Understand what you invest in
By definition, all investors are exposed to investment risk. For managed investments, the nature of the risk varies greatly depending on the objective and the mandate given to the manager. As an individual investor, before you select a unit trust you need to be very clear on your goals. Your time horizon, return objectives and your ability to stomach ups and downs all need to be compared against the return objective and characteristics of the funds you are considering
In considering a fund's objectives you need to examine its mandate, which dictates how the fund is managed. This is usually summarised to investors in marketing material, but more detailed information is contained in the fund's trust deed. The deed is a comprehensive document and includes the fund's return objectives, performance benchmarks, liquidity requirements, fees and specific investment parameters with which the fund managers must comply.
Investment parameters consist of guidelines and restrictions imposed either by the client, by regulations, or the asset manager's own internal investment rules. For example, a parameter would be the limit on the amount of equities that may be held in a fund.
Of course if you do not have the time, expertise or confidence to research your options, you may be better off seeking the advice of an independent financial adviser. Independent advisers are able to provide an objective and well-considered view of all the factors that can affect which fund may be best for you.
But how do you know that the fund manager is going to stick to his/her objectives?
A good unit trust ‘does what it says on the tin' over time, and does not surprise investors who have chosen to invest in the fund based on its objective. There are many theories and statistical measures of risk and they boil down to one key factor: the level of uncertainty that you can expect. The financial services industry makes sure that unit trusts stick to their objectives by enforcing the provisions of the Collective Investment Schemes Control Act 2002 (CISCA). This Act requires all unit trusts to appoint an independent trustee - usually a bank - to ensure that the unit trust adheres to its investment objectives and acts in your best interests. The trustees include an assessment of how the fund has been administered over the course of the year in the unit trust annual report, which is made available to all investors. If you invest via Allan Gray Unit Trust Management Limited the trustee is First National Bank.
Similarly, retirement funds (including retirement annuity and preservation funds) have trustees who make sure they are acting in their members' best interests. Trustees send an annual benefit statement to the members each year to report on their findings.
Understand the company that handles your investments
In addition to its trustee requirements, the CISCA provides an assurance that any money or other assets received from an investor are regarded as trust property. Likewise when you invest via an investment platform your money is held in trust by a nominee company approved by the Financial Services Board (FSB). When you invest through our investment platform, Allan Gray Investment Services Limited, as the administrator, cannot directly hold your assets. These assets are held by Allan Gray Nominees Pty Limited. Legislation dictates that trust property, i.e. the assets the nominee company administers, and those that are under the control of unit trust trustees, under no circumstances form part of the assets or funds of the financial institution itself. Because you are invested in a protected fund and not in the company, if anything goes wrong with the investment management company, your money is safe from its creditors.
The FAIS Act ensures fair and appropriate treatment
In addition to the safeguards discussed above, you are also protected through the Financial Advisory and Intermediary Services Act 2002 (FAIS Act), which sets broader compliance parameters. The FAIS Act, which came into force in 2004, ensures that you are treated fairly and appropriately in your dealings with financial services providers (FSPs) and that all FSPs act with integrity and in the best interests of their clients and the financial services industry.
The FAIS Act regulates the activities of anyone who gives advice or who provides administration or investment management services on certain financial products. It requires all providers to be approved and licensed by the FSB and to operate according to codes of conduct. By making use of an appropriately licensed financial adviser, you are protected under the FAIS Act. This means you can complain to the FAIS Ombudsman if you feel that you have not been given proper and/or objective advice.
Reputation is key
Unfortunately, legislation offers little prospective protection against outright fraud. Investors have to make a decision about whether their chosen fund manager is trustworthy and often do so on the basis of very little research. The combination of reputation, which on its own would not have saved the friends of US Ponzi schemer Berni Madoff, and some simple disciplines like checking published audited annual statements, can reduce this risk dramatically
Aside from ethical issues, the reputational risk that accompanies untoward action is a powerful incentive for an asset manager to monitor and prevent mismanagement and fraud. Good asset managers understand that the single most important precondition for operating a successful investment management company is the earned trust of clients.