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Nothing mysterious about managed funds

MANAGED funds, also known as unit trusts, are one of the most significant elements of Australia’s investment landscape.

More than $97 billion is invested through unit trusts, yet this sector appears to be a dark mystery to many individuals who prefer to stick with what they know – investing in residential property and direct shares.

However, as the cost of investing in unit trusts moves lower – and as many people discover the vagaries of investing directly – it may be opportune to reassess this option.

A unit trust is basically an investment vehicle that pools money contributed by individuals. The pooled money then is invested by a professional fund manager. More than 75 fund managers are active in Australia, with the current top 10 listed in the table.

The key attraction of unit trusts is that individuals with limited funds have access to a world of investment opportunities that otherwise would be out of reach.

For instance, instead of buying shares directly, and having a stake in just three or four companies, individuals can invest as little as $1000 in a unit trust that owns a broad selection of blue chip shares.

Or instead of buying a couple of investment units in suburban Perth, individuals also can invest in a unit trust that owns commercial properties across Australia.

Alternatively, individuals can invest in a ‘diversified’ fund that owns a mix of shares, property, interest-bearing securities and cash. Most fund managers offer three or four ‘diversified’ funds, ranging from low-risk options designed to produce regular income to high-risk options targeting capital growth.

As a rule, individuals should not put all of their money into one unit trust or with one fund manager. By spreading their money across several managers, they reduce the risk.

Individuals with very limited savings can invest through unit trusts. The minimum investment is generally $1000, although some are lower.

The cost of investing in unit trusts is getting steadily lower but there is still substantial variation between fund managers. Research group Rainmaker Information has discovered the following.

Entry fees, which are levied when money is invested in the trust, average 5 per cent but can be as low as 2-3 per cent and as high as 6-8 per cent.

While not all planners rebate or discount these fees, investors should always ask – especially if they are considering investing large amounts of money.

Investors can cut the entry fee to zero if they invest through the Internet via groups like ComSec, Sanford and Your Prosperity.

Exit fees are levied by some funds when money is withdrawn, although these are becoming less common.

The Management Expense Ratio, which should always be disclosed, covers all ongoing expenses. For most equity trusts and diversified trusts, the MER is between 1.8 per cent and 3.0 per cent. As well as fees, the true cost of investing in unit trusts is affected by the buy/sell spread.

Individuals buy units in a trust from the manager and, when they want to sell the investment, they sell units back to the manager. If the buy price is $1 and the sell price is $0.97, there is effectively a 3 per cent exit fee.

Rainmaker’s Alex Dunnin said the buy/sell spread was meant to reflect brokerage costs but, even allowing for that, appear high.

A drawback of unit trusts is that investors lose direct control. In particular, they lose control over the amount and type of income (distributions) they receive each year.

The distributions from a unit trust comprise a mix of income (eg dividends, interest or rent) and capital gains (eg from the sale of shares or property).

This can be a problem if the distribution includes large capital gains, which may not suit the individual’s circumstances.

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