Funds Management

Question 1

What do fund managers provide?

Answer 1

Fund managers provide collective investment services to surplus units by attracting funds from investors and by professionally managing their investment
they contribute to the flow-of-funds through direct financing and provide households with a wide range of investment opportunities

Question 2

Who carries the investment risk in funds management?

Answer 2

The investment risk remains with the contributor

Question 3

Who are the main groups of fund managers?

Answer 3

The main groups of fund managers are superannuation, collective investment vehicles (who are mainly public unit trusts) and life insurance

Question 4

What is a growth asset?

Answer 4

Assets with greater levels of risk and returns such as shares and property trusts, are known as growth assets

Question 5

What is a defensive asset?

Answer 5

whereas low risk/return assets, including cash and interest-earning securities, are called defensive assets

Question 6

What is a growth portfolio?

Answer 6

A growth portfolio is weighted towards high risk/return asset classes

Question 7

What is a balanced portfolio?

Answer 7

A balanced portfolio holds a combination (such as 60:40) of growth and defensive assets

Question 8

What is a superannuation fund?

Answer 8

Superannuation is a long-term savings scheme that aims to generate retirement income from contributions made during a person’s working life.

Question 9

What are the main features of compulsory superannuation in Australia?

Answer 9

The main features of compulsory superannuation in Australia are to ensure that:
* there is a minimum level of contributions (this was 9.5 per cent in 2018)
* that superannuation contributions and earnings are subject to a concessional income tax rate (of 15 per cent), subject to an upper limit
* funds remain in the contributors superannuation account until retirement. (4.1 Superannuation funds, 4.2.2. Superannuation – a contributor’s view)

Question 10

What is an accumulation superannuation scheme?

Answer 10

Accumulation schemes – produce a lump sum that depends upon the size of contributions and the rate of earnings on their investment
the investment and survivorship risk is borne by contributors

Question 11

What is a defined benefit scheme?

Answer 11

Defined benefit schemes – commit to pay a specified benefit (either as a lump sum or pension) to the retiree

Question 12

What schemes make up the superannuation industry?

Answer 12

The industry comprises:
Not-for-profit schemes established by:
employers, categorised as corporate or public service schemes
trade unions, categorised as industry schemes
For-profit schemes established by professional fund managers
known as retail schemes
There are also many self-managed funds (SMSFs)

Question 13

What are self managed superfunds?

Answer 13

SMSFs are trusts with up to four members, all of whom must be trustees of the fund
Assets in the fund are managed by its member(s) for the sole purpose of providing retirement income
Most operate under rules set by the Australian Tax Office
The number of SMSFs has consistently grown
Compared to managed funds, they invest less in growth assets and a higher proportion in defensive assets

Question 14

What is a collective investment scheme?

Answer 14

These are investment vehicles that enable ownership of a small portion of large portfolios of securities (or other assets)
1. Public unit trusts
2. Exchange-traded funds
3. Private equity funds
4. Hedge funds

Question 15

What is a public unit trust?

Answer 15

ASIC-regulated collective investment schemes that raise funds by selling units to the public, which represent a share of their assets

Question 16

What are property trusts?

Answer 16

Established by financial institutions or property developers to acquire a large property such as a shopping centre
Usually closed-ended (i.e. have a fixed number of units)
Most are ASX listed, which reveals their price
Unit holder’s receive the property’s revenues less fees
Trusts also use debt funds, exposing unit holders to interest rate risk and funding risk

Question 17

What are equity trusts?

Answer 17

Invest in shares listed on major exchanges, like the ASX
Some invest in broad equity portfolios (such as balanced and growth), some hold narrow portfolios (a particular industry) and some invest in overseas shares
They are generally open-ended, meaning the trust can issue more units
They do not need to be listed to provide investors with liquidity, given their investments are listed
unlisted trusts will buy and sell their units at the assessed current value of their assets

Question 18

What are exchange-traded funds?

Answer 18

ETFs are listed, pooled investments in assets (mostly shares) that have been selected to achieve returns that closely match those of a benchmark index

Question 19

What are hedge funds?

Answer 19

Pooled investment schemes that use a wide range of complex and non-traditional investment strategies and very high levels of debt
Managed by specialist financial managers
Mostly US based where the managers are very aggressive
seeking high returns and taking large risks
at times some achieve very high returns, but there is a high failure rate
mostly institutional and high net worth investors

Question 20

What are private equity funds?

Answer 20

Investment vehicles that aim to buy companies, improve their financial performance and resell them at a profit
They use a combination of equity supplied by investors in the fund and debt
‘Private’ because they are not companies:
controlling partners invest in and run the fund, whereas
limited partners supply equity, pay fees to the controlling partners and must be patient because the investments have a medium- to long-term horizon

Question 21

What is insurance?

Answer 21

The industry has two broad categories: life insurance and general insurance
Insurance enables mutually shared risk:
policyholders pay premiums into a fund
payouts from the fund are made to those that suffer insured events
and so the insurance company incurs a contingent liability

Question 22

How do insurance companies work?

Answer 22

Insurance companies are prepared to sell policies because they expect the premiums will exceed their costs and payouts
They pool premiums and invest part in assets to generate income and to form reserves to meet their future obligations
they face investment risk on these assets
Policies are designed to reduce the risks posed by moral hazard, adverse selection and fraudulent claims

Question 23

What are the three forms of life insurance?

Answer 23

There are three general forms of life insurance:
Term life policies provide financial compensation in the event of the insured’s death (or permanent disability) during the policy’s term
most are held as part of superannuation schemes
Whole-of-life policies do not have a set maturity date and attract annual bonuses that provide policyholders with a savings feature
Endowment policies have a set maturity date and attract annual bonuses that provide a savings feature

Question 24

What is general insurance?

Answer 24

These cover a wide range of events that inflict losses, and provide financial compensation if an insured event occurs
Examples of general insurance are:
 house and contents insurance
 motor vehicle and third-party insurance
 travel insurance
Reinsurance is used by general insurance companies to spread their payout risks

Question 25

What are the two approaches to investment management?

Answer 25

There are two broad approaches to investment management:
Active investment management
the pursuit of above-average returns where portfolios are managed by replacing under-performing assets with those that are thought will do better
Passive investment management
the practice of maintaining portfolios so that their performance closely matches that of a benchmark index

Question 26

What is active investment management?

Answer 26

Active management seeks to achieve above average returns – that is, higher than those of competing managers and the ‘market’
They aim to make superior selection and timing decisions,
that is, which shares to buy and sell and when to buy or sell them
Necessitates ongoing research and more frequent trading, costs which are passed on to investors through fees
The two main methods of assessing asset value are technical analysis and fundamental analysis

Question 27

What is technical analysis?

Answer 27

Technical analysis uses historical data to attempt to predict future asset price movements and so reveal when to buy & sell
Analysts look for persistent trends and cyclical price patterns by considering:
price channels, price support & resistance lines and
momentum indicators
Evidence of consistent above-average returns is not strong – nonetheless it is widely used

Question 28

What is fundamental analysis?

Answer 28

Attempts to calculate an asset’s value as the present value of its expected future payments
this is then compared to the current price – overpriced assets would be sold, underpriced assets bought or retained
Fundamental analysis can include market & industry analysis, financial statement analysis and discounted cash flow analysis

Question 29

What is the relationship between Passive investment management and index funds?

Answer 29

These managers form a portfolio (an index fund) that replicates the returns achieved by a benchmark index, such as the ASX200
Invest in shares in proportion to their role in that index
or, (to lower costs) hold fewer shares and accept a small tracking error in the portfolio’s returns
Requires very little research and few changes to the portfolio
so the management expense ratios (MER) of passive funds are less than active managers

Question 30

How are investment managers’ performances measured?

Answer 30

Assessing the performance of investment managers is not just a matter of comparing their returns!
Returns need to be considered with reference to the risks taken,
and comparisons made between managers in the same asset class,
plus fund returns are unstable, and past returns are not usually a good indicator of future returns

Question 31

How does ratings of investment managers work?

Answer 31

Ratings agencies such as S&P and Morningstar rate managers on their quantitative risk and return history and a qualitative assessment of the manager’s skill
they use a five-star rating scale, where 3 stars indicates an expectation of average returns, 1 or 2 of below average returns, and 4 or 5 of above average returns
Ratings influence the allocation of investments between active managers
Research indicates that higher-rated managers can continue to outperform, but not consistently