Understanding unit trust categories
According to the latest statistics from the Association for Savings and Investment South Africa (Asisa), there are 1 550 unit trusts registered in South Africa. That is a huge number of funds for any investor to navigate.
To simplify this universe, Asisa requires each fund to be placed into a specific category so that investors are able to identify and compare similar portfolios. In a sense, this gives each fund a label that provides a broad idea of what assets it will hold and its likely risk-return profile.
These categories are defined on three tiers. The first shows where they may invest, the second describes what they may invest in, and the third is a sub-category of the second, further defining what the asset allocation can look like.
The chart below provides a graphic illustration of how this categorisation is applied:
At the first level, funds are defined by their geographical focus. South African funds must invest at least 60% of their portfolios in local assets. In addition, they are allowed 30% in international markets, plus a further 10% in Africa excluding South Africa.
These are by far the dominant funds in the local market. They account for over 88% of all money invested in South African unit trusts.
The second most popular are global funds, which must invest at least 80% of their assets outside of South Africa. They are therefore still allowed to allocate to the local market, but are not restricted with regards to how much they may allocate anywhere else.
Worldwide funds may invest entirely without geographic restrictions. They may allocate between South African and international markets as the managers see fit.
The final category is regional funds, which must invest at least 80% of their portfolios in a specific country or region. Examples would be funds that are focused on the USA, Africa outside of South Africa, or Europe.
The second tier describes the asset class or classes in which the fund managers may invest. Again, there are four categories.
Multi-asset funds – which are able to diversify across listed equity, bonds, property and cash – are the most popular. They make up just over 48% of the entire market.
Interest bearing funds are the next most used. They may only invest in money market instruments and bonds. They may not allocate any money to listed stocks, property or cumulative preference shares.
For equity funds, managers must invest a minimum of 80% of their portfolios in listed stocks. This includes listed property.
The final category is real estate funds. These portfolios must invest at least 80% of their assets in listed property shares.
The third level of classification defines more specifically what funds may invest in, and what their asset allocation limits are. This is most significant for multi-asset funds, where there are six sub-categories.
Multi-asset high equity funds may have up to 75% in listed equities and 25% in listed property. For multi-asset medium equity funds, the limits are set at 60% in listed equities and 25% in listed property. Multi-asset low equity funds can have a maximum of only 40% in listed equity and 25% in property.
In broad terms, this corresponds with the levels of risk and expected return from each of these categories. Multi-asset high equity funds will have the highest volatility, but also the highest expected long-term return. Multi-asset low equity funds will be more stable, but will have lower expected long-term returns.
Multi-asset flexible funds have no restriction on their asset allocation. They can shift between shares, listed property, bonds and cash as the managers see fit.
Multi-asset income portfolios focus primarily on generating income through investing in a combination of money market instruments, bonds, preference shares, listed property and dividend-paying equities. They are however restricted to having a maximum of 10% in listed stocks, and 25% in property.
The final multi-asset category is target-date portfolios that aim to produce an optimal return to be realised at a specific date. The asset mix will change over time as that date approaches, being more aggressive early in the life of the fund, and more conservative later on.
Equity funds have seven sub-categories. Equity general funds are the most popular, and will invest across all sectors of the market, although managers may adopt different styles such as value, quality or momentum.
Large cap, mid and small cap, resources, financials and industrial funds are all sector-specific. They must invest at least 80% of their portfolios in the particular part of the market on which they focus.
Finally there are unclassified funds that invest according to a specific theme or in a particular sector that is not covered by any of the other sub-categories. This includes preference share funds.
The sub-categories for interest bearing funds refer mostly to the duration of the instruments in which these funds may invest. To ensure liquidity, money market funds may only invest in bank deposits that are not fixed for periods of longer than 13 months.
Interest bearing short-term portfolios may also invest in bonds, but on a weighted average these instruments may not have a duration of longer than two years. Interest bearing variable term funds can invest in any type of bond or money market instrument. This can include long-dated government bonds.
Article by Patrick Cairns ~ Moneyweb