In South Africa, exchange-traded funds (ETFs) and unit trusts are two common ways to invest in diversified portfolios. ETFs track a market index and trade throughout the day, offering flexibility and lower costs. Unit trusts are typically actively managed and priced once daily. The right choice depends on your goals, level of involvement, and cost preferences.
Key Takeaways
- ETFs Offer Real-Time Trading: ETFs are listed on the stock exchange, allowing investors to buy and sell throughout the day with transparent pricing and typically lower fees.
- Unit Trusts Provide Professional Management: These funds are actively managed by portfolio managers and may suit investors seeking long-term guidance without frequent trading decisions.
- Both Have Distinct Roles: Each option carries different benefits and risks, and combining them can support diversification, cost control, and personalised investment goals.
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What Are Unit Trusts?
Unit trusts, also referred to as traditional collective investment schemes, typically operate under an active investment strategy. In these funds, qualified portfolio managers make ongoing decisions regarding asset selection, guided by research, analysis, and expected market developments. Unit trusts are valued once per day, and investors buy or sell units through licensed investment platforms or directly via asset management firms.
Though they follow a different operational process compared to ETFs, unit trusts remain a popular and reputable vehicle for those pursuing long-term growth, particularly among South African investors who prefer structured fund oversight and professionally guided asset allocation.
What Are ETFs?
Exchange-traded funds (ETFs) are financial instruments that allow individuals to invest in a diversified portfolio by purchasing units listed on a stock exchange, in a manner similar to buying ordinary company shares. Although ETFs are most commonly linked to passive investment strategies that replicate the performance of a specific index or market segment, they may also be structured with active management. A defining feature of ETFs is their ability to be priced and traded in real time, with investors having access to up-to-date information on holdings and market value throughout the trading day.
Whether held for passive exposure or actively managed returns, ETFs offer visibility and liquidity, enabling investors to monitor performance continuously and make timely decisions based on real-time data. This level of transparency can assist with more deliberate investment planning.
Differences Between A Unit Trust And An ETF
| Category | Unit Trust | ETF |
|---|---|---|
| How is it regulated? | Must be registered as collective investment schemes and fall under the Collective Investment Schemes Control Act. | Most are also registered under the same Act. Some are structured differently but must comply with stock exchange listing requirements. |
| Are the underlying securities held by a trustee or custodian? | Underlying investments are always held by a trustee or custodian on behalf of investors. | If structured as a collective investment scheme, assets are held by a trustee. Otherwise, they may be held via legal structures like a special purpose vehicle. |
| Is it listed on the stock exchange? | Not traded on a stock exchange. Available through approved investment platforms or directly from fund managers. | All South African ETFs are listed and can be traded during market hours. |
| Is it actively managed or does it track an index? | Most are actively managed to outperform benchmarks, though some do track indices. | All are designed to track a specific index or commodity and are not actively managed. |
| How can I invest? | Directly through the management company or via a financial service provider offering a regulated investment platform. | Can be bought via a stockbroker, ETF-specific platform, or an investment platform that includes ETFs and unit trusts. |
| How can I disinvest? | Submit a formal instruction to the manager or platform. Funds are usually paid out within 48 hours. | Instruction given to broker or platform. Sale can occur during market hours, but payout may take up to 3 business days. |
| Can I include it in a retirement fund? | Yes, if the portfolio complies with Regulation 28 of the Pension Funds Act. | Yes, subject to Regulation 28 compliance. |
| Can I include it in a tax-free savings account? | Yes, provided the unit trust is eligible. Those with performance fees may not qualify. | Yes, but only if structured as a collective investment scheme. |
| What are the fees and charges? | Possible costs include: • Initial fee (often waived) • Ongoing management fee • Advisory fee (if adviser is used) • Platform admin fee • VAT on services | Varies based on platform: • Stockbroker: monthly fees, brokerage, Strate costs, investor levy, VAT • Platform: admin fee, possible VAT |
| Transparency | Discloses asset allocation and most holdings quarterly. Full holdings available on request. | Offers full daily disclosure of all holdings. |
| Dividends | Distributed regularly. Can be reinvested into more units. | Distributed regularly. May require a trade for reinvestment. Some are “total return” ETFs with internal reinvestment and no trade cost. ETNs usually do not pay dividends. |
| Pricing | Priced once daily. NAV confirmed after transaction, typically the next business day. | Priced in real-time and traded throughout market hours. Orders can be placed anytime during trading hours. |
Risks to Consider
Market Risk
Both ETFs and unit trusts are affected by overall market performance. When share or bond prices decline, the value of the investment will also fall. Unit trusts may experience greater volatility if they are focused on specialised sectors or depend heavily on a single fund manager’s decisions.
Liquidity Risk
ETFs are designed for real-time trading, but this advantage can be reduced when there is low trading volume. This may lead to wider bid and offer spreads, particularly during market stress or for lesser-known funds, which can make transactions more expensive. Unit trusts do not trade throughout the day and are only priced once daily. Investors may face delays in receiving their proceeds, which is usually within one or two business days after giving a disinvestment instruction. This limited flexibility can become a challenge in fast-moving markets.
Tracking Error (ETFs only)
ETFs aim to mirror the performance of a specific index, but in practice they may not match it exactly. Differences can occur due to fund expenses, replication techniques, or changes in the underlying benchmark. This discrepancy is known as tracking error and it may reduce expected returns, especially in more volatile markets. It is advisable to check historical tracking data when selecting an ETF.
Counterparty and Structural Risk
Some ETFs are structured using derivatives or synthetic mechanisms. This introduces counterparty risk, as the returns depend on a third party honouring its obligations. If the counterparty fails, the investor may suffer a loss. Unit trusts generally avoid this kind of risk because they hold actual assets directly through a regulated trustee or custodian.
Concentration Risk
ETFs that focus on a particular sector or theme may be heavily invested in a small number of shares or industries. This increases vulnerability to poor performance if that sector experiences difficulties. Unit trusts vary in approach. Some focus on narrow areas, while others diversify across asset classes or regions. Reviewing the fund’s underlying holdings can help identify whether it is too concentrated.
Cost-Related and Trading Behaviour Risks
ETFs can appear cost-effective, but their trading comes with expenses. Investors using stockbrokers may incur account fees, brokerage costs, settlement charges, and VAT. If they trade frequently, these expenses can accumulate and reduce returns. Unit trusts involve their own set of fees, such as annual management charges, possible adviser fees, and administration costs, which also impact the investment’s performance over time.
Strategic and Regulatory Constraints (Unit Trusts)
Unit trusts are subject to regulatory limits on how they allocate capital. For example, there are restrictions on how much can be invested in unlisted securities or in any one listed share. While these rules help protect investors from excessive risk, they may also restrict a fund’s potential returns in certain investment strategies.
Behavioural Risk
ETFs provide investors with control and visibility, which can lead some individuals to trade more often than is beneficial. This reactive behaviour may result in poor timing and lower returns. Unit trusts tend to promote a long-term investment mindset, but investors may still make emotional decisions if the fund underperforms or if markets become volatile.
Country and Political Risk (Relevant to ETFs)
ETFs with offshore exposure or those that follow global indices may be affected by South African political or economic developments. In some cases, this can disrupt liquidity or cause price movements that are unrelated to the underlying global assets. Such risk is especially relevant during times of domestic instability or when foreign exchange conditions become unpredictable.
Choosing Between ETFs and Unit Trusts
The choice between unit trusts and ETFs should be based on your personal investment preferences, the level of involvement you’re comfortable with, and your overall financial objectives. If you prefer a simplified, managed approach where professionals handle the investment decisions on your behalf, unit trusts could be more appropriate, particularly if you’re new to investing and aiming for long-term financial stability or capital protection.
On the other hand, if you are more focused on keeping investment costs lower and would rather maintain a greater level of control over your portfolio, ETFs present a cost-effective and flexible alternative. These can be well suited to individuals who are comfortable with taking a more active role and are targeting higher returns through trading or growth-focused strategies.
Each product type has its advantages, and for many beginners, using a combination of unit trusts and ETFs can help strike a practical balance between the structure of professional oversight and the benefits of lower costs and liquidity access.
Conclusion
Choosing between ETFs and unit trusts in South Africa depends on your investment goals, cost sensitivity, and preference for active or passive management. ETFs offer transparency, lower ongoing fees, and flexibility through intraday trading, which may suit self-directed investors who prefer hands-on portfolio control. In contrast, unit trusts provide the benefit of active management, simplified access, and structured guidance, which can be ideal for those seeking a long-term, managed approach. Many South African investors choose to combine both products to balance cost efficiency, diversification, and professional oversight within their portfolios.
Frequently Asked Questions
What is the main difference between ETFs and unit trusts?
ETFs are traded on the stock exchange and usually track a specific index, offering intraday pricing. Unit trusts are priced once daily and are often actively managed by professionals aiming to outperform a benchmark.
Which is better for beginners, ETFs or unit trusts?
Unit trusts may be better suited to beginners who prefer a hands-off approach, as they are managed by fund professionals and accessed through investment platforms. ETFs may appeal more to those who are comfortable making their own investment decisions.
Can I invest in both ETFs and unit trusts using a tax-free savings account?
Yes, both ETFs and qualifying unit trusts can be included in a tax-free savings account, provided they meet the regulatory requirements. However, unit trusts with performance-based fees may not qualify.
Are there any differences in fees between ETFs and unit trusts?
Yes. ETFs generally have lower annual fees but may incur brokerage, settlement, and platform costs. Unit trusts may include management, advisory, and platform fees, with VAT applied where relevant.
Can both ETFs and unit trusts be used for retirement investing in South Africa?
Yes, both can be included in retirement funds if they comply with Regulation 28 of the Pension Funds Act, which sets out investment limits to manage risk.
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