With the rise of Exchange Traded Funds (ETFs), comparisons have been made with unit trusts as to which provides the optimal vehicle for retail investors. The reality, however, is that unit trusts and ETFs are two very different investment products and are not necessarily competitors in the retail investment industry.
There are many different types or categories of unit trusts and the funds themselves number 913 while there are 25 ETFs in South Africa offering a wide range of investments into shares, bonds, property, money market and offshore markets.
The key difference between these two products is that unit trusts offer a blend of investments or asset classes managed by investment professionals, while ETFs offer a single entry into each investment, which are index-based and computer programme driven. (The best known ETF currently is the Satrix 40, which tracks the JSE Top 40 shares – aggregated by market capitalisation.)
As a result, ETFs can be a good choice for the experienced investor – particularly those with a knowledge of shares – who has the expertise to make investment decisions on their own. For the normal saver, however, unit trusts tend to be more appropriate as the investments are managed by professionals who have the skill sets to make complex investment decisions. Some of these include:
- asset allocations between equities, bonds, property and cash
- cash weightings – general equity unit trusts can hold between 0% and 25% in cash
- defensive or aggressive strategies
- currency exposures
Another misleading comparison which is often made between ETFs and unit trusts is out-performance, where ETFs are often portrayed as providing superior returns to unit trusts. This will depend on which unit trusts are compared. Since the inception of ETFs in November 2000, premium branded unit trusts such as Allan Gray, Coronation, Investec, Nedgroup Investments Rainmaker (managed by a boutique) and Prudential, have produced an average annual return of 20.5% p.a. This is 4.1% p.a. higher than the Satrix 40 ETF that produced an average annual return of 16.4%.
Investing R10 000 in November 2000 into “premium branded” unit trusts would now be worth R58 141, verses R41 907 invested in the Satrix ETF, which is 38.7% more in value.
Premium Brand unit trust performance Nov 2000 to April 2010
|Fund||Average annual performance|
|Nedbank Rainmaker||22.2% p.a.|
|Allan Gray Equity||21.7% p.a.|
|Coronation Top 20||21.6% p.a.|
|Prudential Equity||18.7% p.a.|
|Investec Equity||18.1% p.a.|
|Average of top five||20.5% p.a.|
|Satrix 40||16.4% p.a.|
|Average unit trust outperformance||4.1% p.a.|
Source: I-Net Bridge
Of course, snapshots of different points in time can be used to back up arguments to favour either unit trusts or ETFs. A recent article comparing the performance of unit trusts and ETFs over five years up to 31/12/2009, showed only five out of 47 general equity unit trust funds have beaten the Satrix 40 ETF.
While this is factually correct, it is important to point out that there are a number of reasons why unit trusts would underperform an ETF over this specific period:
1. Unit trusts always have a cash holding, which may vary between 0% and 25%. In a bull market such as this period where the market appreciated 16.9% p.a. well above its previous 40 year average of 12.6%, these cash holdings will reduce performance.
2. Over this five year period, resources outperformed the market by 20%. Unit trust fund managers have historically always been on average underweight resources. This is largely a human nature issue where the other sectors, financial and industrials, are more tangible to value and hence provide higher levels of conviction to make investments in.
3. Some unit trusts have inflation plus return mandates, resulting in a strategy of capital protection rather than market outperformance.
It’s interesting to note that general equity unit trusts in aggregate have underperformed the All Share Index (J203) over the last five years by an average of 2.3% per annum. This is largely due to the proliferation of new unit trusts increasing to 913 from 550, of which general equity unit trusts increased to 82 from 44. The significance of this is that many of these new unit trusts have untested processes and limited experience, leading to their underperformance and dragging down the sector as a whole.
However, “premium branded” unit trusts such as Allan Gray, Coronation and Prudential have outperformed over this period by an average 1.6% p.a after accounting for fees, which for unit trusts are generally around 1% higher than those of ETFs.
Given these results, these are some of the issues which I believe investors need to consider when choosing whether to invest in unit trusts or ETFs.
- It is important to understand the risks of your investments and by nature ETFs are far riskier than unit trusts and should only be invested in by expert investors.
- One cannot compare all ETFs to all unit trusts, as they each have a different investment mandate. It is more appropriate for example, to compare a property unit trust to a property ETF, or a SATRIX 40 ETF to a general equity unit trust.
- Unit trusts will generally underperform ETFs in a bull market, but the converse is true in a bear market as unit trusts hold cash and can invest more in defensive cash-rich companies.
- Premium branded equity unit trusts have outperformed equity ETFs over the last nine and a half years, proving that selective unit trust fund managers in South Africa do add value.