means there’s a bunch of people that are managing this portfolio and they are very active about it. They will buy at a certain price, sell at a certain price. Of course they have their core ideas and all that, which they will write it out. They will also show you what are their core holdings, what are the demographic percentage that they’re investing in, all that jazz. They will not tell you everything, but they’ll show you most of it, or at least some of it. I won’t say most of it, most of it a bit stretching it. Maybe 30% of the portfolio they will show you and they will have all the themes and all that and then they will actively manage it. Buy, sell, switch around and then do all that stuff based on the core ideas that they have set up with.
But over time, there’s been a beating for active management because a lot of people are saying, “Oh, active managers are not performing as well as just buying the index.” Which is why there’s a rise of index funds, everybody talks about index funds. But a lot of these funds these days, a lot of the funds that you’re seeing that are telling you… a lot of these unit trusts these days, they are telling you they’ll give you like 6.88% or 8% and all that jazz. They are actually using active management. Interesting!
Active management is quite a skill. It does not mean that most active managers don’t do well, means all don’t do well. If the company can really do well, the fund management company can do a good job, picking good stocks and running way above the market, or doing very well above the market, then it’s a good consideration. It’s not that bad an investment tool to really look at even though it’s a unit trust structure, which may incur more costs because of the structure itself. Like I said, you go to multiple people, every time you go to multiple people, the costs will go higher.
Generally, if the active manager can perform very well, 20%, 30%, 40% year on year, great job. 20% year on year is like Buffett level. Even if they perform somewhere like 15% up down, they’re still performing a lot better than average index funds. Average index funds in the US, index funds go at about 10%. In Singapore, it’s about 4%, 5% depending on how long your investment horizon. But not important for today. The idea here is if the active managers do a good job, they can really pay this kind of payout very interestingly.
How do you evaluate active management? The only way to really evaluate active management is track record. Although people keep saying, the past does not indicate the future… which I agree. Yes, I know that but that’s the only way to evaluate. Because if you knew how to really evaluate the investment structure, what are their core ideas, what are they buying, which price are they going for, what’s their valuation model, then you do for them, not they do for you. So generally, when you’re evaluating a unit trust that is using active management investment strategy, you only can look at track record.
The track record I recommend you to look for at least five years of track record, four, five years is like mid cycle. There’s some sort of numbers, you see the team go through this process. You don’t go into those… one year, two years, they got not much track records and they tell you they can do very well, and they can promise you all these and that. You honestly got to reevaluate some of these things. Sometimes, certain funds they do very well in a certain year, because of certain investment themes that they go for and all that stuff. So the idea behind going for track record and going for funds with more than five years of track record, it helps. It helps to give you an understanding that they can consistently do it. That is good, potentially they can keep doing it also. So yes, look for track record.
This will conveniently lead us to point number two and that is charges. You got to look at the one-off charges and the recurring charges. Not all charges are the same. We will talk about this after a word from our sponsor.
It’s actually a lot of fees going on especially because you move through multiple people: distributors, trustee and fund managers. But when you think about it, why the robo-advisors can charge you so low, they vertically integrate. They are the distributor, they are also the trustee, they are also the fund manager. When they vertically integrate, of course the kind of prices that they charge you, the fees that they charge you are extremely low relative to your financial advisors, which are really only doing the distributor route or whether your banks which used to have a strong hold, but now they are changing their fee structure. That’s interesting because they got to keep up with the reality. Keep up with the times! Fees are already coming down… why aren’t you bringing your fees down?
Of course that’s not the main discussion today. The lower the fees, the better it is, assuming the performance is the same, because net of fees as an investor I get more. But the idea here is you must see fees separately, which we also talked about this before. If you see the fees separately, what is a one-time fee and what is a recurring fee. One-time fees are your initiation fee, your subscription fee, your switching fee, your redemption fee, all the fees that they charge you for one time only at 1%, 2%, 5%, what have you not.
The other side is the recurring fee, the year on year. Every year, they charge you a management fee, rep fee and whatever fee that they charge you by is every year. On the every year fee, let’s clear that out first… the lower the better it is for sure. The robo-advisors have set a new low, 0.5% per annum compared to a lot of traditional unit trusts which are doing 1%, 1.5%. You might think 1.5%, 1% difference only… support friend is okay. But actually if you go and compound that 1% over 10 years, 20 years, 30 years, it is significant. I will not talk about that. We’ve talked about this extensively.
I want to bring up this understanding of the one-off fee a little bit more today. The one-off fees seem harmless… like it’s one time only, it’s okay. But I want to point out to you that your one-off fees that are front loaded are extremely painful. If they charge you a 5% subscription fee and the agent charge you another 5% on top of that, there is a net of 10% right before your money even starts investing.
However they do it… they may tell you no added fee. No added fee means you are not paying more than the intended amount you want to invest, but does not mean they don’t take a percentage of the intended amount. Let’s say you want to invest $1,000. They say no added fee, but how much of that $1,000 in the beginning they already charge you. Do they charge you a 5% upfront, or do they charge you at 10% upfront or what have you? All the fees added together, that is a world of difference. If you think about it, a thousand dollars and you make 10% on that $1,000 worth of capital, you make $100. But if the moment you put $1,000 in, all these additional fees that they charge you, all these fees… maybe not additional, but they take a cut off all of your capital. Let’s say you’re only left with $900 or $950, let’s say $900… you make 10%, that is $90, that’s a $10 difference. It does not look like a lot, but you go and compound that, it is pretty significant.
What if they charge you every time you put in your new capital, there’s also a fee? Every time you put in new capital, there’s a fee… your regular savings plan. So please go and check out this thing. You want to make sure the front load fees are as low as possible, best is zero. This is important because like I said, if in the beginning, your capital size is already being skimmed off, it’s going to affect your net profit. Don’t think too lowly of front load fees. “5% is okay, 3% support friend”… no, it adds up. So please be very clear of the fees, especially the front loaded fees other than all the fees that we’ve always been talking about and all that stuff.
Rule of thumb, lower fees better for sure, be very cognizant about front load fees and be very cognizant about no additional fees. This is a marketing tactic. No additional fees does not mean they don’t take money from your initial capital be aware.
Of course for many other more detail in terms of the various fee structure, you can go to Money Sense. www.moneysense.gov.sg has quite an extensive discussion about unit trust, probably because a lot of people buy it. They wrote some stuff there. You can take a look, get a little more clarity, or course you can also listen to all the other podcasts. It’ll give you a lot more clarity about the different little components. Today I’m not going to go into all of them.
The third point I want to bring out specifically when evaluating a unit trust is the complexity of the product. What happens in a unit trust structure or in any kind of structured investment product using unit trust? It’s a lot of times they’re trained to envision the individual, envision a one-stop solution for the individual. As a retail investor, what do you think you’ll need? A lot of them are trying to create that one fund that you only buy this one fund. It’s easy for retail investor. Fair.
But the more they do for you, the more hedging, the more kind of fix distribution, all these interesting things that they do for you… the more features that they do for you, tends to be that it gets complex and it tends to be that the fees are higher. This is the part where we really need to dig into individual funds, which we are planning to do. Please drop all the interesting funds that you want us to do going forward. We’ll talk about the individual features and is it worth it to pay for all these individual features.
Based on what we understand of most of us, we have a general demographic. I kind of know where you guys are and we can talk about whether the various individual funds work. But the rule of thumb is, the more complex the structure, like fixed payout… actually the fixed payout is quite complex because there are other people. There are three tiers, if you look at Maybank, just a short story… If you look at the Maybank Multi Asset Fund, there are three tiers A, B and C. The C guys are the guys that are taking 6.88% per annum. The A are your compounders. They are not getting withdrawal, they are getting the money, keep going back, running back. Then there’s the B, I think about 4% or up to about 4%, probably whatever surplus that they have.
This is very important. Why? Because when there are a lot of people in A, at least there’s a significant, let’s say 20, 30% of people are in A… that means they don’t withdraw at all, they compound. This gives the trust management fee, it gives them money to make so that they can continue to operate this trust. If everybody is doing tier three, which is tier C, take 6.88%, every time the money is just leaking and leaking, it’s going to make it very hard to manage the fund. Because every year the money needs to keep going out and net of fees is going to probably be way higher than 6.88%.
If you think about it, the more these kinds of things they are trying to do for you with all these additional features, additional stuff, it’s usually going to have a lot of fine print, a lot of caveats whether is it capital protected and all that stuff and it’s also tend to be more expensive. You got to ask yourself: do you really need it? It’s like when you buy sunglasses or you buy sunscreen, some people will want to buy the 200 or 300, but actually the power 30 is good enough already for you. You don’t really need 200… is there even 200, 300? But anyway, that’s the sunscreen protection.
The idea is what do you really need? Are you overpaying for additional features that you don’t need? This is very individual. So please look for your financial planner and look for your financial advisor, whoever that you think understands these things and are qualified based on your particular needs. This has to be very specific. But rule of thumb, more complex, more expensive. We will go into each of them as we move along. Review, that’s good!
We’ve come to the end and I think there’s a lot to talk about in unit trusts and I hope this forms the basis before we go into different products. I’m going to sum it up today, the three pointers of evaluating a unit trust.
Number one is the investment ideology. Is it passive index or is it active management? If it’s passive index, then you want to have low tracking error so that it attracts the index to the best of its abilities. If it’s active management, the way to evaluate is really only track record at this point in time. So try to avoid funds that are very young. Of course when they’re very young, they will give you good perks to try to get you in like no initial subscription fee and all that jazz because they want you in. It’s up to you to decide whether it’s worth it for you. But track record is really the only way to evaluate actively managed fund.
Number two is one-off charges versus recurring charges. Recurring charges, pretty understandable. The lower the recurring charges, your management fee, your platform fee, whatever fee that are recurring every year they charge you, the lower the better. We’ve talked about this again and again, one-off charges of course lower better, but I want to bring additional today about the front loading charges. All the money that they charge you way ahead in the initial phase of your capital, it’s going to be very painful because it compounds over time. It gives you lesser capital to compound over time. So be very cognizant about that. Even when they say no additional fees included, please go and check what is the fee that they charge on your capital. So front load fees, additional awareness.
Third point is the complexity of the unit trust. Unit trusts tend to want to create something that is one-stop for you. They don’t want you to buy multiple things. They are trying to envision what is the clientele and they will create this product just for this clientele and just target this one clientele. The more complex it is, usually it gets a lot of fine print, a lot of caveats, maybe not capital protected etc, and generally fees are higher. You look for what you really need. It’s not everything additional features means better for you. So with that, we’ve come to the end and I hope you learnt something useful today. See ya!
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We’ve come to the end of this episode. I know evaluating unit trusts is very complicated because there are a lot of things within it. Today’s episode serves as an amalgamation of all the things that we’ve talked about and some sort of reinforcement on some of the things that I think are particularly important when looking at unit trusts and forms the basis for us to continue discussion and product review as we go along.
Product review is a very profitable business. A lot of sponsors looking for product reviews, so we’re going to explore that. If you have any particular product that you want us to review, please drop it in our Telegram group, drop it in our Instagram, whether it is structured investment product or certain robo-advisors or what have you not. Anything that you want us to review, please drop it in and we’ll do our best to do it for you. We will try to build a whole segment then we can charge sponsors. But anyway, we’re going to do some first. Please let us know what you want.
So that’s that. I hope you get a little bit more clarity when looking at unit trusts. It is not as scary as what you would think it is. I used to think it’s very scary and very jialat (Hokkien, used to describe a dire situation in a bad way), very lousy. Truth is, if the fees are getting lower and the structures are getting simpler, then actually it’s not that bad. In the industry where it is very commodity, everybody is trying to race to the bottom, then things are getting better. You start to see more and more interesting funds, interesting unit trusts. Open for discussion.
Next week, we’re going to spend some time to talk about CPF (Central Provident Fund). Since we are rolling with unit trusts, I really want to talk about CPF. I wouldn’t say it is a unit trust, but it’s a very big structured financial product in Singaporeans’ lives. Finally, we’re talking about CPF and we’re going to talk a little bit about how to optimize your CPF, that’s one thing. We’re also going to talk a little bit about investing with CPF money. I think a lot of people are trying to get your CPF money these days and they’ll tell you this one can just use CPF OA (Ordinary Account) or CPFIS (CPF Investment Schemes) to invest and all that stuff. We’ll talk about this in the next few episodes, that’s all great and stuff.
Later this week, you’re going to hear from Jean Paul. Jean Paul is the General Manager of FSMOne. I know some of you probably use their broker at FSMOne and we’ve talked a lot about fixed income. Particularly, I think there was a lot of discussion about Asian high yield bonds because that is what they really wanted to talk about with their investor community and all that stuff. So I got them on to talk about it broadly. It’s really educating people about what bonds really do. What really happens in these kinds of structured bond funds like fixed income products, what happens? So he came on to talk a lot about that, so that’s great.
By the way, for all our community members, you will have early access to some of these information that we think is good. We’ve interviewed a lot of people and those that we think are very worthy and should push ahead, we’ll do special members release. For everyone else who want to support us, please join as a member and you have a good time.
With that, take care! See you guys, bye!
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