Page 56 - Profile's Unit Trusts and Collective Investments 2021 issue 2

CHAPTER 2

Pros and Cons of Collective Investment
Schemes
The relative advantages and disadvantages of collective investment schemes is best illustrated
by comparing CISs to other methods of investing in securities.
As described above, the main advantages of CISs include transparency, freely available price
and performance data, a high level of regulation, professional management, and guaranteed
buy-back of participatory interests.
Direct Investment
If you have enough capital, acquiring a share portfolio directly through a stockbroking firm is the
most obvious alternative to equity unit trusts. As a private investor, you need skill, time, and a cool
head to invest successfully in the stock market. Private investors have greater investment flexibility
and many may well outperform fund managers over time. Research suggests, however, that the
majority of retail investors with stockbroking accounts would be better off using unit trusts or ETFs.
A major review of academic research, conducted by Barber and Odean in 2013, found that
private investors earn poor returns (even before costs, which are an additional drag on
performance). Retail investors, it seems, are poor stock pickers who trade too often (driving up
costs and impairing returns). To quote from the study, “many individual investors seem to have a
desire to trade actively coupled with perverse security selection ability.”
The advantages of direct investment include lower costs and more investment flexibility. The
main disadvantages are the high level of expertise required, the considerable amount of time
required to manage one’s own portfolio, and the relatively large amount of capital needed to
achieve adequate diversification. Obviously, direct investment is not ideal for regular monthly
contributions – another advantage of a collective investment scheme for a small investor.
Not all broking firms can offer a daily portfolio valuation (although most major firms now have
sophisticated online facilities where clients can access portfolio details and related information).
Depending on the securities actually purchased, a direct portfolio may prove less liquid than a
collective investment – the CIS manager is obliged by law to redeem participatory interests
immediately, whereas securities are traded on a willing buyer willing seller basis. In thinly traded
stocks, it may take a week or two to convert holdings into cash.
Like collective investment schemes, JSE broking firms are highly regulated, and investors
bear little risk of being victims of fraud if they deal with member firms.
Privately Managed Portfolios
A private equity portfolio of sufficient size can be entrusted to the care of a stockbroker or asset
manager. After investment objectives and a risk profile are established, shares are bought and sold
on the client’s behalf. Stockbrokers typically charge their clients an annual management fee of 1% of
the value of the portfolio. A privately managed portfolio with a stockbroking firm may or may not
attract entry costs (usually no more than 1.5%); these have become highly negotiable given that
many unit trusts no longer charge initial fees. A major disadvantage is the large amount of capital
required (many large broking firms will not accept portfolios under R1m). Another is the lack of
third-party, published performance data for the portfolio management divisions of broking firms.
This can lead to a lack of competition, and a certain complacency when it comes to managing clients’
money. It also makes it difficult for investors to choose the right firm.
A number of asset management companies also offer privately managed portfolios. These
companies tend to be more expensive because they have to pay for the services of a stockbroker
to execute trades. Unlike broking firms, asset management companies tend to charge an
“upfront fee” as well as an annual service fee (ie, similar to a unit trust). This is sometimes
linked to the performance of the assets under management. Entry level for this type of
investment is typically about R100 000.
Given a good firm, the advantage of this kind of service is personal attention and carefully
tailored investment solutions. Disadvantages include the fact that prices and performance data
are usually not available daily, making it difficult for clients to follow the progress of their
investments. Only a few companies are prepared to quantify their private client returns.

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