If all you do is saving money in a bank, hate to tell you but you’re losing money than making. Surprised? It’s simple math. A bank savings account offers about 3.5% average interest rate in Sri Lanka. Inflation (increment of price levels) in Sri Lanka is more than the average bank interest rates. So the value of your money is going down faster than the amount of interest you’re earning by saving.
You need to invest your money in assets that beat the inflation in Sri Lanka. Whenever we think about investing, we are stuck with fixed deposits and stocks. But there are so many other great investment products that most of us have no idea of. One such investment product is unit trusts.
This is the only guide you need to learn about unit trusts in Sri Lanka.
What is a unit trust?
Imagine there is an asset that you can’t buy on your own. So you ask a couple of your friends to pool in and collectively buy it. That’s the basic idea of a unit trust.
Unit trusts are also known as mutual funds. Different kinds of funds have different names. But the principle is the same. So what the hell is a unit trust?
There are certain assets and investment opportunities that you and I simply can’t buy on our own. Why? Because they require a lot of money and some are not available for individual investors. But a fund management company can collect money from hundreds of individuals like you and me. Then they can use that fund to invest in such assets. That’s called a unit trust and it’s a fund.
A unit trust can invest in assets such as shares, treasury bills and bonds, debentures, fixed deposits, commercial papers and many more.
How does a unit trust work?
Fund management companies create unit trusts and they collect money from investors like you and me. Every unit trust is managed by a person called the fund manager. Usually, this person is an expert backed by researchers and analysts who are looking at different investment opportunities in the market. The fund manager decides to invest in different assets like stocks, treasury bills, treasury bonds, debentures, and other securities. (Even though the technical term is unit trusts, most call them funds.)
There’s also another party called trustees (hence they are called unit trusts!). They overlook the funds and keep the fund manager in check. They ensure that the fund is run based on the objectives and goals of the fund. Trustees are responsible to protect the investors, in this case, you.
Investors in the fund (you and me) are called unitholders.
How can you invest in unit trusts?
When you’re investing in a unit trust, you’re buying units of the fund. A unit is a small piece of the fund. Imagine there is fund worth of Rs.100 million. A unit of this fund is Rs.100. If you’re going to invest Rs. 2000, you’re going to get 20 units (Rs.2000/Rs.100 unit price). Simple as that!
The unit price (Rs.100) is also known as the market price or NAV (net asset value). Don’t worry too much about the technical stuff. All you need to know is the unit price.
How are you going to make money from unit trusts?
When you invest in a unit trust, you’re going to earn from 2 streams. Capital gains and dividends.
Capital gains – Let’s take our previous example. You have 20 units at Rs.100 per unit. Now what? After some time, the value of the fund is going to increase (hopefully). With that, the value of each unit will also increase. Now a unit price is Rs.110. Then the value of your investment will increase from Rs.2000 to Rs.2200. You have gained an income of Rs.200.
Dividends – Also, most funds give you a dividend per share quarterly, semi-annually or annually. A dividend is an amount the fund decides to offer for each unit you hold. For an example, your fund manager will decide to give you a dividend of Rs.2 annually for every unit you hold.
So like investing in shares, you’re going to get a capital gain as well as dividends.
Advantages of investing in unit trusts (what’s the big deal?)
There are so many cool benefits that you’re not going to get from investing anywhere else.
- Diversification – If you invest in the stock market, it’s only stocks. If you invest in a fixed deposit, it’s only fixed deposits. But if you invest in a unit trust, it could be a combination of stocks, fixed deposits, treasury bills and bonds, debentures and lot more. Rather than you have to diversify your investments, a unit trust automatically does it for you.
- Higher rate of return – Unit trusts most of the time offer a better rate of return than depositing your money in a bank account. They are also great for beating the inflation rate in the country. Between a fixed deposit and a unit trust, you’re most of the time better off with a unit trust.
- You don’t have to invest in millions – With units; you’re going to get access to investment assets which are usually available for corporate investors or high net worth individuals. Even if you have just Rs.1000, you can still buy units which have invested in so many assets from a wide range.
- No hard work for you – This is the best part. You don’t have to worry about analyzing and doing hard work. The fund manager does the hard work for you. They figure out the best assets to invest. You can just invest, sit and relax!
- Independent trustee – Every fund has an independent trustee who is legally obligated to take care of your interest and the fund.
- Withdraw your money anytime – One of the major issues in fixed deposits is, you have to keep your money in the bank for a certain time period. What if you suddenly need your money? You don’t have that problem with units. Most of the funds allow you to withdraw your money anytime.
- Tax-free – Can unit trusts get any better? Most unit trusts are tax-free for individual investors. Even if you save some money in a bank, you’re being taxed for the interest income you earn. In units, it’s completely tax-free.
What are the different types of unit trusts?
When you’re going to select a unit trust, things can be a bit confusing because so many companies offer different types of funds. It’s better to have an idea of what these funds are so that you can choose easily.
Unit trusts can broadly be divided into open-ended and closed-ended funds.
Open-ended funds are open to enter and exit. The fund is not restricted to a number of units. They can issue any number of units based on the availability of investments from people like you and me. There is also no maturity period. These are the most common funds.
In closed-ended funds, you can’t enter and exit whenever you like. The fund offers you a time to buy units and then they close it. Once closed, you can’t withdraw your money until the maturity period. But if the fund is listed in an exchange (like the Colombo Stock Exchange), investors can sell their units. If you don’t understand, don’t worry too much. You’ll get the hang of it.
Based on these two classifications, there are so many funds with different features and attributes.
- Gilt-edged funds – These funds only invest in government securities like treasury bills, treasury bonds, and repurchase agreements. They are super low risk and the return is also low. These funds regularly pay a dividend.
- Income funds or high yield funds – These funds invest in fixed income securities that provide a higher return. Usually, they invest in corporate debt securities that offer higher yields/return. They also invest in treasury bills, bank deposits and repurchase agreements. These funds pay a regular dividend for the unitholders.
- Growth funds – The goal of growth funds is to provide a capital appreciation over the medium and long-term. These funds mostly invest in shares and a small portion on fixed investments. The risk is higher in these funds and the long-term return can also be higher. You won’t be getting a dividend in these kinds of funds.
- Index funds – These funds will invest in the share market with the same proportion of the market capitalization in a price index. For an example, there is a price index in the share market called S&P 20. This index tracks the top 20 companies in the Colombo Stock Exchange. If the fund is investing based on the index of S&P 20, you’re going to invest based on the proportion each company holds in the index. If S&P 20 price index climbs by 12%, the unit trust will also climb by 12%.
- Balanced funds – These funds are for investors who are looking for a capital gain as well as a dividend income in the medium and long-term. As the name suggests, these funds are balanced between shares and fixed income investments. You will get a dividend at the end of every year and the unit price will also increase over time.
- Money market funds – These funds are great for individuals as well as companies to earn an attractive rate of return in a short-term period. These funds usually invest in short-term fixed-income securities like treasury bills, commercial papers, bank deposits, repurchase agreements, and asset-backed securities. They are super flexible so you can even deposit some money for a short time and get a good return. If you have excess money, these funds are great. They also pay dividends once a year.
- Sector funds – These funds are purely based on the stock market. A fund manager will decide that a sector in the market (like the banking sector or manufacturing sector) will perform in the future, and will invest only in companies which in a specific sector.
How do you choose a unit trust to invest?
The Unit Trust Association of Sri Lanka website has a list of all the fund management companies. These companies have different funds with different names. Click here to see a list of all the unit trusts available in Sri Lanka (Check out the latest performance report).
When you visit a website of a fund management company, you’ll be able to see all the funds that are available. Once you select a fund, you will see all the information about that fund. Some of them are
Fund objective – You need to know the objective of the fund to realize if it matches your investment objectives
Fund type – What type of a fund is it (look at our fund classification to understand)
Fact sheet – This has all information about the investment portfolio, unit price, valuation of the fund, annual return/yield etc.
Investment/Withdrawal – What’s the minimum investment and when can you withdraw your money
Trustee – Who is the trustee of the fund?
Fund manager – Who is the fund manager of the fund (Usually it’s the fund company)
Historic performance – How has the fund performed over the years?
Fees – There are couple of charges such as management fee, trustee fee, exit fee, commissions etc. You need to know what those are before investing.
When you’re going to select a fund, you’ll have to look into all these stuff. If you’re feeling a bit overwhelmed, don’t be. It’s not that difficult. Once you speak with a fund management company, they will guide you through all the information. Just look at some funds and their facts sheets and you’ll get the hang of it.
What’s the down side?
Is there a way of losing your money? I bet that’s the final question you have in mind.
A unit trust is a fund that invests in different investment securities. They can be stocks, fixed deposits, treasury bills, debentures etc. If the values of these securities go down, the value of a unit can go down. So there is a chance for you to lose your money. This is applicable to any investment you make in life. There’s always going to be a risk.
But if you look at most of the funds, they have performed significantly well over the years. One thing you need to keep in mind is, even though most funds guarantee a rate of more than 10%, in case if you that goes down, they are not going to be responsible for your money. But I guess you already knew that!
That’s basically everything you need to learn about investing in unit trusts in Sri Lanka. Unit trusts are great for any beginner or experience investor to diversify their portfolio. Hell, they are way better than just saving money is a bank. If you’re convinced, I have a challenge for you. Speak to a fund management company and open an account. Then invest at least Rs.1000. Let me know once you do it. If you have any questions, add a comment and let me know.
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