PUBLIC trading of shares on Malaysias stock exchange first began in May 1960 (known as Malayan Stock Exchange until 1964). Since then, the local financial market and regulation have evolved in terms of structure, size and sophistication.
The KLSE Composite Index, regarded as the main market barometer, was launched in 1986. The second board for smaller companies was launched in 1988 while the Securities Commission was established in March 1993.
Synonymous with the development of a stock exchange is the evolvement of unit trust. The worlds first unit trust was established in London around 1868, almost a century earlier than Malaysias pioneer unit trust fund launched by Asia Unit Trust Bhd in December 1966. This was soon followed by Amanah Saham Mara Bumiputra fund, the first fund introduced in June 1967, catering to bumiputra investors.
Today, there are over 250 investment funds in Malaysia across a variety of fixed income and equity instruments in 15 categories of unit trusts, according to fund analysis firm Lipper. Many of them are open-ended funds. Over recent years, closed-ended funds have been fast gaining popularity in Northeast Asian financial markets like Hong Kong, Taiwan and across the causeway in Singapore.
According to Lipper, guaranteed funds are among the top selling closed-ended funds in Hong Kong for the past 2 years. Unit investment trust is the other popular closed-ended fund.
As local regulations continue to ease, it is a matter of when rather than if unit investment trusts would be introduced in Malaysia. What are unit investment trusts, commonly referred to as UITs? What are the similarities and differences compared to open-ended unit trust funds popular in Malaysia today? To learn how to choose a UIT when it is introduced locally, investors need to first understand the differences between the two and how UIT works.
Similar to unit trust, assets of a UIT are not held by the fund manager, but under an independent trustee. The trustee represents all investors of the UIT and unit trust fund. Both consist of a professionally selected and diversified basket of securities, either stocks or bonds, created to try to meet a stated investment objective.
However, unlike unit trust that has an infinite life with no pre-determined closure or maturity date, the life or tenure of a UIT is fixed (usually 2-5 years) and pre-determined before launch.
Hence, UIT is a closed-end investment fund with a one-time offering to investors after which the offer is withdrawn or close (hence the term closed-end funds). Investors can only subscribe to close-ended funds during the offer period. For unit trust, investors can subscribe to the fund any time or the offer is always open.
In terms of the way both funds are managed, UITs employ a buy-and-hold strategy while unit trust funds are actively managed and may be changed regularly. For UIT, once a portfolio is created, it is expected to remain relatively constant, in terms of its holdings. That is, a UIT buys a relatively fixed portfolio of securities (for instance, five, 10, or 20 specific stocks or bonds), and holds them with little or no change for the life of the UIT.
Because the investment portfolio of a UIT generally is fixed, investors know more or less, what they are investing into for the duration of their investment. For bond UIT, investors even know the target average yield to maturity of the portfolio and credit quality. Assuming no default or early redemption by the bond issuer, yield of the bond UIT can be compared with bank time deposit rates to determine if the UIT returns and risks are acceptable for investors.
UITs are created to meet a stated investment objective, usually to seize short- or medium-term tactical investment opportunities. Once the securities are selected, they are held until the trust matures and proceeds are distributed back to investors. While UITs have a pre-determined lifespan, investors may redeem their holdings prior to maturity, albeit with a small fee. Similar with unit trust funds, prices fluctuate daily and there is no guarantee that the price of the UIT, when redeemed, will equal or exceed the purchase price.
The affordability of share ownership has improved with the introduction of 100-board lot trading on the KLSE early this year. However, unlike the share market, the large capital requirement (RM5mil) for bond investments continues to prohibit individual investors from maintaining a diversified and proper investment asset allocation.
Introduction of bond funds that invest in a diversified portfolio of diligently researched and selected fixed-income securities has partially bridged this gap. Nevertheless, depending on the bond funds cash level, it may not provide investors the ability to fully seize new tactical opportunities in the fixed-income market. This is where a bond UIT comes in to provide a relatively transparent investment strategy and tenure to capture such short- or medium-term prospect.
Some investors perceive that equity UITs are risky, bond UITs are not. But equity and bond UITs carry inherent investment risks. Being passively managed, certain aspects of UIT risk are higher and it is possible that securities in the UIT will depreciate, and that the trust may not achieve its intended objective.
Interest rates fluctuate over time. For bond UITs, default risk and interest rate risk can cause the price of a bond to change. A rise in interest rates will result in a decline of the value of bonds and net asset value of the fund holding it. Bond prices fall because they pay lower coupons (or interest) than new bonds issued with higher interest payments.
This is true for regular bond funds but not for bond UIT. The returns from bond UIT are fairly predictable compared to the regular bond fund, as the bonds will generally be held till the UIT matures. Price fluctuations resulting from interest rate movement are less pertinent issue for bond UIT compared to default risk.
What is default risk? It refers to the inability of the bond issuer to pay the principal and interest on the bonds. According to Ratings Agency Malaysia, investment grade bonds (AAA, AA, A, BBB) have historically carried lower default risk than high yield bonds (BB, B, CCC, CC and C ratings). Being passively managed, default risk for bond UIT is higher than a bond fund.
A bond UIT with allocation into investment grade bonds is inherently less risky (in terms of default probability) than another UIT with high yield bonds. Generally, investment grade bonds tend to outperform to rise in price when the economy initially emerges out of a recession or economic slowdown. High yield bonds usually run up when investors are comfortable over the sustainability of economic growth and rising corporate earnings.
The other risk factor, particularly for bond UITs, is liquidity risk. Where the fund invests in bonds, the fund is exposed to liquidity risk, given the fact that the Malaysian bond market is not as liquid as its stock market. As a result, it may not always be possible to immediately sell or buy fixed-income securities at the prevailing market price. However, this risk is mitigated for a bond UIT fund, as it adopts largely on a buy-and-hold strategy.
Other risk issues such as market risk, company specific risk and inflation risk are also pertinent, especially because UITs are not actively managed. These risk factors are documented in detail in fund prospectus. Investors should understand these risks before investing.
·If you have any feedback on our articles, please email us at cis.malaysia @ citicorp.com
This is the final article in Citibanks wealth management series.
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A copy of the valid prospectuses of the unit trust funds distributed by Citibank Bhd have been registered and lodged with the Securities Commission. Applications for unit trusts may only be made on forms of application available with the prospectuses. A copy of the prospectuses can be obtained from Citibank Bhd by calling 03-2383 8833, 04-227 6666 or 07-276 8833