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Book your seat at the Allan Gray Investment Summit taking place on 22 July at the Cape Town International Convention Centre and 23 July at the Sandton Convention Centre.

Have you chosen the right unit trust?
by Lettie Mzwinila, Business development manager at Allan Gray

It's a good idea to review your investments about once a year to make sure that things are on track. But what if they aren't? How can you tell if "this, too, shall pass" or if you are invested in the wrong unit trust? And what should you do? Lettie Mzwinila explains.

Before investing in a unit trust, it is important to research your options carefully and make sure you understand what you are getting yourself into. It pays to gather as much information as possible upfront. Start by looking for an investment manager whose ethics and investment approach resonate with you, and who has a proven track record. As with any long-term relationship, trust is at the centre: If you trust your chosen manager, you will be less tempted to run for the hills if things go poorly temporarily. 

Once you have chosen a manager, familiarise yourself with their offering before making any decisions. Carefully "read the label" of your chosen unit trust, making sure that your investment objectives and timeframes match those of the unit trust. Doing your homework will go a long way in setting you up for investment success. (We will go into more detail of how to do this a bit later.) 

...Doing your homework will go a long way in setting you up for investment success...

Periods of uncertainty are to be expected when investing, especially in the short term. Investors are often tempted to switch during these volatile periods - i.e. to sell out of a unit trust that is doing poorly and move their investment to a unit trust that is doing better at the time. The problem with this behaviour is that you end up locking in losses.

You should only make changes to your unit trust selection if your goals or circumstances have changed - not in response to short-term market movements. The key is to distinguish between this scenario and when you have selected a unit trust that is not appropriate for your needs and are now being caught off guard by the ups and downs. 

How do you determine which it is? 

Wrong decision vs. short-term blip

Let's consider Jack and Thandi, who invest in the same unit trust. The unit trust is mandated to have up to 75% exposure to equities, which have the potential for higher returns, but come with significant volatility over the short term. Jack chose this unit trust based on an around-the-braai discussion with a friend about its recent good performance. He is saving for an overseas holiday next year.

...You should only make changes to your unit trust selection if your goals or circumstances have changed...

Thandi, on the other hand, is saving for her daughter's tertiary education in 10 years' time and did thorough research to ensure that she chose an appropriate unit trust. She made her selection after learning that the unit trust is suitable for investors who seek long-term capital growth and have at least three years to invest, are comfortable with market fluctuations and prepared to accept the risk of capital loss. 

A year later, both Jack and Thandi are disappointed to see that the unit trust has fallen in value - i.e. it has earned a negative return. But their reaction to this is very different. Can you guess who decides to switch to a different unit trust

The answer is Jack. Panicking that his holiday is in jeopardy, he cuts his losses and cashes in his investment in reaction to this poor short-term performance. Sadly, his behaviour  is not uncommon: Research shows that this type of investor behaviour is one of the biggest detractors of returns. 

Thandi, however, does not switch her money into a different, winning unit trust, despite the temptation. She is more confident in her initial choice and has a longer time horizon for her investment. She also selected the investment manager carefully and decides to give them the benefit of the doubt. 

Fast-forward another four years and Thandi has experienced inflation-beating returns. These returns didn't come in a straight line; there were a few down periods, but they averaged out to provide a satisfying overall return. Jack is still licking his wounds after that initial loss and prefers to steer clear of investments. 

The key difference between Jack and Thandi is that Thandi took the time to appropriately match her investment choice to her needs, and the timing of those needs. Jack skipped the upfront research, landing himself in the wrong unit trust, and was ultimately left disappointed and out of pocket. 

How to choose a unit trust or review your decision

In the above example, the unit trust was being managed according to its mandate and, despite poor short-term performance, was performing as expected. Jack was simply invested in the wrong unit trust. So, how can  you be more like Thandi when choosing a unit trust?

Investment managers are required to publish minimum disclosure documents for all the unit trusts they manage. These are usually called factsheets and are designed to give you an overview of the characteristics of the unit trust, its objectives and how it aims to achieve them, along with up-to-date performance, risk and fee figures. By carefully studying the information provided - with the help of an independent financial adviser if you need guidance - you should be able to gain a good understanding of how a unit trust is managed and what you can expect.

...before you make any changes, thoroughly research all your options...

These are key things to look out for on the factsheet: 

  1. Time horizon: The factsheet will usually tell you what the ideal investment period is, or it may tell you whether the unit trust is suitable for a long- or short-term investment. Make sure the ideal investment period and the number of years for which you intend to invest are aligned.
  2. Highest and lowest annual returns: Decide whether you'll be able to stomach the expected ups and downs. The highest and lowest annual returns will give you an idea of the range of returns you might experience while invested.
  3. Maximum drawdown: Assess how likely you are to permanently lose money if you invest in the unit trust by looking at its maximum drawdown. This is the unit trust's maximum percentage decline over any period. You then need to determine whether you can afford to take the risk.

If these figures are not on the factsheet, you can request them directly from the investment manager.

If you are reviewing your selection and you find a mismatch between your ideas of the unit trust and what the factsheet outlines, you may have chosen an inappropriate unit trust, just like Jack. In this case, it may be best to switch to a different unit trust that is more appropriate for your needs. However, before you make any changes, thoroughly research all your options. It's also important to be aware that you may incur capital gains tax.

Being confident that you have a well-thought-through strategy and are invested in the appropriate unit trust(s) will help you stay the course when there are periods of volatility or temporary underperformance. This has been shown to allow for better returns over time.

If you need some help navigating these decisions, it's a good idea to consult an independent financial adviser.

Book your seat at the Allan Gray Investment Summit taking place on 22 July at the Cape Town International Convention Centre and 23 July at the Sandton Convention Centre.

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