Preliminary note: this is the fourth post in the series on Unit Trusts. You should read Unit Trusts: How They WorkUnit Trusts: Match-making for Difficult Personalities and Unit Trusts: Why We’re All Active Investors before you read this one.

So to briefly recap, after spending a bit of time analysing your risk tolerance, you’ve decided on where you place yourself in the Unit Trust universe:

  • Can’t Handle Any Kind Of Risk At All: Money markets funds, Stable funds, Optimal funds, some Bond funds.
  • On The Fence About It: Balanced Funds, Global Balanced Funds, other Bond Funds.
  • Yes, Let’s Do It: Equity Funds, Global Equity Funds
  • I LOVE RISK: you’re looking in the wrong place – you’re actually looking for somewhere with slot machines and a blackjack table.

Sidebar: there’s one type of unit trust I haven’t really spoken about: which is the property/real estate type. This is definitely one where you get all kinds of risk – high, low, medium. But I think I’m going to deal with Real Estate Investment Trusts (REITs) and Property Unit Trusts in their own post.

You’re also aware that a Finance House promises you a long-term return that’s higher than the market return (after fees). And you know that there are different kinds of fee structure.

So now you have to pick an investing house. Here are the things you should be thinking about:

  1. The size of the investing house (and the fund in question);
  2. The investing style of the fund;
  3. The fees
  4. Past Performance

Of course, you don’t need to (pardon the cliché) reinvent the wheel. Public reputation will have done much of the work for you: as other people iterate toward a certain finance house, you can be pretty sure that it’s happening because they’re the service provider that’s offering the best return-to-cost ratio. But you should still check that the wheel’s tyre hasn’t gone flat without anyone noticing. And that the tread isn’t completely smooth.

The Size of the Fund

This is something that is far more important than people give it credit for. You see – there is a trade-off between size and fees. Large funds can be a good thing for the following reasons:

  1. Large funds mean larger trades – so better discounts can be negotiated with brokers and clearing banks (I will have to write a post one day explaining how actual trading works – but just take my word for it on this one).
  2. Larger funds do not necessarily cost more to manage than smaller funds (fund managers will cost in the same ballpark regardless of whether they run big or small funds; and you will always need a backup staff to do the research, recording, checking and such). So generally speaking, spreading those costs between more investors will mean lower fees for everyone.
  3. Large funds tend to be naturally more conservative and long-term in outlook.

It’s great to get lower fees – but it’s the last point that I’d like to spend some time on. You see, as the pool of money to invest gets really big, it gets more and more difficult to “outperform” the market. Especially in small markets (like South Africa’s) – there are sometimes only a few companies that have enough shares available to cope with the size of the trades the fund manager will be forced to take. At some point, the fund becomes big enough to significantly influence the share price. Which can be great in some ways – because when the unit trust fund buys shares, it causes the share price to spike. And then because it sits in those positions, it gives the market some stability.

But this is where it’s important to know your alternatives. Because when the fund basically is the market – the question then becomes: should you really pay higher fees for a return that’s extremely unlikely to be better than that of a passive tracker fund? (see this post for the difference between active and passive investing)

Or let me put it this way: for good reasons, the FSB (in South Africa) prevents unit trusts from owning more than 5% of a company (or 10% of a company that has a market capitalisation* of more than R2 billion). The unit trust is also limited to a maximum of 5% of its portfolio value in any one share. Here’s a scenario of how that can impact in practice:

  • A unit trust has an investment in shares (the maximum 5% of the company) worth R100 million.
  • The share price doubles due to a positive earnings announcement (so the investment is now worth R200 million).
  • If the unit trust has a portfolio worth R3.9 billion before the increase in share price – its return is 2.6% (R0.1 billion ÷ R3.9 billion).
  • If the unit trust has a portfolio worth R39 billion before the same increase in share price – its return is 0.26% (R0.1 billion ÷ R39 billion).

Unfortunately: the bigger the fund, the more you have to spread the returns around. Of course, by the same argument, the more you have to spread the losses around as well…

Conclusion: larger funds are safer; but if you really wanted to be safer, then you could have done it more cheaply (in terms of fees) with a passive-fund investment.

The Investing Style of the Fund

There are two main styles of investment (I’m talking specifically about equities – but it does apply across the board):

  • Conventional: where the fund manager tries to anticipate market reactions by buying when the market is going up, and selling when the market is going down.
  • Contrarian: where the fund manager works out what he thinks a company is worth, and then buys when the share price is cheap and sells when it’s expensive (it’s the Warren Buffett approach). Contrarians get very excited when stock markets are crashing – it makes for lots of good deals! This style is quite similar to “value” investing – but the difference (as I understand it) is that contrarians really watch out for stocks where the market is super pessimistic about their prospects.

My personal bias is toward a contrarian investment style – it just make sense to me. In our daily lives, people overreact to bad news, then they get comfortable and it’s suddenly not so bad. When that plays out in a market, you get overreactions to bad news (dramatic plunges in price), followed by adjustment back to a more normal expectation. Contrarians would buy up during the bad news part. Makes for good gains!


As I discussed in the last post, fees cut into your return. In general, where you have a low management fee, this comes with a higher cost somewhere else (higher performance fees, or high penalties on withdrawal/switching to another unit trust); or they’re lower because the fund is larger, in which case you may as well buy a passive index-tracking fund.

Past Performance

I’ve saved this one for last – because it’s the one that seems to carry the most weight. It’s the statistic that every Unit Trust fund manager will quote in his sales pitch. And genuinely, I think that it’s the least important. Here’s why:

  1. When markets do well, conventional investors do well. When markets do badly, contrarian investors do well. In general, everyone will have good years and bad years – which means that last year’s performance isn’t necessarily that great a predictor of this year’s performance.
  2. But regardless, many people do believe in past performance – which means that they’ll be pushing their money in the direction of the good performers, which increases the size of the successful funds. And as I showed before – outperformance becomes increasingly more difficult to maintain as you have more money to invest.
  3. And at the same time, the funds that didn’t perform well have less money to play with (as people migrate to the more successful funds), which means that anyone leaving is quite likely to be leaving when that fund’s investments are cheap!

I just think that the whole past performance story should be treated with some caution. It’s fine to look at how that fund has done over its lifetime – I think that gives some indication of the skill of the fund manager. But that impact tends to be equalled out by the factors I mentioned above. And more than that – the focus tends to be on last year’s performance rather than the fund’s performance over time (which isn’t really an indicator of much!).

The Real Conclusion

In the end, I’m saying that your unit trust selection is really a choice between equals. If you want safety and (relatively) lower fees, then you need to go with a large-sized fund. If you want an investment that will hold its value better than the rest during a market crash, then you should go with a contrarian-style fund. Those are all good things to think about. And you do need to think about it – in South Africa alone, there are almost 1,000 unit trusts to choose from (here’s the list). So you do need to find some way of whittling down that list**.

But the whole debate over unit trust selection? It’s honestly the least important step. The most important part is setting up a debit order and committing yourself to the saving process.

That’s the real financial liberation.

*Market capitalisation = value of all trading shares (number of trading shares × share price)

**You may want a financial adviser. But he’ll probably just take you through the same step-by-step process as I’ve described in these posts, select around 15 suitable unit trusts, hand you some pamphlets and then ask you to pick one.