Page 136 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 7

Costs of Investing in REITs
REITs are bought and sold through a stockbroker, who takes a commission on the purchase
value of the investment (between 0.3% and 1.5%). The only other costs are securities transfer tax
(STT) of 0.25%, payable to the government, STRATE fees of 0.005787% and a small protection
levy (these fees are payable on all JSE equity transactions).
Income Tax
The income from a REIT is usually paid out every six months in the form of a distribution.
Currently distributions from REITs are treated as taxable income in the hands of investors. In
terms of section 25BB, an amendment to the tax legislation, distributions are characterised as
“taxable dividends” rather than interest. DWT does not apply to REIT distributions. Most UTREFs
(Real Estate unit trusts) pay out income on a quarterly basis. The tax treatment of a UTREF’s
distributions depends on the shares held by the UTREF – distributions may include a dividend
portion (taxed at source under DWT) if the UTREF holds shares other than REITs, but most
income from a UTREF will be taxable in the hands of the investor.
Derivatives

Derivatives are not an asset class per se, but their increasing use within collective investment
schemes – especially as building blocks for hedge funds – means they require some explanation.
A derivative instrument is one “derived” from (or based on) another. Derivatives, which
include, amongst others, warrants, futures and options, are therefore instruments which are
linked to other assets, and which have no value without the existence of the other assets. Put
simply, shares have value in their own right, but an option on a share has no value if the share
ceases to exist.
The popularity of derivatives stems from three main factors. Firstly, they allow traders and
asset managers to make profits when markets are falling as easily as when markets are rising.
Secondly, they enable asset managers to hedge positions in physical assets. Thirdly, they are
generally cheap and easy to trade.
Managers of collective investment schemes are permitted to use derivatives subject to certain
limits. The rules are complex and vary according to the type of fund. Hedge funds, for example,
can use derivatives more extensively than other collective investment schemes. Fund managers
of non-hedge funds are restricted to using derivatives for hedging or, to a limited degree,
extending existing long positions. Short exposure cannot exceed long positions. Long positions
effected with derivatives cannot exceed the value of the portfolio, which effectively limits cash in
margin accounts to (at most) around 10% of a unit trust’s assets. Hedge funds, on the other
hand, can use derivatives to create net short positions (ie, to profit from falling markets) or to
gear up portfolios (ie, to increase long exposure beyond the value of the portfolio’s assets).
Managers of non-hedge funds may not write options, and the CISCA subordinate rules prevent
managers from using the leverage properties of derivatives to gear up a portfolio (ie, to increase
long exposure). This does not apply to hedge funds, although even hedge funds are precluded
from taking naked short positions.
The three most common types of derivatives are futures, options and warrants.
Futures
A future is a standardised forward contract, and a forward contract is simply an agreement to
buy or sell a specific asset at some future date and pre-defined price. The standardisation of
forward contracts on futures markets gave rise to secondary trade in the contracts themselves, and
today futures markets are amongst the most heavily traded markets in the world.
The forward contract arose because of the need for hedging. A forward contract allows a farmer
to lock in a favourable price for his crop while it is still in the ground (ie, if he thinks prices will be
lower by harvest time). At the same time, it allows a cereal manufacturer to lock in a favourable
price for winter production (ie, if he thinks prices will rise later in the year). Entering into a
forward contract or future to buy because you think prices will rise is called going long the market,
and entering into a forward contract to sell because you think prices will fall is called going short
the market.

134 Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts