A unit trust is a combined investment scheme where money from many investors is pooled together for combined investment. A mutual funds or unit trust is an investment arrangement that pools money from several investors who share same financial objectives, investment strategy and risk tolerance (Maslina Ahmad and Razali Haron).
The money that pooled from various investors will be invested in a diversified portfolio of authorized or licensed investment company that will be managed by a professional manager fund that will act on behalf of the unit trust's investors. Basically, the three party involved in the unit trust scheme which is managing company, trustee and unit-holders. Managing company is the company that provide financial services in this case is a mutual fund that receive money from a group of investor and managing company will invests those fund in a portfolio of securities. The trustee is an independent organization that appointed to monitor the management of unit-holders' money to protect the unit-holders best interest and safeguard the investment. Furthermore, all the transaction will be governed by the Securities Commission of Malaysia.
Unit trust also shows a very vital role in Malaysian capital market. Unit trusts are one of the key players in the market and thought to have the influencing power to draw small investors to capital market (Maslina Ahmad and Razali Haron). It is more attractive and offers a broader investment base for small investors. As a result, this has made strong competition between the unit trust fund management companies in the unit trust activities. As such, more innovative unit trust products have been developed and introduced in order to attract potential investors.
The Islamic unit trust funds were introduced in the mid 1990's after the increasing demand from Islamic investors. Tabung Amanah Bakti, has launched in May 1971, was the founder of Islamic unit trust by Asia Unit Trust Berhad as its fund manager. Over the centuries, even though the unstable market, the Islamic funds managed to grow 102% in 2000 to RM1.6 billion compared with RM 834 million in 1995 (Maslina Ahmad and Razali Haron).
As at September 30th, 1998, there were 13 Islamic unit trusts in action. This figure has growing to 20 in June 2002 and 34 in February 2003 including mostly of equity funds and several bond funds (TheEdge, February 24th, 2003). As at October 31th, 2012, there were 169 Islamic-based unit trusts in operation (www.sc.com.my). This paper will explained and understanding what is unit trust fund and what advantages and disadvantages of investing in unit trust.
Literature Review
Conventional Unit Trust
Conventional Unit Trust is a scheme where Investment Company pooled the money from many investors. Conventional means that Investment Company or Financial Institutions that offer Unit Trust that not follow the Shari'ah principle which is not follow Al-Qur'an. In October 1991, Securities Commission launched the Guidelines on Unit Trust Funds, whereby the Unit Trust Company can only invest in authorized Malaysian assets, including listed and unlisted securities of Malaysian companies, bankers' acceptance (BA), Negotiable Certificates of Deposits (NCD), Cagamas bonds, Malaysian Government Securities (MGS) and Government Investment Certificates (GIC) (Maslina Ahmad and Razali Haron).
But, in March 1994, the Securities Commission has providing a facility by which trust funds can participate (10% of portfolio) in overseas stock. Hence, conventional unit trust funds can invest in any of the above Malaysian assets without any limit as long as the funds must not touched its full official size. Furthermore, Conventional Unit Trust providing a good selection stock to create the portfolio without any restriction or rules to follow unlike the Islamic Unit Trust. Besides that, conventional unit trust can invest in any authorized asset without know the operation base of the company.
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This is an example and explanation of unit trust fund structure.
Islamic Unit Trust
Over the past decades, Malaysian capital market has remained increasing at a very fast speed and more people especially muslims also want to invest in unit trust (Fikriyah Abdullah, Taufiq Hassan, Shamsher Mohamad, 2007). In view of the circumstance that capital market is operational based on interest; for that reason not shocking that the operation of capital market does not obey to the Shari'ah principles (Islamic law as revealed in the Quran and Sunnah). Therefore, it is hard for Muslim investors representing more than 50 per cent of the entire people in Malaysia, to take part easily in the Islamic Capital Market (ICM) (M. Kabir Hassan, Abu Nahian Faisal Khan, Thiti Ngow,2010). The increasing demand for alternative investment vehicles, which conform to the Shari'ah principle has urged the Malaysian government to present several methods with the aim of increasing the Islamic capital market (ICM). For instances, an Islamic bank was established in 1980 and the Kuala Lumpur Shari'ah Index was presented in 1999 with the objective of satisfying the investment needs of Muslim investors.
According to Mervyn K.lewis (2010), when asking people surround you what they know about Islamic banking, they respond by speaking about the "negatives" side only. Islam prohibited interest, gambling and speculative activities and does not tolerate involvement in alcohol and the industry of pork. Perhaps they know what Islam is against, rather than function of Islam Law. Those people who contribute capital to the pool obtain papers verifying their contribution (certificates, units or shares), permitting them to a pro-rata (equally or as agree by both parties) share of the profits (or losses) of the fund. Each fund subsequently has its own characteristic structure, maturity, capital contribution, level of risk and expected return required.
However, according to Mervyn K. Lewis, (2010) there are two important conditions must be met to ensure that Islamic investment funds earn halal profits according to Shari'ah principle. First, either the principal amount or the rate of return can be guaranteed in the contract which means no fixed return secured, instead the units must carry a pro-rata share of the actual profits earned by the fund. Second, the funds obligate to be invested in business and activities suitable to Islamic principles. Based on the Shari'ah principle, transactions in the capital market must be permissible from illegal activities or components such as usury (riba), gambling (maisir) and uncertainty (gharar).
The Securities Commission's Shari'ah Advisory Council (SAC) with the objective of advising the Commission on Shari'ah regarding to the Islamic Capital Market (ICM) is established in May 1996. The Islamic Capital Market refers to the market where the activities are accepted in line with shari'ah principles, which do not challenge with the principles of Muslims and the religion of Islam. In other word, it is the capital market that has to be free from the participation of prohibited activities by Islam such as usury (riba), gambling (maisir) and ambiguity or uncertainty (gharar).
The Islamic unit trusts mostly investing on the investments in portfolios of 'halal' stocks and bonds act in accordance with the Shari'ah principles. Such 'halal' stocks which is excluded companies relating in activities, products or services related to conventional banking, insurance and financial services, gambling, alcoholic beverages and non-halal food products and also companies that produce tobacco which the products can cause illness, death, disease or even promote social ills. From an Islamic perspective, the above industries are eluded as they symbolize components that are prohibited by Allah and the damaging effects of such products on manhood (Maslina Ahmad and Razali Haron). Furthermore, the earnings of Islamic unit trusts also avoid the occurrence of usury (riba) or interest over the process of purification (cleaning) by the elimination of such amounts representing the interest element. In orders where a fund has involuntarily made profits investing in non-permissible areas, the fund will be liquidated and the earnings of the gain will then be contributed to charities.
This supported by Imran Tahir, Mark Brimble, (2011), a useful clarification is that the amount of interest income contained within dividend paid to the shareholder must be set aside and not taken by the investor. Also, while selling a stock the same process must be followed. This practice is discussed as dividend purification and hence a Muslim would not be violating Islamic law, because they not possess the interest element of the dividend.
Maslina Ahmad and Razali Haron stated in their paper that the Shari'ah principle of 'musharakah' acts as a base for Islamic unit trust whereby it is a sharing financing involving contract between the provider of capital and the user. For that reason, the contributor of funds is the unitholders in an Islamic unit trust. An official contract amongst the unitholders, capital, profit, the offer and acceptance and the investment undertakings are also offered in the practice of the Islamic unit trust.
The concept of 'al-wadiah yad dhamanah' or guaranteed safe custody also involve in the procedure of the Islamic unit trust fund. According to the funds existence, the holders of assets are the investors, fund manager acts as custodian holder, and money that invested is an asset. After the manufacture of the fund, the owners of assets are the unit holders, the custodian is the trustee and the assets consist of all assets of the fund. Besides that, the concept of 'al-bai'bithamin ajil' is also experienced in the Islamic unit trust whereby there is a contract of buying and redemption of units of funds. In this case, the buying or redemption price is the fund managers forward selling or buying price at the next valuation point once investors decide to buy or unit-holders decide to redeem their shares. In addition, the valuation point is the price at the close of trade for the day.
However, according to the 'al-wakalah' principle, the price must be set at the time the contract of sale or purchase is performed. In fact, the existing way of Islamic unit trust does not follow to the 'al-wakalah' principle. Maslina Ahmad and Razali Haron state that the daily historical price would be more appropriate in order to observe the Shari'ah principles. Despite having the same standard measures for other conventional unit trusts as described in the Securities Commission's Guidelines on Unit Trust Funds (1997), the Islamic unit trust funds essential to meet the criteria as advised by the Securities Commission's Shari'ah Advisory Council (SAC).
In instance, the Islamic unit trust funds can only investing in securities permitted by the SAC. The trust funds are also compulsory to appoint a shari'ah group or shari'ah counsellor who must be approved by the Commission. The SAC has approved 684 securities registered on the KLSE and categorized them as 'halal' stocks as at October 25th, 2002, so Islamic trust fund managers can buying the stock without hesitation anymore.
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This is an example of unit trust structure of Islamic unit trust.
How Unit Trust is work?
Trust deed
A contract that binds 3 parties (specifically, Unit Trust Management Company, the trustee and the unit trust fund's investors or known as unit holders) to the deed.
The trust deed required to be registered with the Securities Commission.
Trustee
Trustee can be either the independent trustee of Malaysia or companies or public trustee of Malaysia.
A trustee is normally reliable financial organization selected by a deed of Trust to ensure safeguard the interest of the unit holders.
Trustee is appointed to ensure compliance of the management company with the request of the Trust Deed, Securities Commission's guidelines on Unit Trust Funds and Securities Commissioner Regulations 1996.
Trustee is an authorized owner of the assets of the fund; the trustee is liable to certify that the fund manager investing the funds follow the trust deed or contract.
Management Company
Management Company be responsible for investment expertise to monitor and manage the fund and has the main responsibility of investing the funds agreeing to the investment goal or objectives.
The Management Company also acts as the Administrator of the fund to keeping the records of unit trust fund investors or the unit holders.
Investors or Unit holders
The contributor of funds over acquisition of unit trusts from the management company would presume to obtain profits from the investment.
If investors purchase an Open-end Fund, the investors can purchase units at any period, while the fund has not touched its full official size.
Besides that, Unit holders can trade the unit trusts back to the management company.
The Securities and Exchange Commission
The Securities and Exchange Commission is liable to protecting the welfares of the investors who make savings (investment) in unit trusts.
SEC formulates systems for the procedure of unit trusts and has the essential power to guarantee the appropriate conduct of the business.
Moreover, SEC has the power to license or hang up the licenses of Management Company to run unit trusts if fraud or anything bad happens.
Type of funds
There are numerous types of fund by different objectives, investment strategies also level of risk involved. To decide the types of fund that stay suitable for you, you need to consider the following factors:
What your investment objectives or goals?
Do you plan to invest in short or long period?
What level of return that you seek?
How much level of risk you can tolerate?
In general, there are the few categories of unit trust fund offered in the market:
Equity Fund
These funds primarily invest in the stock market. Equity funds carry very high level of risk and are expected to provide a high return in the long term.
Balanced Fund
Invests equally in equities and fixed income instruments and create a balance return of both current income and long term capital gains. It is involves of portfolio of bonds, preferred shares and ordinary shares. It is fit for investors with average risk tolerance. Balanced fund have greater risk than income funds but is likely to deliver a higher return in the long term by manner of capital increase (appreciate) and dividend payments from time to time.
Bond Fund
Invests mostly in bonds & other debt securities, with lower risk level. Furthermore, bond fund produces fixed level of current income. It is suitable for investors with low risk tolerance and mainly for investor who want to diversify their assets.
Money Market Fund
Invests generally in money market instruments (short-term treasury bills that are usually not offered to individual investors), with low risk level because the ease to liquidate.
Structured Fund
Invests mostly in structured notes that obtain highly rated zero coupon securities that are enough to repay 100% of the principal amount of the structured notes on maturity date (usually 3 years). The net earnings as of the structured notes are first circulated for the purchase of zero coupon securities at the same time as the balance goes into the fund investment with goals to produce returns.
Income Fund
It yields high level of current income by investing in high-quality shares that give a good dividend. Commonly arises from more well-known companies and normally observed as low risk. Income funds invest in fixed income securities. Mostly these funds ought to a lower risk compared to equity funds and they make payment a yearly dividend to unit holders.
Aggressive Growth Fund
Aggressive growth fund is highly speculative and seeks high capital gains. This fund normally invested in low price stocks, stocks with relative high P/E ratio and also highly volatility. Compared to growth fund, this fund is even more risky.
Growth Fund
The main goal in invest in growth fund is capital gain and long-term growth. Growth fund generally gives little dividends or current income. Since of unclear long-term perception, growth fund is quite risky.
Types of Trust Fund
According to the book of "introduction to Malaysian Derivatives" there are two types of trust funds:
The Opened-End Fund
The opened-end fund is means that there is no fixed combining of money and no maximum of number unit of shares to buy and sell. Unit holders are allowed to buy and sell at manager's price in any business day. Besides that, when shareholders buy units, more funds are offered for investment by the management companies, while redemption reduces it. The fact is the shares of the funds are not listed on the Bursa Malaysia Securities Berhad (BMSB). Buying and selling rate is determined by the Net Asset Value (NAV) of the trust.
The Closed-End Fund
The closed-end fund is means that there is a fixed capital base and number unit of shares to be offered to the public. In fact, unit holders are the shareholders of the company that buy and sell of shares and other financial assets. The trading mechanism is similar to the Initial Public offering (IPO). Furthermore, the share of the funds is required to be listed on the BMSB and therefore the price of the shares will be determined by the market forces as any other quoted ordinary shares. Usually sell at premium or discount to Net Asset Value (NAV).
Advantages of Unit Trust
Diversification
"Not putting all your eggs in one basket" phrase that can be used to describe the investment in unit trust. One of the benefits investing in unit trust is diversification of risk to the investor. Lack of resources or money is the key or an important factor to choose unit trust investment because they cannot create a suitable diversification on their own. Furthermore, they can diversify their portfolio by create portfolio of market securities rather than focused on stock portfolio of one or two investments only. The investment return will be less volatile (unpredictable) when broad the spread of investment.
Funds with variety of objectives
All types of funds that explain earlier in the types of fund are generated for different purpose of investment goals. The fund managers will help an investor to find a suitable funds that meets their objectives or purpose in terms of risk and return that investor want.
Record keeping services.
Unit trust investment management company also provides the record keeping services where management company preserves and manages the accounts of shareholder's movement or activity for a specified year. These services ensure that all transaction that been made ease to track back and great convenience for the investors.
Professional management
Unit trust investment been handle by a professional management whereby the fund managers who are an expert about investment, knowledgeable, have good performance record, ability to read the future of investment they participate and have high integrity. All fund manager have they certificate or approved that they a qualified in what they do. The fund managers have a good training and background make sure that decision making or judgment is controlled and followed with sound investment principles. In fact, unit trust funds appreciate that fund managers bring the knowledge and skill that they have. Besides that, fund manager's expertise that has a duty to create above-average investment returns in long term for an individual and retailer investors.
High liquidity
Unit trust can be easily buy and sell. Therefore the investor will not suffer from liquidity risk.Mostly investors prefer their asset to be liquid.
That is, they can easily buy and sell without any trouble. A high return of investment provided by unit trust fund does not necessarily mean a good investment if the return cannot be "cashed in" or liquidate or sold. Hence that, a poor liquidity creates another risk factor that can allow by the investor.
Affordability
Individual investors who have a limited money to invest, unit trust are the best investment they can get. Unit Trust investment requires only a small amount of money to take part in a portfolio of investment which enjoys the same benefits as in direct investment which requires large amount capital.
Wholesale investment costs and access to other asset classes
Retailer's investor seem not having any problem when making direct investment in Bursa Malaysia. But individual investor who making direct investments in Bursa Malaysia will experience charges and costs that are greatly higher. With unit trusts, the financial side of the transaction are more acceptable. For examples, the brokerage fees or other charges on the investment are lower and favourable.
When fund manager investing in bigger amounts, fund manager capable to secure access to wholesale earnings and products that are difficult for the individual investor to achieve. Furthermore, most individual investors cannot have straight access to the Malaysian Government Securities market (MGS) because the amount of each contract could run into millions of ringgit.
Investment exposure
For the newbies in unit trust or individual investor, perhaps Unit Trust Funds is the best way to gain the investment exposure, although it might hard to gain exposure to a particular asset class. For illustration, if an investor with limited fund wants to get exposure in Malaysian property market, Malaysian bond market and equity market, it seems to be difficult to at the same time hold a direct asset or investment portfolio in all of them.
But with unit trust funds, the investor has potential to diversify or spreading his money everywhere to all of these asset classes, individual investor able to gain the exposure in the investment at the same time.
Disadvantages of Unit Trust
Load fee
The load fee or load charge on open-end fund is the charge that you paid during buy share. Which mean, load fee is sales charge additional to the fund's NAV once unit trust is sold. A no-load fee describe as no sales charge when buy unit trust fund.
High annual expense
High annual expenses have to be borne by the investors. In instance, the operating expenses like management fees, postage fees, accounting fees and legal fees. These expenses will give burden to the investors and can create hesitation to the investors to join the unit trust fund.
Transaction costs.
Every trading or transaction in Market will cost the individual and retailer investors the transaction cost. In unit trust, the management companies responsible to pay transaction costs when buy and sell securities or shares although they trade in big blocks. This will discourages trading except the possible profit is extensive.
Conclusion
A "Unit Trust" is a combined investment plan where the capital contributions of investors are pooled into an officially formed trust fund. Unit trust is an alternative investment plan for investors who seek the investment opportunities that offer reasonable return with minimal risk. Furthermore, unit trust is good opportunities to newbies investors who do not have experience in investment activities and only have limited money or capital to invest. Although conventional unit trust is exists before the Islamic unit trust, which provides a good investment return to the investors. Today, more investors of conventional unit trusts switching their investment and choose Islamic unit trusts (including non-Muslim investors). Nowadays the increasing demands of Islamic unit trust very encouraging and Malaysian unit trust operators offering a wider range of Islamic unit trust products.
As at October 31th, 2012, there were 169 Islamic-based unit trusts in operation (www.sc.com.my) and more types of fund that created by the Unit Trust Companies to satisfied the demands from the consumer. Nevertheless Muslim investors have an opportunity to invest in unit trust according to the shari'ah principles and accordance to Islamic law where the return of unit trust investment are free or avoid from incidence of riba' or "usury". Perhaps more Shari'ah-based unit trust funds give investors the opening to invest in a diversified portfolio of Islamic securities that are managed by professional managers in accordance with the Shari'ah.
