LEGAL VIEWPOINT: Unit trusts as investment instruments – By Dr AbdelGadir Warsama Ghalib, Legal Counsel, Bahrain

Dr AbdelGadir Warsama Ghalib, Legal Counsel, Bahrain

Unit trusts, offer to the public another type of good potential investment that is practically indistinguishable from that undertaken through shares in limited liability companies. The intermarriage of a trust and a corporation, as a matter of fact, produced the corporate type of the limited liability company (LLC). In other words, the unit trust is in turn a kind of the offspring of a clear union between the trust and the limited liability company. All supplement each other and give same result.

Asia 728x90

The basic principle of unit trusts is very simple, it is that sort of investment vested in trustees under a trust deed that divides the beneficial ownership into a number of shares, normally described as units and the general public, the potential investors, are invited to purchase these units.

Such an arrangement, generally known as management trust, was not uncommon earlier, and was in fact merely an example of the deed of a kind of a company, from which it differed only in that the trust held shares in other businesses instead of itself engaging in trade activities.

For some time, there has been legal discussions regarding the registration of trust deeds, the high court in England, upheld that there was no „association“ between the holders of the beneficial interests, and that trustees were not „carrying on business“ since holding and varying investments was not a clear type of business. Hence, in other words, the trust was not illegal and did not require registration as a company. Such an entity is sometimes recognized as an investment trust company.

In such type of activity, the managers of the trust (generally a private company) purchase a block of various investments and vest them in trustees (in practice a   trust corporation such as a bank or insurance company), to be held on the terms of an elaborate trust deed.

This divides the beneficial interest in the trust fund into a large number of shares or units. In the first instance, trustees hold the units on trust for the managers who then sell them to the public at a price based on their market value plus a small service charge to cover expenses and profit for the managers.

Managers have the power to increase the number of units by vesting additional securities in the trustees. The managers also provide a market for unit holders by buying back and reselling units. It is the practice for the trust deed to fix certain period for the life of the trust and, at the end of this period, the underlying investments are realized and unit holders repaid. This is the situation, unless they elect to continue the trust for a further term or to convert it into an investment trust company.

If the portfolio of underlying investments is fixed or variable subject to very    rigid conditions, the trust is described as a fixed trust. In this event the first panel of investments is generally described as one unit and the shares that are sold to the public are described as sub-units. The managers then add to the trust by vesting in the trustees from time to time one or more additional unit similarly constituted and divided into the same number of sub-units.

Both fixed and flexible trusts have the advantage, as far as the investor is concerned, of simplicity and of spreading the risk over a wide range of investments. For this reason they appeal particularly to investors who have only small sums and who, accordingly, would be unable to secure the advantage of a spread investment by a direct purchase of shares except in an investment trust company. The fixed trust has the further advantage that the investor knows exactly what he is getting, i.e. a share of the beneficial interest in a fixed block of investments.

A completely flexible trust is for practical purposes virtually identical with an ordinary investment trust company. It has, for the unskilled investor, the advantage that he knows that he is obtaining units at a price which bears a close relationship to the value of the underlying investments.  Its disadvantages are that he cannot obtain the benefits of „gearing“ unlike when investing in equity shares of an investment trust company.

In the U.S. from which modern unit trusts sprang, it is now unusual to operate through the device of a trust. The American company can buy its own shares and accordingly it is possible to achieve the same end as that of a unit trust by an open-ended investment trust company or mutual fund. The U.S. has also recognized that investment trusts, whether in the form of companies or trusts, and whether open or closed ended, are essentially the same „entity“ which should be distinguished from the ordinary trading company and be specifically regulated.

To achieve some rationalization of the control of unit trusts, some actions are needed. These would cover qualifications of the managers and trustees, essential provisions of the trust deed, and the banning of undesirable names. All this, among others, are to be looked at very carefully. This is needed to give this investment venture the necessary power, which by turn will invite more potential investors.

Print Friendly, PDF & Email