Taking the leap into the world of investing can be overwhelming at first, particularly when you encounter all the industry jargon and technicalities… after all, what you really want to know is what are the best investment options available to beginners in South Africa, like you? Right?
The good news is that investing need not be daunting, especially when you get your bearings by understanding the fundamentals.
So, are you ready to dip your toe into the interesting world of investing?
Stick with us as we unpack the fundamentals of collective investment funds.
What is an asset class?
An asset class is a group or class of similar investments or securities, that have similar characteristics.
There are four asset classes:
- Cash (the short-term money market),
- Property (the share market)
- Equities (the share market)
- Bonds (the long-term money market).
What is an Index?
Think of an index like a measure or a ruler – it tracks the performance of a class of assets (for example, Real Estate, Commodities or Bonds) or a basket of securities (a collection of multiple stocks or other securities with a similar theme).
When we talk about an index, we’re referring to a portfolio or collection of stocks or bonds, that are designed to mimic the composition and performance of a particular financial market index using a passive investment strategy.
Indices that focus on particular industries (such as the automotive sector) or asset classes (such as real estate or commodities) are also available. Investing this type of index would mean you are buying a basket of property or car stocks.
The most popular indices in South Africa are the market cap indices, like the JSE Top 40 Index. These indices are used to gauge or benchmark the performance of a sub-set of shares (for example the JSE Top 40) against the overall market performance.
An index is a great way to start investing, because, instead of having to buy individual shares traded on a stock market, it enables you to buy a group of stocks.
So, say you wanted to buy a collection of stocks on the JSE Top 40 Index. The index will go up if the majority of the top 40 South African companies listed in the Index perform well, and will go down if they were performing poorly, because the index is calculated on what is known as a ‘weighted average’.
An index fund consists of a portfolio of shares bought in the same proportion as a specific index, replicating its performance exactly.
The fund can be structured as either an Exchange Traded Fund (ETF) or as a Mutual Fund (also known as a Unit Trust).
ETFs are frequently referenced in the context of index funds because many ETFs are index-tracking funds.
How does an index fund work?
When investing in an index fund, you are buying shares in the companies that make up that specific index. Investors and fund managers are not actively involved in choosing which trades to make because the fund follows an index – which makes this a passive investment strategy.
Speaking of passive investment strategies, what exactly is the difference between an active investing strategy and a passive one – and which one is best suited for you?
Choosing an investment strategy: Active and Passive investing
Passive investing is a strategy that tracks an index or portfolio by mirroring the performance of a specific index through the purchase of an index fund.
While active investing involves choosing the most attractive investments based on each investment’s worth, with the goal of beating the market, or outperforming the index.
At 1nvest, we believe that investors will be best-served in combining both passive and active investment strategies, so that when market conditions change you benefit from both investment positions.
What is a collective investment fund?
When buying into an investment fund, your money is combined together with that of other investors into that same fund – so you are buying a portion of the investment fund.
Investment funds are created by a fund house, and are managed by a fund or asset manager.
The fund manager will then invest on behalf of investors – referred to as participants – across different shares, bonds or in real estate.
The benefit of investing in a collective investment fund is that it provides you with a simple way to diversify your portfolio.
The best collective investment fund options in South Africa
It’s difficult to label an investment fund as ‘the best’, because there are many different types of investments funds, suited to different types of investors and their particular goals.
In South Africa, different investment funds include actively managed funds, passively managed funds, those traded during the day or traded only at the close of day as well as funds with high or low associated expenses and fees.
Let’s unpack some of the options available under collective investment funds.
Index Tracking Unit Trust
It’s important to distinguish between a Unit Trust and an Index Tracking Unit Trust.
A Unit Trust is a pool of the individual investor’s money into a Unit Trust, that is then overseen by a fund manager who invests in individual securities, shares or bonds.
They are open-ended funds, which means that when you invest in a Unit Trust, the fund manager creates new units in unit trusts and cancels these when you sell.
Unit Trusts are less transparent than ETFs, as the investor will never know what the underlying range of assets are that make up the fund. Unlike ETFs, a Unit Trust can also outperform or underperform its benchmark index. Because of the number of unit trusts available, it’s also very difficult to choose which is the best unit trust to invest in.
An Index Tracking Unit Trust tracks an index, like an ETF, but the key difference is that the trading is only done once a day, so there will be a lag between the time at which a buy or sell order is submitted and when that order is executed.
How does an Index Tracking Unit Trust work?
Index Tracking Unit Trusts are only normally sold through financial advisors. You can invest in a Unit Trust Index Tracker Fund through an online platform, like 1nvest.
The purchase is then executed at the Net Asset Value (NAV) of the fund on the price that the market closes at. This process is repeated in reverse when you sell. The unit price will change daily as the NAV of the unit trust changes with the market.
What are the considerations with a Unit Trust?
- Less Liquidity: As Unit Trust dealings are only completed once a day, Unit Trusts offer less liquidity to the investor.
- Higher Management Fee: Because Unit Trusts have fund managers and researchers involved in stock picking, there are higher management fees associated with the investment product.
Exchange Traded Funds
What is an ETF?
Exchange Traded Funds, or ETFs, are regulated as a collective investment scheme and consists of a basket of assets that you buy and sell on an exchange.
So, they represent a partial ownership of a portfolio. The ETF fund is traded on an exchange, so you can buy and sell during the trading day – the benefit of this is that you can buy or sell at a moment’s notice in response to news that may impact listed companies or the market.
A further benefit of ETFs is that you don’t have to buy the components individually, making it a far more affordable investment fund option that offers you exposure to a variety of asset classes.
You will also always know what the underlying assets are that make up the fund, and because the ETF tracks an index, like the JSE Top 40 Index, your ETF will never underperform against the benchmark.
How does an ETF work?
A fund provider, like 1nvest, designs a fund to track the performance of a class of assets and sells this to you, the investor.
As the investor, you would be buying a share or portion of that basket, just like if you were buying company shares.
As we now know, most ETFs track a specific index that benchmarks a segment of the market, like the S&P 500 index which is a measure of the stock performance of 500 leading companies in the USA.
So, when you purchase a share of an S&P 500 index fund, you are investing proportionally in all 500 companies in that specific index.
What are the considerations with an ETF?
- Liquidity: Because you will always know what the underlying assets are and its ratios, you will always know what the ETF’s price is – enabling you to buy and sell when you want to during the trading day.
- Diversification: An ETF invests in a range of stocks which make up the index, providing you with greater diversification from a single investment.
- Volatility: Despite the diversification an exchange traded fund offers, this does not make your investment immune to volatility in the market, and you can still suffer losses in a down market.
ETF vs. Unit Trusts
Index Tracking Unit Trust
· Traded throughout the day, providing you with more hands-on control
· Listed on a registered stock exchange and the ability to trade throughout the day at different prices
· Cover major indices, providing investors with diversification options
· Provides transparency and liquidity as they can be bought and sold during the course of the day
· Trade online via a brokerage account either with an online broker or a traditional broker and buy and sell ETFs at your own discretion.
· Ideal for the investor who wants more guidance rather than a purely ‘DIY’ approach
· Index tracking unit trusts aren’t listed and are only priced at the end of the day at a unit price
· Easily accessible and provide investor diversification
· Provide less transparency as the range of underlying assets is not disclosed to the investor
· Requires a financial advisor to buy and sell on an investor’s behalf
· Due to the range available, it can be difficult for the investor to decide which unit trusts to invest in.
ETF vs. Index funds
· Traded throughout the day, providing you with more hands-on control when you need it
· Lower minimum investment required than index funds
· ETFs can be more cost-effective, depending on the commission and brokerage fees charged.
· Bought and sold for the price set at the end of the trading day, which means that you’ll get the same price as everyone else who bought and sold that day
· Tend to have a much higher minimum investment amount.
· Can attract higher administrative and operating costs.
Your investment options: What to consider before investing
ETFs, Index Funds or Index Tracking Unit Trusts – how do you decide which option will be best-suited to you?
The first step in making a choice about your investment strategy is to decide what kind of investor you are.
- Hands-on investor: If you have more knowledge about the market and want to be more involved in direct share investments and want access to alternative investments, such as forex and global markets, then ETFs may be the better choice.
- Leave it to the professionals: If you want to invest in index tracking funds but don’t want to manage the complexity of knowing when to buy and sell during the day, then Index Tracking Unit Trusts may be better suited for you.
- Risk-averse investor: If you are more risk-averse with a longer-term investment horizon, then investing in Index Funds may be more suitable.
- We would always advise you to consult with a licensed Financial Advisor before making important investment decisions.
How to start investing in ETFs and Index Tracking Unit Trusts
Ready to start investing?
Your next step will be to find the right financial advisor or online share trading platform to get you going on your investment journey.
1nvest has partnered with some of the best platform providers to provide you with the most affordable access to Unit Trusts and ETFs. With low administration costs and access to a Tax Free Investment Account, we will get you set up and investing – quickly and simply.
All you need to do is register for the investment fund of your choice.