Investing & Money
piece written on the 12th February 2014 by  

I’ve been doing some research into unit trusts and exchange traded funds to try to get to the bottom of which one is better for people to invest in. Unfortunately there isn’t an explicit answer to this so I’m going to share what I’ve found out below.

Unit Trusts are investment vehicles that are managed. In other words, a team of portfolio managers manage the portfolio and adjust accordingly. On the other hand, an Exchange Traded Fund (ETF) is not managed, the portfolio follows an index, such as the Top 40 blue chip shares on the JSE. One might immediately jump to the conclusion that a Unit Trust is therefore a better option, but there’s another factor to take into account: TER.

TER stands for total expense ratio. This is the global standard used to measure the impact that the deduction of management and operating costs has on a fund’s value. In other words, it gives you an indication of the effects that these costs have on the growth of your investment portfolio. Expressed as a percentage, a fund’s TER is calculated by dividing the portfolio costs by the market value of the fund. The fund’s market value (total assets) is the daily average value of the portfolio over
a specific period (e.g. a financial year).

Note: Old Mutual released a PDF explaining the expenses, advantages and disadvantages of TER, you can download it here.


TER formula

With a Unit Trust the TER is generally higher than that of an EFT for the simple reason that a Unit Trust is managed and therefore more man hours are required, therefore you pay more of a service fee. The most important take away from this is to take TER into account when weighing up the difference between a Unit Trust and an ETF- the EFT might look like it is “cheaper” (ie. lower TER), but if it’s not managed there’s a chance it won’t perform as well as a managed Unit Trust. Again, reiterating my previous comment – this still doesn’t mean there’s an explicit answer to which is better.

iMod reader, Jackson, popped a comment below about the cost of buying in the two products. In other words, what the costs is to buy into the products and it’s something I completely forgot to include. Here’s what Jackson had to add:

“Unit Trusts, if one buys directly (i.e. no adviser), have no cost to enter (or at least thats true for the vast majority). An ETF on the other hand, as its listed on an exchange, has to be bought from a stockbroker… a brokers account generally has a monthly fee and a fee associated with each buy or sell transaction. For a small investor, these can be significant and far more than the TER mentioned. If costs are an issue, a consideration is to buy a unit trust based tracker fund. These track an index (like the ETF) and as a result are cheaper (have a lower ongoing TER) as there is no active management involved. The tracker funds have the rest of the benefits of a unit trust – like no initial fees!”

Logically thinking though, in an upward trending market, an EFT with a lower TER would more than likely perform better, whereas in a downward trending market, a managed Unit Trust with a higher ETF might perform better. That’s something to keep in mind when making a decision.

At the end of the day you owe it to yourself to do research – there’s no cut-and-dry solution to this.

Additional Reading