Frequently Asked Questions

 

Q1. What are unit trusts?

A unit trust is a collective investment that enables you to pool your money with other investors who have similar investment objectives. Experienced investment managers invest this pool of money in different assets in financial markets. This includes a wide range of local and international shares or equities (companies listed on a stock exchange), bonds, property, money market instruments and their derivatives.
The total value of the pool of invested money is split into equal portions called participatory interests of units. When you invest in unit trusts, you buy a share of the units of the total fund. The unit price (also known as the net asset value (NAV)) is dependent on the market value of the instruments in which the pool of money is invested and therefore rises and falls. It is calculated daily.

There is a wide range of collective investment funds offered in South Africa. These are both rand and foreign currency based, catering for a myriad of investor needs. This includes funds that generate income to capital growth in the medium to long term (three to five years and longer). Units should be held for these periods to reap the full benefit of the investment and to sustain any market ups and downs.
Collective investments such as unit trusts are the most accessible, flexible, protected, regulated and transparent long-term savings vehicles.


Q2. Why invest in unit trusts?

Spreads risk

Unit trusts invest in a range of underlying assets. This means that all your eggs are not in one basket. Your risk is spread amongst many assets rather than amongst one or only a few. If any assets perform poorly, your investment won’t necessarily perform poorly as there are other assets that may have done very well.

Easy and accessible

Unit trusts are a very convenient way of investing in markets which you otherwise would find difficult to access. You can invest in them with as little as R50 per month (monthly debit order) or a R1000 lump sum.

Good returns

History has shown that average unit trust returns compare very favourably with returns from more traditional investment products. The longer you leave your money invested in most unit trusts, the greater the opportunity for growth.

Expert decision-making

Unit trusts are managed by highly qualified investment managers, whose full-time job it is to make investment decisions. Few people have the necessary time, skills or experience to actively manage their own investment on a day-to-day basis.

Value for money

Unit trusts are designed to give you good value. The pooling of money increases buying power, enabling investment managers to buy assets the small investor normally cannot afford. Fees are competitive and clearly set out. They comprise an annual management fee of 1-2% (excl. VAT) of the fund’s market value and an initial fee up to a maximum of 5% (excl. VAT) of your investment. These usually decrease on a sliding scale for larger investments. The initial fee is deducted from the amount invested before units are purchased at the NAV price, and the annual management fee is deducted before income distributions are declared. Unit trust fees are deregulated and investors should familiarise themselves with all fees applicable to any investment as these may differ from fund to fund.

You always know how much you own

The NAV prices of units are quoted daily in the national press, and can also be obtained directly from the unit trust company. You can calculate the value of your investment at any time by multiplying the number of units you own by the NAV price of your fund.

You are protected

Your money is held separately from the managing company’s assets in a trust. If anything goes wrong with the company, your money is safe. The local industry is also strictly regulated by the Registrar of Collective Investment Schemes, the Association of Collective Investments and each unit trust company’s trustees to protect your investment. A vigilant financial press and analysts who continuously monitor the performance of the industry also protect you. In addition, you receive optional quarterly reports and an annual report listing all the assets in which your unit trust invests.

Flexible investment options

You can either invest a lump sum amount so that your entire investment immediately benefits from the growth and income potential of the chosen unit trust. Or you can make a regular monthly investment, an easier way of building up capital. The latter smoothes your investment into the market over time (called rand cost averaging) rather than being affected by a market movement at a particular time. Unit trusts are also transferable and you can invest in somebody else’s name.

Easy access

Unit trusts are liquid so you can cash in all or part of your investment at any time and have ready access to your money, often within 24 hours.

Tax effective

Compared to other investment vehicles, unit trusts are tax effective in terms of Capital Gains Tax (CGT). Firstly, unit trusts are exempt from paying CGT. Unit trust investors only incur CGT when they sell their units in a unit trust. This allows investors to defer tax and to plan their investments appropriately. Secondly, the applicable CGT rate can be as low as 4.5%, depending on the investor’s marginal tax rate, or as high as 10.5%, which is on par with shares. Relief measures such as the R10 000 exemption and the offsetting of losses against gains can also be used.


Q3. How to choose a unit trust?

There is a wide and ever increasing range of unit trusts available. Funds are classified as domestic, worldwide, foreign or regional depending on where the fund is invested. The former is South African, worldwide is a mix of domestic and foreign and the latter two are offshore. These categories are further classified into a second tier: equity, asset allocation and fixed interest. Domestic and foreign funds within these categories have similar risk portfolios.

When choosing a unit trust, you should identify your needs first and select a fund that best suits these:

What is your time scale?

Are you a short- or long-term investor? Although some unit trusts cater for short-term needs, most unit trusts need at least three to five years for your money to grow, so that market fluctuations are smoothed.

What is your risk?

The type of fund you choose will depend on the amount of risk you are prepared to take. Factors are age, health, income, alternative liquid assets, financial/unit trust knowledge, and whether or not you have dependants. An investor seeking security and income should select a money market fund, an income fund, an asset allocation fund or a mix thereof. A more aggressive investor can select a general equity fund or an equity fund that invests in a specific sector of the market such as financial and industrial companies, resources and basic industries or smaller companies.

Note: The risk / return spectrum of fund of funds is dependent on the combination of underlying funds in which the fund is invested and its investment objective. Fund of funds allow investors to benefit from the investment talents of a range of investment managers. In theory this should even out the risk involved, depending on the type of funds selected.

Is the objective of the fund in line with your investment aims?

Do you want income or capital growth? Both these options require a match with the risk profile of the investor. If you require regular income, you would choose an income or money market fund. If you require both income and capital growth you would choose a bond or asset allocation fund. If you require capital growth, you would choose a general equity fund, which is considered a medium risk fund with a broad spread of investments. Alternatively, you could select a more specific equity fund that carries higher risk.


Q4. You, Unit Trusts & Capital Gains Tax

Overview

Compared to other investment vehicles, unit trusts are a great deal in terms of Capital Gains Tax (CGT), which became from effective 1 October 2001:

  • Unit trusts are exempt from paying CGT and unit trust investors will only incur CGT when they sell their units in a unit trust.
  • Unit trust investors will only bear a CGT cost once – when they sell their units. When a portfolio manager restructures a unit trust portfolio, that is sells an underlying share or bond in adherence to its mandate, CGT will not be incurred. Certain other investment products, in comparison, will not be as tax effective. They will sustain a CGT cost every time a transaction in the portfolio is realized, which could be many times over the lifetime of a product. In the US, for example, where in contrast, unit trusts do pay CGT within the unit trust, extra costs to investors were more than 0,5% in 1999.
  • Having CGT paid outside of the unit trust means that unit trust portfolio managers can focus on their core business of managing an investment portfolio according to a mandate, rather than being distracted by tax issues. This could result in more focused and better investment performance.
  • The CGT rate applicable to unit trust investors could be as low as 4,5% depending on the investor’s marginal tax rate or as high as 10,5%, which is on par with shares.
  • Unit trust investors are empowered to decide when to become liable for CGT, allowing them to defer tax and to plan their investments appropriately. Relief measures such as the R10 000 exemption and the offsetting of losses against gains, can also be used.
  • CGT policy for unit trusts is transparent. Unit trust investors will know when CGT is incurred.

In conclusion, CGT policy is in line with the objective of a unit trust as a medium- to long- term savings and investment vehicle and should encourage unit trust investors to treat them as such. You could, for example, not pay CGT for as long as 20 years, if you hold onto your investment. Unit trust investors should, however, not become obsessed with not paying CGT, thereby losing sight of their overall investment objectives.

All local and foreign unit trusts will be subject to CGT, except for money market funds, which have a fixed price and which generate income rather than capital gains or losses.

Understanding the Basics

On 1 October 2001, Capital Gains Tax (CGT) was implemented in South Africa. Up until this date capital gains have not been taxable in South Africa, only income as defined in the Income Tax Act, 1962.

To give effect to the proposals relating to CGT, an Eighth Schedule has been added to the Income Tax Act, which determines what constitutes a taxable capital gain or assessed capital loss. A new section 26A of the Act provides for the inclusion of a taxable capital gain in taxable income. Gains or losses are therefore not treated in terms of a separate taxation mechanism, but included in the existing income tax mechanism as set out in the Eighth Schedule.

Gains or benefits you may receive, by definition, are either capital or income. Whereas prior to 1 October 2001, if the amount was not income, the gain was tax free, it is now either included in your income or excluded by exemption in the Eighth Schedule. Understanding the treatment of various types of capital gains that you may enjoy in your lifetime is therefore important. This brochure sets out the treatment of one such asset, your unit trusts.

CGT as it Applies to Unit Trusts

The Association of Collective Investments, in its representations to SARS when CGT legislation was being drafted, strongly motivated that unit trust portfolios should be exempt from CGT. Unlike other share portfolios, CGT is not triggered when the portfolio manager sells shares within the portfolio. Unit trust portfolio managers are therefore enabled to manage the portfolio according to their mandate, without having to concern themselves with CGT.

However, upon deciding to sell your investment in a unit trust, CGT will be triggered. Thus the investor is empowered to decide when to become liable for the payment of CGT, with the benefit of deferring the tax and planning appropriately. Furthermore, there are other relief measures that can be utilized by the unitholder – these are explained below.

How Gains are Included in Your Income

The taxation of capital gains is triggered by your disposal of an asset. In this sense your role in managing your exposure to this tax is very important. When you decide to sell an asset, such as units in your unit trust portfolio, you are triggering a “CGT event”.

Measuring Gains

To measure a gain, it is necessary to have a base off which to measure that gain. This “base” is referred to as the “base cost” in the Act. Hence, the gain or loss becomes the difference between the market value of your units at date of sale, less the base cost. It is important to realize that this gain or loss is calculated per individual asset that you may have sold. For unit trusts, the calculation is therefore done per fund.

Determining Aggregate Gains

Once the gain or loss has been calculated for each individual asset sold, the gains and losses are added together to determine an overall gain. Three relief measures apply:

  • The first R10 000 profit is exempt from CGT for each taxpayer.
  • Losses can be offset against gains.
  • Losses can be carried forward.

Each tax year, the South African Revenue Service (SARS) will allow each taxpayer an exclusion of R10 000 on the sum of all realized capital gains and losses. This means that should you have sold units, the first R10 000 gain will be exempt from CGT. It also means that should units sold in one fund have been sold at a loss and the units from another sold at a gain, you have the benefit of setting off the loss against the gain. The net gain is then further reduced by the R10 000 exclusion benefit. If the sum of the capital gains and losses is negative, the aggregate loss must also be reduced by the annual exclusion of R10 000. In future years your net capital loss as assessed by SARS may be used to further reduce this figure, which is then referred to as a “net capital gain” or “assessed capital loss”.

Rate of Inclusion in Your Income

In addition to the measures mentioned above, further relief is provided by including only a percentage of the “net capital gain” in your taxable income for the year. This rate is 50% for trusts and companies, and 25% for individuals. Hence, only 25% of the gain as calculated above is included in your taxable income and taxed at your marginal tax rate. It is important to realize that only gains are taken into account at this stage. Losses cannot be used to offset income. Such an assessed capital loss is, therefore, ring-fenced and can only be set-off against capital gains arising during future years of assessment.

Practical Considerations

Base Cost for Investments Made Prior to 1 October 2001

For unit holders invested before 1 October, an average price will be calculated, by using the average of the repurchase or sell price at which a unit would be redeemed by a unit trust management company, for the preceding five business days. Foreign unit trust funds, however, do not necessarily price their units every day, and will therefore be valued according to the last published sell price before 1 October 2001.

To make it easy for you to determine the base cost of existing unit trust investments, the Association of Collective Investments, will publish a list of all calculated prices for local and foreign unit trusts registered with the Financial Services Board and who are associate members of the Association on its web site at www.aci.co.za. These prices will, in due course, be published in the Government Gazette by SARS. Furthermore, your individual unit trust management company should send you a statement following 1 October, clearly recording the base cost of your investment.

Base Cost for Investments Made on or After 1 October 2001

For investments made on or after 1 October 2001, the actual cost that you pay for the units, including any initial charges, is used to calculate the base cost. The unit trust management company will track your cost of purchases (e.g. debit orders) over time on aweighted average base cost basis, so that, when you sell units, the base cost will have been automatically calculated over time on your behalf. Each time you buy units the management company will recalculate the weighted average base cost by multiplying the existing number of units by the existing base cost of the units The total cost, calculated at the buy price, of the new units bought is added to obtain a new monetary value. This is then divided by the sum of existing units and new units to arrive at the new weighted average base cost of all units in the account.

The above method of calculating the base cost of units has been adopted as an ACI standard and is the method of calculation that management companies are required to use when reporting capital gains to SARS in terms of legislation.

However, a unit holder is entitled to use any of the methods provided for in the Eighth Schedule of the Income Tax Act when computing gains or losses and reporting these to SARS. Section 30 of the Schedule provides for the time-apportionment method and section 32 deals with the base cost of identical assets and provides for using any one of the specific identification, first-in/first-out or weighted average methods.

A unit holder wishing to use any method other than the weighted average must ensure that all records are available to be furnished with the annual income tax return. It is recommended that the unitholder consults a tax expert or financial adviser prior to using the alternative methods.

Foreign Currency Gains

The regulations on foreign currency transactions are available as a draft and have as at the date of writing, not been finalized by SARS. This is expected by the end of 2002. It is, however, expected that foreign exchange gains realized at the time of sale of units in a fund denominated in a foreign currency and converted back into Rands, will represent a taxable gain.

Tax Returns

At the end of the tax year you will receive a statement (IT3E) from all South African unit trust management companies reflecting any gains or losses you may have incurred during the tax year. It is then up to the taxpayer to include any net gains in his or her tax return. All local management companies are obliged to send copies of the IT3E to SARS. Foreign unit trust funds will not issue tax statements and unit holders in these schemes are required to calculate the gains and losses themselves.

Events That Trigger a CGT Event and Need to be Taken into Account in Your Tax Return

  • Sales of units or switches out of a fund.
  • Transfer of units, where beneficial ownership of the units change.
  • The death, sequestration or emigration of a unit holder.
  • The divorce of a unit holder married in community of property.

The management company will report the event as at the date of the transaction. However, a valuation certificate for an account can be obtained from the management company for the actual date of the event and be used in the unit holder’s income tax return.

Events That DO NOT Trigger a CGT Event

Where a unit holder transfers units from a personal account with a management company to a bulk account of a Linked Investment Service Provider (LISP) or vice versa, or where a unit holder donates units to a spouse, no CGT event is triggered. The original base cost has to be transferred to the new account. To facilitate this management companies will issue valuation certificates to enable the base cost to be carried forward.


Q5. What are the different types of charges on a unit trust?

Trying to determine how much you’ll pay to purchase or sell units in a unit trust fund may seem quite confusing at first, especially when you are confronted with NAV prices, initial fees, exit fees and just recently, multiple classes of units. This fact sheet will explain the different fees and charges you are likely to encounter as a unit trust investor. Firstly, a look will be taken at how unit trust prices are disclosed in the media and any regulatory requirements which may apply. The different fees and charges that are levied by management companies will be explained and to conclude the fees and charges of different fund types differ are explained.

How unit trust prices are disclosed in the media?

You can determine how much a unit will cost you if you buy a particular unit trust or how much you will receive should you wish to redeem your units by simply opening up a daily newspaper. All publications will quote one price, the NAV price and the initial fee, expressed as a percentage inclusive of VAT of the amount invested.

NAV price

The NAV price, is the price at which you can buy or sell units. In other words, this is how much you will have to pay to purchase units in a particular fund.

Forward pricing

Unlike share prices which fluctuate throughout the day, unit trusts have a fixed price for the day. With forward pricing, the price is established each evening, using closing prices of investments for the day, and then applied to all the transactions that took place during the same day. This means that all sales, repurchases and creation of new units can only be priced and process4ed at the end of the day.

De-regulated fees

Unit trust fees and charges were deregulated on 1 June 1998. Prior to deregulation, unit trusts were not legally allowed to charge more than 1% as an annual management fee and 5% for initial charges. After deregulation, the ceiling on annual fees was removed, meaning that funds launched after deregulation do not have the same restrictions imposed on them. Fees are thus determined by market forces and the actual costs incurred can differ from fund to fund.

Any level or type of fee may be changed, but the management company has to give its unit holders three months written notice of any increase in fees, additional fees or change in calculation of fees and charges.

Following the de-regulation of fees and charges, multiple classes of units were introduced. This allows management companies to identify different types of unit holders and to differentiate between the service offered to different clients and the annual fees they charge. For more information about multiple classes please see our fact sheet entitled “The facts on multiple classes of unit”.

Different types of fees and charges

Unit trust management companies are obliged to disclose all fees and charges to their investors, and these are usually disclosed on all marketing material. Each unit trust fund has different fees and charges, but these costs can be broadly classified into two categories: once-off entry costs and on-going annual costs.

Initial fees or once-off entry costs

Initial fees are levied when purchasing units, be it an initial lump sum, additional deposit or debit order. Generally speaking the higher the investment amount the lower the initial charge. Initial fees are charged by the management company of which a portion is used to pay broker commission and the remainder covers marketing and administration costs. These fees are are deducted from the amount invested and can range between 1% and 5%. However, since deregulation has come into effect, there are no maximum restrictions in terms of initial charges. Some management companies do not charge initial fees at all which is in line with the international “no-load” trend.

VAT on initial charge

Value added tax is levied on the initial charge at a rate of 14%.

Annual fees

This is an ongoing fee levied by the management company for administering the units and managing the investments. Prior to deregulation, these charges had a ceiling of 1%. VAT of 14% is payable on the service fee. These fees are calculated on a daily basis, and are automatically deducted from income distributions on a monthly basis.

Trailer fees

Some management companies pay broker fees out of the annual management fee. These are trailer fees, which are paid to brokers to provide on-going investment advice to their clients.

Switching fees

Fees are levied if an investor switches from one fund to another. Some companies charge a fixed fee for each switch, but most do not charge for switching between funds within the management company.

Exit fees

Some management companies do not levy initial fees or charge a reduced initial fee but levy an exit fee. This is a fee you pay if you sell an investment within a certain period i.e. within the first year, and is based on the original capital as well as growth of the fund.

Performance-based fees

Performance-based fees have recently been introduced to the market. Instead of charging a fixed annual fee of say 1%, annual fees are linked to the performance of the fund. A maximum performance fee will be charged if the fund exceeds a given relevant benchmark, for example the JSE All Share Index, by a certain percentage. Should a fund under perform its benchmark, the annual fees may be waived entirely.

Benchmark return e.g. JSE All Share Index

5% per annum

20% outperformance of benchmark

3% per annum (max annual fee)

20% underperformance of benchmark

0% per annum (min annual fee)


Q6. Do fees and charges differ for different fund types?

Equity funds vs. fixed interest funds

Generally investment charges for equity unit trust funds are higher than the fees of fixed interest funds such as money market funds and bond funds, because investing in equity markets are riskier and more time consuming from a research perspective, than investing in fixed interest markets.

Although money market funds may require a high initial lump sum (anything from R20 000 to R50 000), no initial charges are levied. In addition, no commission is payable to brokers and no MST tax is levied.

Actively managed funds vs. passively managed funds

Actively managed funds tend to charge higher fees than passively managed funds. Passively managed funds such as index funds follow a chosen index e.g. All Share index (ALSI) with the aim of replicating the stock market’s performance. The only risk the investor is exposed to is market risk. The fund manager need not select shares that may outperform the index. In essence no active decision-making is required for these funds and hence they can charge lower fees and charges. Conversely, fund managers of actively managed funds endeavour to outperform a given benchmark through superior stock selection, and a keen understanding of the market. This active management of the fund allows management companies to levy higher fees and charges.

A traditional unit trust vs. a fund of funds

Funds of funds do have higher fees and charges than traditional unit trusts. A fund of funds is a unit trust fund that invests in a range of other unit trusts. These could be funds within a management company’s own range (internal fund of funds) or a selection of funds managed by various management companies (external fund of funds). In the case of a traditional unit trust, one layer of fees and charges is payable i.e. an initial charge and an annual fee. With a fund of funds, an additional layer of fees is payable i.e. in addition to the initial fee and annual charges applicable to the fund of funds, the management costs of the underlying funds must be accounted for too. To remain competitive, in-house funds of funds often do not charge the second layer of fees and charges and some management companies absorb the second layer of costs. Investors should check with the management company if and at what level underlying investment costs are payable.

Concluding remarks

It is important to consider fees and charges when selecting an investment product. Just like shopping for any good or service, you need to shop around, compare the initial charges and annual charges of different funds, be aware of any additional costs such as exit fees and switching fees, as they may influence your investment significantly. Beware of investing in too many funds as this increases the cost of investing and can lead to over-diversification.


Q7. What are LISP's, Wrap Funds, etc?

Introduction

Many investors invest in more than one fund in order to diversify away the risk of selecting the wrong fund manager or management style. Selecting a range of unit trusts enables them to spread investment risk. To meet this need for diversification, packaged products have been designed, which allow investors to invest in a single product consisting of a number of unit trusts or investment portfolios bundled together to suit particular risk/return profiles.

Packaged products include funds of funds, wrap funds and linked products, all of which have unit trusts as underlying investments. Multi-manager funds differ in that the underlying investments are not unit trusts, but investment portfolios managed specifically for the multi-manager.

Fund of funds

A fund of funds is a normal unit trust fund that invests in a range of other unit trusts. These could be funds within a unit trust management company’s own range (internal fund of fund) or a selection of funds managed by various unit trust management companies (external fund of fund). A fund of funds may not invest in less than two underlying unit trusts.

Linked Investment Services Providers (LISPs)

LISPs offer a range of investments linked to unit trusts and other underlying investments. LISPs provide administrative systems to combine various retail investment products including unit trusts, funds of funds, multi-manager funds and wrap funds. By investing through a LISP, investors are given access to a wide range of underlying investments. LISPs also offer compulsory financial products such as retirement annuities and provident funds that are linked to underlying unit trusts.

Wrap Funds

A wrap fund is a portfolio comprising underlying investment products wrapped into a single product. The underlying investments need not be unit trusts. A wrap fund is not a registered unit trust, but most wrap funds hold a portfolio of separate unit trusts and money market accounts/instruments. The underlying combination of investment tools or instruments is selected to meet the risk/return requirements of individual investors. The combination of the underlying instruments is typically conservative, balanced or aggressive.

Multi-manager funds

A multi-management unit trust invests in a blend of specialist portfolios of equities and fixed interest instruments, by combining the investment styles of different fund managers into one investment product. A multi-manager unit trust has a few fund managers, each responsible for managing a portion of the overall portfolio. Each portfolio manager follows a specific investment mandate, as specified by the multi-manager, and the managers are usually selected based on their strength in that particular area. The final combination of these mandates is balanced to meet a specific risk profile. This portfolio is then managed on an ongoing basis to ensure that the investment managers are true to mandate, and that market conditions still support the underlying portfolio mix.

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