What unit trust to choose?
The choice of unit trust funds in South Africa is staggering _ there are about 700 on the market _ and the average investor might find it bewildering to know which one (or two or three) to invest in. In our second article about collective investment schemes we simplify the choice by describing how unit trust funds are classified, and how you can choose the right ones for you.

The first level of classification is geographical. Here, funds are classified as domestic, foreign, or worldwide funds. Domestic funds invest largely in South African markets (85 percent of their assets), while foreign funds invest largely outside of South African markets (85 percent of their assets must be in non-South African markets). This is a good category if you want some offshore exposure.

Worldwide funds can invest in a mixture of local and foreign markets. Each category in this level can be married to any category in the second level listed below (for example domestic equity, worldwide equity).

In the second level, funds are classified according to their underlying investments. In this level there are four categories, and each category has sub-categories. We are going to describe each category, mention some of the sub-categories within each category, and also highlight some points to show how the different types can fit into your overall investment needs:

Categories
Equity funds invest a minimum of 75% of their assets in equities (i.e. shares) at all times. This is the largest category of unit trust funds. Equity funds are expected to deliver medium- to long-term capital growth. General equity unit trusts can invest in a broad range of shares, while specialist equity funds invest in a much smaller universe of shares _ for example, only in resources shares. There are many specialist sub-categories, including mining and resources, financial, value, growth, and smaller companies.

Asset Allocation funds invest in a spread of investments in the equity, capital, money and property equity markets, and are useful if you would like a wide exposure to all these asset classes. This category has five sub-divisions: prudential low equity (good for long-term capital growth), prudential medium equity (good for medium- to long-term capital growth), prudential high equity funds (good for maximised long-term capital growth), flexible funds which maximise total returns, and absolute and real Return funds which have certain performance targets.

Fixed Interest funds invest in government and corporate bonds and in the money markets. Bond funds offer a broad exposure to the bond and money markets. Money market funds cannot invest in money market instruments or bonds that have a maturity of more than a year. They offer investors a popular, higher interest rate alternative to traditional bank savings vehicles and are useful if you want to park money for a relatively short time.

Real Estate funds invest predominantly (at least 50%) in listed property shares, property investment trusts and property holdings and development companies. The objective of these funds is to provide high levels of income and long-term capital appreciation.

You'll notice that none of these funds offer short-term capital growth. It's an important thing to understand about unit trusts _ they are not short-term investment vehicles. It takes years for a unit trust account to really come into its own and show overall growth. Operate your unit trust account with a medium- to long-term view (at least five to 10 years for good returns).

When choosing a unit trust, consider your tolerance for risk. In specialist equity funds, such as mining and resources, the risk is higher, because of their narrow focus (the fund manager cannot move out of the specialist sector if it is underperforming). A general equity fund is further down on the risk scale, and right at the bottom of the risk scale are money market funds. The beauty of unit trusts is their affordability, and so you could, if you wanted to, invest in three or four across the risk scale.

Also ask to see the mandate of the unit trust funds you are interested in. A mandate is a definitive document reflecting the fund's main characteristics and a signed commitment of both the management company and asset manager. By reading it you will get a good idea of the specific rules, parameters and regulations that a fund's investment/asset manager must abide by in the execution of the management of the fund.

We haven't discussed the funds that don't fit into the above categories, and we'll cover them in the next issue. They include fund of funds, index funds, multi-manager funds, and exchange traded funds.

Click here for previous issues of Money Matters.