Collective Investment. Unit Investment Trusts
It is no secret that the people of Kazakhstan have accumulated considerable amounts of surplus wealth over recent years. Real estate used to be a highly liquid investment instrument only a short time ago. Today, when more and more experts are saying that the real estate sector is overheated, unit investment trusts have become a very attractive investment alternative, given the valuable opportunity that they offer to maintain a balance between risk and profitability.
Some Background about UITs
A unit investment trust (UIT) is a form of collective investment. The trust pools the money from many individual investors and engages an investment company for trust management. The holders of investment units or shares (unitholders) are the owners of the UIT’s assets on an equity ownership basis. A unit is a security which certifies its holder’s right to a share in the trust’s assets. The unit price is calculated by a management company on the basis of the overall value of the trust’s assets. A unit is not a deposit, which is why investors in UITs do not receive fixed dividends. A trust’s profitability depends on the growth of its unit price. This is why the unit price as a number is not as significant as its dynamics.
The forerunner of the modern UITs was established in Belgium in 1822. A hundred years ago, the USA applied this scheme; today, 40% of its population invests in UITs. There are approximately 50,000 investment funds in the world with overall assets reaching $14 trillion.
The particularity of this investment scheme is that a private depositor invests money in securities and other profitable instruments via a professional investment company. A depositor does not need large amounts to enter the fund because UITs are a collective investment. UITs also provide access to a wide range of securities for investment and therefore reduce their risks. High profitability (up to 70% annually) is due to preferential taxation. Revenues from investment are not subject to corporate income tax. Dividends distributed among unitholders are exempt from taxes as well. Legal entities and individuals, as well as residents and non-residents of Kazakhstan, can hold shares in UITs.
However, experts stress that previous investment results do not reflect future revenues; that is why neither the government nor the investment company can guarantee the profitability of this investment.
There are three types of UITs: closed-end, interval and open-end. Each type is aimed at its own group of investors. Open-end funds appeal to a greater mass of people with their low entrance investment requirement and conservative investment policy. Their profitability is lower compared to interval and closed-end funds; however, accumulated dividends are available once a fortnight or even more often. Interval UITs imply higher profits but larger exit intervals. Nevertheless, some domestic investment companies offer interval funds where one can withdraw as often as in open-end funds. As for closed-end funds, they usually follow an aggressive strategy aimed at achieving high profits. However, the risk of losing money is considerable. Besides, unitholders can withdraw from closed-end funds only once a year. Investment companies are forbidden from advertising closed-end funds because of the high risks, even though they have the right to create all types of funds.
In Kazakhstan, UIT activities are regulated by the Law on Investment Funds, which was enacted in 2004. In the same year, the Compass management company established the first UITs. The minimum admittance requirement was $100,000, which was unrealistic for most of the people of Kazakhstan. Funds for mass investors appeared two and a half years ago, on 5 January 2005, when Centras Securities established Kaznacheistvo – the first open-end UIT with a minimum admittance requirement of 100,000 tenge.
It is worth noting that conditions are becoming more and more attractive for unitholders. There are open-end funds with a minimum requirement of only 50,000 tenge in Kazakhstan today. In 2006, Kazakhstan had 87 funds which collected approximately $400 million, boosting the market four times. The previous year results showed annual profitability of 16.5% to 87.7%. Taking into account these impressive indicators, it is natural that the number of unitholders is growing in arithmetic progression in Kazakhstan. Today, the number of unitholders approaches 5,000, compared with fewer than 3,000 in 2006.
As of 1 July 2007, total assets of UITs rocketed by 39%, exceeding 90 million tenge. There were 149 UITs, including 117 closed-end, 15 open-end and 17 interval, operating on the securities market. These figures can be compared with 75 UITs, including 59 closed-end, 9 open-end and 7 interval, operating as at 1 July 2006. During the year, the number of UITs has almost doubled. However, the closed-end funds, which were set up for specific projects, accounted for the largest part of the growth.
Experts believe that autumn and winter will entail a massive influx of investors due to bonuses and “thirteen-month” salaries. That is why investment companies are opening new funds. Besides, the untapped potential of Kazakhstan’s investors is really considerable. According to various surveys, from 8% to 13% of Astana and Almaty citizens know what a UIT is. The situation is much worse in other areas. That is why a number of companies are looking at extending their services to the regions today.
Individuals, mostly Almaty citizens, aged between 20 and 50, are the main investors in domestic UITs. However, nationals of Turkey, Russia and Kyrgyzstan are also beginning to take an interest in Kazakhstan’s UITs.
A point to note is that there is at present no significant competition among investment companies; they consider bank deposits and real estate as their main competitors. They are planning to attract large amounts from these sectors.
Income Does not Wait
Representatives of investment companies do not give away much information about the instruments held in the portfolios of their UIT investors. Almaty Investment Management says that the composition of securities is constantly changing in the portfolios of their UITs, depending on analytical information about issuers and the market. Orda Capital (Shymkent) says that the company is free to make its own decisions, and it invests in the securities of issuers that are the most promising according to their analysts’ opinion. It should be noted that Damu Invest, an open-end fund managed by Orda Capital, took first place in terms of profitability (66.27% as of 1 July 2007) during the first six months of 2007. This fund invests only in corporate securities quoted on the Kazakhstan Stock Exchange.
REAL-INVEST.kz also has good results: the net assets of its funds grew four times during the first six months of 2007. This was due to increased investments in its fund and the growth of unitholder’s dividends. The company pooled from 40 to 75 million tenge per month from individual investors. The number of Real Invest’s interval funds tripled; the unit price of Favorit – company’s best UIT – increased by more than 18%.
According to Maksim Tolmachev, the RESMI marketing and sales department director, one of their major advantages is maintaining a high level of profitability. In particular, RESMI forecasts that the Monetny Dvor interval fund’s annual profitability will remain at the level of 25% (this figure remained stable during the past two years).
Does It Make a Difference?
The crisis in international markets entailed a reduction in the price of Kazakh banks’ shares, which slightly interrupted the dynamics of UITs’ profitability. Nevertheless, investment companies say that this attracted new investors who are highly interested in purchasing UITs’ shares while they are reduced in price. Experts believe that the slowdown won’t be protracted and that the events of August will not affect the results forecast for the end of the year. Orda Capital’s specialists said that the situation on world trade floors did not influence Kazakhstan’s UITs significantly, except for the first week after the crisis when the UITs’ unit price fell.
RESMI assets growth rate nearly reached the planned target; at the same time the annual plan for attracting new investors was significantly exceeded countrywide. According to Real Invest, the terms of sale for UITs’ shares did not change and no discounts were offered as experts considered that this step would be premature.
Maksim Tolmachev commented that UITs are an investment tool, not a speculative one; which is why he recommends making equal monthly or quarterly investments, saying that waiting for a favourable moment to enter the fund, even during the reduction of unit price, would be less advantageous.
According to Marina Zabolotnaya, the head of Orda Capital, Kazakhstan’s UITs have a sufficient profitability margin to protect themselves from critical events in world stock exchanges. First, today’s unitholders do not purchase units for speculation purposes. Second, the reduction of quotations on the securities market cannot provoke a massive exit of unitholders because the activity of UITs so far is not too extensive. Ms Zabolotnaya said that risks that exist on the securities market should not have an effect on the decisions of a UIT investor. Besides, the entrance and exit of unitholders is a continuous process in open-end funds. However, trust assets were not reduced during the crisis.
Nevertheless, the end of summer was not an easy time either for banks or investment companies. According to recent data, only six out of 18 open-end and interval funds reported positive return as of 31 August 2007.
If Damu Invest (managed by Orda Capital) became a leader in July with monthly profitability of 9.28%, Global Finance of Tsesna Capital took the leading position in August 2007 with a mere 1.79%. According to experts, the unit price fell mainly due to the reduced price of Kazakh banks’ shares. However, the majority of analysts remain optimistic. They say that by the end of the year these fluctuations will not have a significant influence on the profitability rate.
What Do We Have as a Result?
The real estate market froze waiting for something to happen after interest rates on mortgage loans were raised. In this situation real estate loses its attractiveness with the result that the greater part of available surplus money can flow into the collective investment market. Moreover, bank deposits are now considered as a high risk instrument with low profitability due to the recent events. That is why investment companies expect increased growth in domestic UITs. The market participants say that insurance companies and pension funds, which traditionally prefer trust management, are taking a growing interest in UITs even though there are legal barriers. Managers, meanwhile, do not want to focus on legal entities for fear of losing individuals, the main category of investors. Specialists believe that individuals are the key factor in the further development of UITs.
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