What it means
Many investors lack the money or time to build a diversified portfolio on their own. A unit trust solves this by combining money from many people, which the manager then spreads across shares, bonds or other assets.
Each investor owns units, and the value of those units rises and falls with the value of the underlying holdings. The structure has three main parties.
The manager makes the investment decisions and runs the fund, the trustee holds the assets on behalf of the unitholders and checks that the manager follows the rules, and the unitholders are the investors. Keeping the assets with an independent trustee is a key protection if the management company runs into trouble.
Unit trusts are typically open-ended, which means the fund creates new units when people invest and cancels units when people sell. The unit price is based on net asset value, which is the total value of the fund's assets minus its liabilities, divided by the number of units.
That differs from an investment trust or closed-ended fund, where shares trade on a market at a price that can drift away from underlying value. Costs matter a great deal.
Investors usually pay an annual management charge, and may also pay an initial charge when buying or an exit charge when selling. Over many years, small differences in these charges can have a large effect on what investors keep.
Businesses use unit trusts for corporate savings, for pension schemes and for holding surplus cash in diversified form. Like all investments they carry risk, so the value of units can fall as well as rise.
The risk level depends on what the fund holds, so the fund factsheet should be read before investing. Regulation is a further layer of protection.
In most countries unit trusts must be authorised by a financial regulator, publish prices regularly, follow limits on what they can hold and provide a document with key information in plain language. Even so, authorisation does not mean the fund is low risk or that it will perform well.
In practice
Real-world examples.
Example
A dentist with $40,000 of spare savings invests in a unit trust that holds a spread of global shares. She avoids picking individual stocks and receives a regular statement showing the value of her units.
Example
A small company puts part of its surplus cash into a bond-focused unit trust for diversified exposure. The finance director records the units at fair value and reviews the fund's charges each year.
Example
A pension scheme for a firm of 60 employees invests part of its assets through a property unit trust. The trustees check the fund's liquidity terms, because property units may be slow to sell.
Formula
Calculation
Net asset value per unit = (total assets - total liabilities) / number of units in issue
A unit trust holds assets of $52,000,000 and has liabilities of $2,000,000, with 5,000,000 units in issue. The net asset value is 52,000,000 - 2,000,000 = $50,000,000, and the value per unit is 50,000,000 / 5,000,000 = $10.00. An investor who puts in $30,000 at this price receives 30,000 / 10 = 3,000 units. If the fund's assets later rise so that the unit value reaches $11.00, those units would be worth 3,000 x 11 = $33,000.Case study
Seen in the real world.
Greenhaven Wealth is an illustrative, fictional manager that launched a unit trust focused on mid-sized companies. It started with $20,000,000 from about 800 investors and issued 2,000,000 units at $10.00 each.
Over the first year the fund's holdings rose by 12% and the manager charged an annual fee of 1% of assets. The trustee held the shares in a separate custody account, and confirmed each month that the fund's holdings stayed within the limits in the trust deed.
New investors paid the updated unit price when they bought, so existing holders were not diluted by later arrivals. The illustrative lesson is that the structure protects investors through separation of roles and a transparent price, but charges and risk still need careful review. Each unitholder received a short annual report showing the holdings, the charges deducted and the performance against a stock market index.
Watch out
Common mistakes.
- Assuming a unit trust is guaranteed, when the value of units can fall as well as rise.
- Ignoring charges, when a small annual percentage compounds into a large difference over many years.
- Confusing a unit trust with an investment trust, when the latter is a company whose shares trade on a market.
Questions
People also ask.
How is a unit trust different from a mutual fund?
Both pool investors' money, but a unit trust is set up under a trust deed with an independent trustee, while a US mutual fund is usually a company or trust under different regulation.
Can I sell my units at any time?
Usually yes, as most unit trusts are open-ended and will buy units back at net asset value, although some funds may delay redemptions in difficult markets.
Who owns the assets?
The trustee holds legal title on behalf of unitholders, who are the beneficial owners of the fund.
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