Unit Trusts support to plan investments

Adopted from Daily Mirror

As a continuation of our discussions about Unit Trusts in the past three weeks, now is useful to understand the types of structures available in Sri Lanka. During the first decade of operation since beginning in 1991, it was only permitted to operate open - ended funds. However, the Unit Trust code was amended by the SEC in 2002 to enable the launch of close-ended funds. The issue related with the close-ended funds is that the investors may find it difficult to withdraw their investments before the terminal date of the fund. To overcome this issue the Managers may introduce an interval scheme so that the investor can withdraw full/part of their investment if necessary and continue with the balance until the termination of the fund.  In the event the full withdrawal is permitted, the remaining investors will continue till end of the fund’s full period. Alternatively, the units of the close-ended fund can be listed on the Colombo Stock Exchange (CSE) to provide required liquidity for investors to sell and realize into cash.

Definition of open-ended fund

The open- ended funds do not have a fixed maturity. You directly deal with the Unit Trust for your investments and redemptions (Withdrawals). The key feature is the liquidity. You can conveniently buy and sell your units at Net Asset Value (NAV) related prices.

Definition of close-ended fund

The funds that have a specific maturity period often ranging from 2 to 10 years are called close – ended schemes. You can invest in the fund at the time of the initial public offer (IPO) and thereafter buy or sell the units of the fund on the CSE where they are listed. The market price of the units at the CSE could vary from the fund’s NAV depending on the demand and supply situation, unit holders’ expectations and other market factors.

Definition of interval scheme

This combines the features of open- ended and close – ended funds. The interval schemes essentially address the need for redemption and periodic investments of the investing public. The investor in a close-ended fund may have the facility to periodically at a pre determined dates at NAV related prices withdraw or invest additional money in the fund. New investors can also join the fund at those interval periods. The interval features can be incorporated in listed close-ended funds as well.

Planning investments

Before commencing any investments it is necessary to decide on your goals and your time frame. 

Particularly answer the following questions:

What are you investing for?  To meet child’s education or marriage, to meet future health expenses, to buy a house, retirement or any other long term preferences.

How long do you expect it will take to make enough money to meet your goal?

When will you want to spend the money you are investing?

These are important questions to be answered to determine your investment plan and the time question.

You may have a lump sum to invest which you would like to grow or from which you wish to draw an income. You may decide to invest in installments periodically (for example, on a monthly basis) with the idea of accumulating up a lump sum.

Generally, the longer the time period before you need the money, the greater the amount of risk you are able to take in the expectation of greater reward. It is important to realize that you do not want to find yourself having to sell your investment just when the price has fallen. If you plan to spend the money soon, say in few years perhaps to meet your Child’s college fees or nearing retirement and are planning to take an income from your retirement fund, you will have to safeguard the value of your money.

If your circumstances change after making your investment than you have anticipated, and as a result you have less time to wait, then it is important to monitor your portfolio and change your asset mix to accommodate your new objectives.

Generally, the less time you have before cashing in your investments, the less risky your holdings need to be. In other words you have to consider investments that have safety and liquidity features. 

Deciding on the best asset mix

The value of shares goes up and down in the short term, and it can be difficult to predict. However, in the longer term they can be expected to deliver better return than other assets. It is also true but lesser extent for bond (debenture) investments. The cash only offers certainty in the short term.

Broadly speaking, you can invest in shares for the long term, fixed income securities for the medium term and cash for the short term.

As the length of time you have shortens, it becomes necessary to change the asset mix of your investments, for example, gradually moving from shares to bonds to cash. It is often possible to choose an option to lifestyle of your investments – this is where your mix of assets is risk – adjusted to reflect your age and time you have before you want to spend your money.

Managing this risk is a skill. It needs a high level of numeracy, a good understanding of why and how the value of investment s can change, the presence of mind not to be swayed by every bit of news you hear and the ability to be objective. It may take time to learn these characteristics.

If you are unsure, talk to a financial advisor with the investment skills to help you. They can help you to decide on your initial investment and help to rebalance it as your circumstances or market condition change. The following illustration is to give an idea to you when constructing an initial investment portfolio:

The income can be in the form of interest or dividends. If you take and spend this income, your investment will grow more slowly than if you let it accumulate by reinvesting it. By not taking income you will earn interest on interest and the reinvested dividends will increase the size of your investment, which may generate further growth. This is referred as “compounding”. The Unit Trusts offer automatic reinvestment feature to achieve the compounding effect in your long term investments.

The above idea can be used in investment in Units of Unit Trusts. In summary, before investing you have to decide on your goals, time period and when you will spend that money. After identifying those parameters you can start investments directly or through Unit Trusts which offer share, bond, and cash management types of funds to select according to the above chart.