5 questions you should ask before investing in UITFs

By Ruth M. Floresca, MoneySense magazine

Posted at Nov 09 2009 03:59 PM | Updated as of Nov 09 2009 11:59 PM

Sure, they have gotten some bad rap but don’t count Unit Investment Trust Funds (UITFs) out yet. They can form a good part of your investment portfolio. Certainly, with more than 80 funds in the market, there are a lot more UITFs than mutual funds to choose from—more than double in fact.

Although both are pooled funds, they differ such that UITF investors buy units of participation in a fund while mutual fund investors buy ownership shares of a company. And while mutual funds are regulated by the Securities and Exchange Commission (SEC), which conducts a licensing program for agents, UITFs are regulated by the Bangko Sentral ng Pilipinas (BSP) and are sold mainly by banks whose marketing personnel go through an industry training and certification process. But those are hardly critical distinctions for the discriminating investor. Aside from more choices, UITFs do have some particular advantages, which are discussed later.

If you are seriously considering investing in UITFs, just make sure you know what you’re getting into. The trust entity will explain the benefits and disclose the risks incidental to investing in UITFs but in the end, you make the decision. So before you place your hard-earned money, ask yourself these five questions:

1. What is my investment goal?

Ma. Lourdes "Marily" de Vera, senior vice president of Banco de Oro Universal Bank’s Trust Banking Group says that you should be clear about this question: "What is your goal? Income or capital growth?" She says that prior to making an investment, it is very important to properly match your investment objective with that of the fund’s features and objectives.

If you want capital preservation or regular income, opt for the more conservative money market or bond funds. If you want your money to grow more aggressively, consider balanced or equity funds.

Remember, however, to tie your preference to a personal financial goal. Why exactly do you want regular income? If you have more pressing needs such as financing your current lifestyle in retirement, it makes sense to be a little more moderate in your expectations. But if you are saving for retirement decades from now, investing in a money market fund is a mistake. In the same way, if you absolutely need the money in a year or so, avoid funds that invest in stocks, as there’s a possibility you may be forced to withdraw at a loss.

Now, you probably have varying financial goals that you may want to save up for at the same time. In that case, "opt to open several accounts with specific or independent objectives," advises Nanette Ferrer, first vice president and trust officer at Rizal Commercial Banking Corporation (RCBC).

If you are not clear about your personal investment objectives, then you could be investing in a UITF for the wrong reason, and worse, with disastrous results.

2. What kind of returns can I expect?

In general, you are more likely to earn more from investing in pooled funds like UITFs than from going it alone by buying individual bonds and stocks. "There are opportunities for potentially higher returns due to possible market-to-market gains on top of accrued income from investments," Marily explains. Plus, "as an institutional portfolio, UITFs are given preferred investment quotes by government securities dealers and financial institutions which are not available to individual investors," Nanette notes.

And certainly, they have proven so far to be superior alternatives to traditional products such as government securities and bank deposits. Nanette illustrates: "Based on the performance of UITFs since their inception in 2005, fixed income UITFs have provided higher returns than traditional deposit products or the benchmark 91 day treasury bills. Equity UITFs have likewise outperformed the PSE index on many occasions."

Marily also notes that UITFs are not subject to reserve requirements, which drag the yields of funds, imposed on bank deposits and common trust funds (CTFs), the predecessors of UITFs. This allows full investments of the UITF in higher yielding securities.

The average return you can expect from a UITF, expressed as return on investment (ROI), is closely tied to its investment objective. Aggressive equity funds theoretically should return higher yields than, say, bond funds, in the long haul.

The ROI is used to measure the historical performance of a particular fund. This return is being often compared to the pertinent benchmark, set in advance, which the fund seeks to outperform. As an investor, it is a good gauge of comparing competing funds in the same class.

Of course, returns are not guaranteed so don’t expect that you will earn the same ROI. Since UITFs are subject to marked-to market valuation method, the price may fluctuate depending on the volatility of the market. As such, indicative rates cannot be quoted by the trustee. Yields are variable and cannot be guaranteed. Historical performance of the fund may provide an indication of how well the trustee is managing the fund but this is not a guarantee of future performance, explains Marily.

Your own return depends on when and at what price you buy and sell. The price for each UITF participation unit is called the net asset value per unit (NAVPU). This is the basis when investing in or redeeming from the fund. The NAVPU is released daily on banking days and the value of which reflects the current market prices of the various investments that comprise the UITF. The difference between the units’ value at the time of purchase versus the value at the time of redemption represents your income or loss.

3. How long do I plan to be invested?

Investment horizon plays a key factor in determining what type of UITF you should invest in. "Ideally, the longer a client stays invested in the fund, the better his chances of earning more since the underlying investment outlets become less prone to market volatility over time," states Lea Angeline Almerol-Maranan from Bank of the Philippine Islands’ Trust Marketing Department.

Marily adds that most of the UITFs in the market also have a recommended investment time horizon, which a client must faithfully observe in order to moderate the risks of investing. "Last year, the UITF industry experienced a sell-off between May to June when the market experienced a correction in bond prices," recalls Marily. "Majority of the investing public was not familiar with the mechanics and dynamics of fixed-income investments as UITFs were novel outlets to them. This enhanced investors’ risk aversion and they unnecessarily pulled out funds from UITFs as quickly as possible," she adds.

Marily shares that clients who followed their advice and stayed the course were rewarded as their funds recovered and posted more respectable returns compared to traditional deposit products. "We trust that the experience would have taught clients that temporary price volatilities should not cause them to panic as these are normal occurrences. Furthermore, investors should keep their original intended time horizon when investing to maximize returns."

4. How much risk can I take?

Pooled funds such as UITFs have inherent advantages in hedging against certain risks. Diversification, for one, as risks are spread out across various investments held by the pooled trust fund. Nanette says, "Given its sheer size, a UITF is able to invest in different types of instruments like time deposits, treasury bills, FRTNs, commercial papers, and corporate bonds with varying maturities."

Unlike other asset classes such as real estate, UITFs are very liquid. Clients can redeem units of participation any time. There is no difficulty cashing in because investments are limited to marketable or tradable securities, says Marily.

Theoretically, you lower your risk of making poor investment decisions on your own as UITF participation enables clients to access the expertise and services of seasoned fund managers who have the capabilities to actively monitor the markets for possible investment opportunities.

But obviously, UITFs are far from risk-free. Their own investments can lose money due to changes in interest rates, drop in market prices of bonds and stocks, changes in exchange rates, an inability to sell assets quickly, or failure of a borrower to repay its obligation.

Given these, you have to ask yourself how much risk are you willing to take? You should assess if your risk appetite falls under these general categories: highly conservative, conservative, moderate, or aggressive.

"An investor therefore has to first correctly assess himself and determine his risk profile," Marily says. "Second, he should know and understand fully the specific UITF’s features, fund objective, and level of risk before finally selecting the best yielding UITF suited to his investor profile and investment objectives," she adds.

Nanette warns, "Investors who cannot imagine losing money on an investment are not suitable to invest in UITFs. They would be better off in traditional deposits. Investing is not a case of ‘you can have your cake and eat it too.’ Those who do not want to take on any risk are stuck with low yielding investments which is the price of safety."

"The investment mantra is ‘low risk, low return and high risk, high return’ but the latter does not mean that one should be reckless. The role of the UITF fund manager is to prudently achieve the objectives set for the fund without exposing the fund to unnecessary risks," Nanette adds.

Remember also that UITFs are trust, not deposit, accounts. “Since an investor is making an investment and not a deposit, funds therefore are not insured by PDIC,” Marily points out. "In any case, UITFs are also tightly regulated and monitored by BSP. BSP has laid down stringent rules and guidelines for all trust entities managing a UITF to ensure that the local industry conforms to international best practices. Most importantly, allowable investment outlets are restricted only to tradable securities and are valued at current market prices. This ensures fair, transparent, and accurate valuation and prevents price manipulation," she clarifies.

5. How much am I willing to pay?

In comparing competing UITFs, consider how much fees you are willing to pay. The more and higher the fees are, the harder the fund manager has to work to beat both benchmarks and competing funds.

Qualified expenses incurred in managing the fund are charged by the trustee. Fees differ for each type of fund and cover the costs of investment research, management, marketing, and routine administrative expenses of the trustee. These are deducted from the NAV of the fund and are thus already imputed in the fund’s NAVPU.

Nanette says, "The fund’s peso interest earnings are subject to the 20% final tax while dollar interest income is taxed at 7.5%. Equity investments are levied the usual transaction tax which is ¼ of 1% upon sale of stocks. The trustee is entitled to collect trust fees. The other allowable expenses usually deducted from the fund pertain to custody fees and transaction costs related to the fund’s investments."

But unlike mutual funds, you can save on sales charges and commissions. "Mutual funds usually charge for entry, exit, qualified administrative fees, as well as some compensation for its agents which affect the yields of an investor’s funds. UITF fees are simpler and are imputed in the fund’s NAVPU. Bank branch personnel have fixed salaries from the bank and, unlike mutual fund agents, are not paid commissions for UITF sales they make," Marily explains.

From the 2007 edition of MoneySense, the country’s first and only personal finance magazine. You can read more financial tips and stories at www.moneysense.com.ph.