Unit Trusts in Kenya: A Comprehensive Guide

Introduction

Ever wondered how to grow your money without the complexity of picking individual stocks or bonds yourself? Unit Trust Funds (UTFs) in Kenya provide an accessible and professionally managed way to do so. They operate by pooling money from numerous investors like you. This collective fund is then entrusted to expert fund managers who build and manage adiversified portfolio – a mix that might include stocks, bonds, government securities, and other assets, depending on the fund’s objective.

By investing, you purchase ‘units,’ which represent your proportional ownership of the fund’s underlying assets. Your potential returns can come from multiple sources: interest earned, dividends paid out by the investments, and growth in the value of the units themselves (known as “capital appreciation” or “increase in Net Asset Value” - NAV).

Key advantages that attract many investors include:

• Diversification (spreading risk across many assets),
• Access to professional management and,
• The ability to start investing with relatively small amounts (accessibility).

This guide dives deep into UTFs, exploring their structure, the crucial roles of the Fund Manager, Trustee, and Custodian, the different types of funds available, their benefits and risks, the regulations governing them in Kenya, and the key factors to consider before investing.

We’ll also cover how returns are measured, the typical fees involved, and the practical steps to start your investment journey.

Trust Funds

First, we need to understand the traditional concept of a “trust fund”, which forms the structural basis for“unit trust funds”.

A traditional trust fund is a legal arrangement where one party, known as the grantor or settlor, transfers assets (like money, property, or other investments) to another party, called the trustee (e.g., a bank or a specialized trust company). The trustee holds and manages these assets according to the terms set by the grantor, strictly for the benefit of a third party, the beneficiary (e.g., the grantor’s grandchildren).

Now, how does this compare to a Unit Trust Fund (UTF)?

While UTFs utilize a trust structure for holding assets, they operate differently, particularly in their setup and the roles involved:

1. A traditional trust is often a private arrangement set up by one grantor for specific beneficiaries. In contrast, a UTF is a collective investment scheme. A professional Fund Manager establishes the UTF scheme (under regulatory oversight and typically governed by a Trust Deed). Many investors then pool their money together within this established structure by purchasing ‘units’.

2. As an investor in a UTF, you contribute capital by buying units. You become a unitholder, and you are the beneficiary of your proportionate share of the fund’s pooled assets and any income or growth generated. However, you are not the ‘grantor’ in the legal sense of creating and defining the trust structure itself; you are participating in a pre-existing, regulated structure.

3. Far from having fewer parties, the regulated structure of a UTF relies on several distinct entities working together. Key roles (as detailed later) include the Fund Manager (managing the investments), the Trustee (overseeing the Fund Manager and protecting unitholder interests), and the Custodian ( safeguarding the fund’s assets). These independent parties are crucial for the proper functioning and security of the UTF.

In essence, while both use a “trust” framework for holding assets, a UTF is a public, pooled investment vehicle with defined roles for multiple regulated entities, whereas a traditional trust is often a more private, bespoke arrangement initiated by a single grantor.

Structure and Regulation of Unit Trust Funds

In Kenya, Unit Trust Funds (UTFs) are strictly regulated to protect investors. They operate under the framework established by the Capital Markets Authority (CMA), primarily governed by the Capital Markets (Collective Investment Schemes) Regulations, 2001 (and subsequent amendments).

The foundation of each specific UTF is its Trust Deed and Offering Document (or Prospectus), which outline its objectives, investment policies, fees, and operational rules.

This regulatory structure mandates a clear separation of duties among three critical, independent parties to ensure transparency, security, and adherence to investor interests:

1. The Fund Manager:

   • Role: Responsible for the day-to-day investment management and administration of the UTF. This includes researching markets, selecting securities (stocks, bonds, etc.), deciding on the portfolio mix, managing risk, and handling investor subscriptions and redemptions.
   • Investor Protection: While their primary role is investment management, they are bound by the fund’s mandate and regulations, aiming to achieve the fund’s objectives within defined risk parameters. Their performance and actions are overseen by the Trustee.

2. The Custodian:

   • Role: Typically a licensed commercial bank or approved financial institution responsible for the safekeeping of the fund’s assets. This includes holding all the securities (like share certificates and bond documents) and cash belonging to the fund.
   • Investor Protection: The Custodian ensures that the fund’s assets are legally segregated from the assets of the Fund Manager and the Trustee. This separation is crucial; it protects your investment even if the Fund Manager were to face financial difficulties. They only act on verified instructions from the Fund Manager, adding a layer of control.

3. The Trustee:

   • Role: Acts as the ultimate watchdog for the unitholders (investors). The Trustee is an independent entity (often a bank or trust company) responsible for ensuring the Fund Manager operates the UTF in accordance with the Trust Deed, Offering Document, and all applicable regulations.
   • Investor Protection: The Trustee actively monitors the Fund Manager’s activities, including investment decisions, compliance with limits, calculation of the unit price (NAV), and fee structures. They have a * fiduciary duty* to act in the best interest of the investors, ensuring fairness and adherence to all rules designed to protect your money.

Types of Unit Trust Funds

Unit Trust Funds (UTFs) in Kenya offer a diverse range, designed to cater to different investment goals, risk tolerance levels, and time horizons. Understanding the main types is crucial for selecting a fund that aligns with your needs.

Below is a breakdown of the most common categories:

1. Money Market Funds (MMFs)

   • Focus: Invest primarily in high-quality, short-term debt instruments like Treasury Bills, fixed deposits, and commercial paper.
   • Objective & Risk: Aim for capital preservation and generating competitive interest income. They are considered the lowest-risk UTF category due to the short maturity and high credit quality of their holdings. They offer high liquidity, meaning easy access to your cash.
   • Ideal For: Cautious investors seeking stability, an emergency fund, short-term savings goals, or a temporary holding place for cash, aiming to earn better returns than traditional savings accounts while minimizing risk.

2. Equity Funds (or Growth Funds)

   • Focus: Invest predominantly in shares (equities) of companies listed on stock exchanges (like the Nairobi Securities Exchange).
   • Objective & Risk: Aim primarily for long-term capital growth through increases in share prices, with potential for dividend income. They carry high risk due to the inherent volatility of the stock market. Fund value can fluctuate significantly, especially in the short term.
   • Ideal For: Investors with a long investment horizon (typically 5+ years) and a **high tolerance for risk **, seeking potentially higher returns over time and comfortable with market fluctuations.

3. Fixed Income Funds (or Bond Funds)

   • Focus: Invest mainly in longer-term debt securities, such as government bonds (Treasury Bonds) and corporate bonds.
   • Objective & Risk: Aim to provide regular income through interest payments (coupons) from the bonds, with potential for modest capital appreciation. They carry low-to-moderate risk – generally lower than Equity Funds but higher than MMFs. Risks include interest rate risk (bond prices typically fall when interest rates rise) and credit risk (the possibility of bond issuers defaulting).
   • Ideal For: Investors seeking relatively stable income, capital preservation over the medium-to-long term, and diversification from equities. Suitable for those with a moderate risk tolerance.

4. Balanced Funds (or Hybrid Funds)

   • Focus: Invest in a mix of asset classes, typically equities and fixed income securities, according to a predetermined ratio (e.g., 60% equity, 40% bonds).
   • Objective & Risk: Aim to provide a balance between growth and income, capturing some upside from equities while mitigating risk through bond holdings. They carry moderate risk, reflecting the blend of underlying assets.
   • Ideal For: Investors seeking a diversified ‘all-in-one’ solution, who desire both growth potential and income generation, and have a moderate risk tolerance and a medium-to-long term outlook.

Other Fund Types: Beyond these main categories, you might also encounter more specialized funds in Kenya, such as:

• Sharia-Compliant Funds: Invest according to Islamic finance principles.
• Sector-Specific Funds: Focus on particular industries (e.g., financial services, technology).
• Offshore or Regional Funds: Invest in assets outside Kenya.

Summary Table:

Growth and Popularity of Unit Trusts in Kenya

Unit Trust Funds have witnessed remarkable growth in Kenya, becoming an increasingly mainstream investment choice. Data from the Capital Markets Authority (CMA) highlights this surge:

• As of June 2024, total assets under management (AUM) reached Sh254 billion.
• The number of investors enrolled hit approximately 1.2 million, marking a dramatic 605 percent increase from just 172,000 investors recorded in March 2021. (Source: CMA Data reported by Business Daily, July/August 2024).

This rapid expansion is fueled by several factors attractive to Kenyan investors:

• Higher Returns: UTFs, particularly Money Market Funds, have consistently offered returns significantly higher than traditional bank savings accounts. Driven by high interest rates on government securities and bank deposits where they primarily invest, some MMFs reported annualized returns reaching up to 18.26 percent in mid-2024.
• Accessibility: Low entry barriers, with some funds allowing investments starting from as little as Sh1,000, make UTFs accessible to a wide range of people.
• Flexibility & Liquidity: Many funds allow investors easy access to their money, often permitting withdrawals without penalties, unlike potential revaluation losses in direct stock/bond trading.
• Technology: Fund managers have leveraged technology for easy online/mobile onboarding, account management, and round-the-clock support, simplifying the investment process.

Money Market Funds (MMFs) remain the dominant category, holding Sh171 billion (or 67.4 percent) of the total AUM as of June 2024, reflecting their appeal for stable, high-interest returns. Fixed Income funds hold the second largest share.

UTFs vs Direct Stock Investments

By September 2024, the number of UTF investors had climbed further to nearly 1.3 million (1,299,300). Crucially, this milestone marked the point where the number of collective investment scheme accounts surpassed the number of direct equity market accounts held at the Central Depository & Settlement Corporation (CDSC), which stood at around 1.287 million. (Source: CMA Q3 2024 Soundness Report data reported by Business Daily, Nov/Dec 2024).

This growing preference for UTFs over direct stock market participation is attributed to a convergence of factors. Alongside the attractive double-digit yields seen in many funds (some exceeding 15% annualized during peak periods post-2022), investors have been drawn by increasing market awareness fueled by social media influencers and targeted marketing. The ease of access through digital platforms, allowing investment and liquidation directly via phone, contrasts sharply with the perceived complexities and recent prolonged underperformance (bear market) experienced by many stocks on the Nairobi Securities Exchange (NSE). The risk diversification offered by pooled funds also adds to their appeal compared to holding individual, potentially volatile stocks.

Potential Risks and Costs Involved

While Unit Trust Funds offer significant advantages, it’s crucial for investors to understand the potential downsides, risks, and associated costs before investing. These include:

1. Investment Risks (Your Capital is Not Guaranteed):

• Market Risk & NAV Fluctuation: The core risk is that the value of the underlying assets (stocks, bonds) in the fund can go down as well as up due to market movements, economic factors, or investor sentiment. This means the Net Asset Value (NAV) per unit can decrease, and you could get back less money than you invested. This risk is higher in Equity and Balanced funds due to stock market volatility and is why UTFs (especially those with equity exposure) are often considered medium-to-long-term investments.
• Interest Rate Risk: Primarily affects Fixed Income and Balanced Funds. When market interest rates rise, the market value of existing bonds typically falls, which can negatively impact the fund’s NAV. Conversely, falling rates can increase bond values.
• Credit Risk: Applies mainly to Fixed Income and Balanced Funds holding corporate bonds or commercial paper. This is the risk that the entity that issued the bond (the borrower) may default on its interest payments or fail to repay the principal amount.
• Inflation Risk: There’s a risk that the returns generated by the fund may not keep pace with the rate of inflation, meaning your investment loses purchasing power over time. This is a consideration even for lower-risk funds like MMFs.
• Liquidity Risk: While UTFs are generally liquid, there could be rare circumstances (like severe market stress) where the fund manager might temporarily suspend redemptions or take longer than usual to process withdrawal requests, especially for funds holding less liquid assets. MMFs typically have the highest liquidity.
• Specialist Fund Risk: Funds focused on specific sectors (e.g., technology), regions, or asset types can be riskier than diversified funds. If that particular sector or region performs poorly, the fund’s value could fall sharply due to lack of diversification.
• No Capital Guarantee: Critically, unlike bank deposits (which might have deposit insurance up to a certain limit),UTF investments are generally not insured or guaranteed by the government, the CMA, or the fund provider. You bear the investment risk.

2. Fees and Charges (Costs That Reduce Your Returns):

UTFs involve various fees that directly impact your overall return. It is essential to understand these before investing by carefully reading the Fund Fact Sheet or Prospectus:

• Management Fee: An annual fee charged by the Fund Manager for managing the fund’s investments and operations. It’s typically calculated as a percentage of the fund’s total assets (e.g., 1-2% per annum) and deducted directly from the fund’s value, reducing the NAV.
• Initial Fee: A one-time fee charged when you first invest in some funds (often a percentage of your initial investment amount). This is less common nowadays, especially for MMFs, but still exists for certain fund types or providers.
• Trustee & Custodian Fees: Fees paid to the Trustee (for oversight) and Custodian (for safeguarding assets). These are usually smaller percentages and are also deducted from the fund’s assets.
• Other Operating Costs: Funds may incur other expenses like audit fees, legal fees, and transaction costs ( brokerage commissions incurred when the fund manager buys or sells securities – related to the original “Portfolio Turnover Costs”). These are also paid out of the fund’s assets.

Total Expense Ratio (TER): Often, these ongoing costs (Management, Trustee, Custodian, Operating) are bundled into a single figure called the Total Expense Ratio, expressed as an annual percentage of the fund’s assets. A lower TER generally means more of the fund’s returns reach the investor.

3. Limitations:

• Limited Asset Exposure: Most traditional UTFs primarily invest in listed securities (stocks, bonds, money market instruments). They generally don’t offer direct exposure to tangible assets like real estate, commodities (like gold), or unlisted private equity, which might be accessible through other investment structures.

Understanding these risks and costs is vital for making an informed investment decision and setting realistic expectations about potential returns and volatility.

Key Considerations Before Investing

Choosing the right Unit Trust Fund is a crucial step towards achieving your financial objectives. It requires careful self-assessment and due diligence on the available options. Here are the critical factors every potential investor should consider:

• Understand Your Personal Profile:

  • Investment Goals: What are you saving for? (e.g., emergency fund, down payment, retirement, general wealth growth). Is your priority capital preservation, income generation, capital growth, or a mix?
  • Risk Tolerance: How comfortable are you with potential fluctuations in your investment value? Can you withstand short-term losses for potential long-term gains? Be realistic about your emotional response to market volatility.
  • Time Horizon: How long do you plan to keep the money invested? Longer time horizons generally allow for taking on more risk (like in Equity Funds), while shorter horizons favour lower-risk options (like MMFs).
  • Liquidity Needs: How quickly might you need access to your invested funds without penalty? MMFs offer the highest liquidity, while accessing funds from Equity or Balanced funds might be better suited for medium-to-long-term money.

• Evaluate the Fund Itself:

  • Fund Type & Strategy: Does the fund type (MMF, Equity, Fixed Income, Balanced, etc.) align with your goals, risk tolerance, and time horizon identified above? Understand its specific investment strategy.
  • Performance History: While past performance is not a guarantee of future results, review the fund’s historical returns over various periods (1, 3, 5 years) compared to its benchmark index and peer funds. Look for consistency.
  • Fund Manager Reputation & Experience: Research the Fund Management company. What is their track record? How long have they been operating? Experienced and reputable managers can be a positive factor.
  • Fees and Charges: Critically compare the costs involved. Look at the Initial Fees (if any) and, more importantly, the ongoing Total Expense Ratio (TER) or Management Fee. Higher fees directly reduce your net returns over time.

• Read the Fine Print:

  • Fund Fact Sheet & Prospectus/Offering Document: This is essential reading. These documents provide detailed information about the fund’s objectives, investment strategy, underlying holdings, risks, historical performance,all applicable fees, and distribution policies. Do not invest without reviewing these.

• Seek Professional Advice (If Needed):

  • If you are unsure about how to assess these factors or which fund best suits your individual circumstances, consider consulting a licensed and independent financial advisor. They can provide personalized recommendations based on a thorough understanding of your financial situation and goals.

Making an informed decision requires balancing your personal needs with a clear understanding of what a specific fund offers, including its potential returns, inherent risks, and associated costs.

Conclusion: Making Informed Choices with Unit Trusts

Unit Trust Funds represent a significant and increasingly popular investment pathway for Kenyans, offering a structured way to access professional fund management and diversify investments across various asset classes like stocks, bonds, and money market instruments. As we’ve explored, their regulated structure, involving distinct roles for the Fund Manager, Trustee, and Custodian, provides a framework for transparency and investor protection.

The key advantages – diversification, professional expertise, accessibility, and liquidity – make UTFs compelling compared to many alternatives. However, realizing their potential requires an informed approach. It’s vital to remember that returns are not guaranteed, and different funds carry varying levels of market, interest rate, and credit risk. Furthermore, understanding and comparing the associated fees and charges is crucial, as these costs directly impact your net returns.

Ultimately, successful investing in Unit Trusts hinges on aligning your choice with your personal financial goals, risk tolerance, investment timeline, and liquidity needs. This involves carefully researching fund options, comparing their strategies and performance, and critically, reading the Fund Fact Sheet and Prospectus to fully grasp the investment’s nature, risks, and all associated costs.

Given their proven growth and adaptability, Unit Trust Funds are poised to remain a cornerstone of the Kenyan investment landscape. By equipping yourself with the knowledge presented in this guide, you are better positioned to navigate the choices available and make decisions that support your journey towards financial well-being. If uncertainty remains, seeking personalized advice from a qualified financial advisor is always a prudent step.