6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 1 - Indirect investments - unit trusts, OEICs and investment trust companies

Question 1

Why are Collective investment schemes popular with investors?

Answer 1

They offer a good way to invest small sumds of money as investments are pooled into a larger fund
Professional fund managers make the underlying decisions
An investor can achieve a balanced portfolio as the fund managers invest in a spread
They offer the ability to persue particular objectives that an investor might otherwise avoid
Risk is reduced by the wide spread of the underlying portfolio

Question 2

What are the characteristics of OEICs and unit trusts?

Answer 2

The allow an investor to participate in large portfolios or shares with many others

Units or shares are sold to investors, each is a small but equal fraction of a portfolio

Unit trusts are held for investors by trustees and invested by managers, OEICs are held by an indepedant depository

There is generally an initial charge and an annual management fee, or alternatively an exit charge may apply

Question 3

What are the IA sector definitions? (Investment association)

Answer 3

Captial protection
Income
Growth
Specialist fund
Those principally targetting an outcome

Question 4

How does the IA determine the different sectors?

Answer 4

Performance measurement companies (such as Standard and Poors) rank the performance of funds in each sector, published weekly and monthly

The fund must have at least 80% of its assets in the relevant sector

To qualify as an Income fund, achieve a yield of no less than 90% of the relevant index

Membership is constantly revised in light of developments and new types of funds

Question 5

What do supporters of index tracking funds believe?

Answer 5

few managers outperform consistently the index
Outperformance generally means higher risks have been taken
Index tracking funds generally have lower charges

Question 6

What are the general rules that restrict investment powers of authorised funds?

Answer 6

The FCA’s specialist handbook - sets out rules for establishing and operating schemes, minimum standards, proportion of transferable securities and derivatives

The trust deed must contain a statement that the fund can invest only in those eligible by the FCA, or narrower investment powers if required

The investment limits of the scheme or prospectus of the scheme, in accordance with the FCA

Question 7

What percentage of securities in an fund, must be within approved securities?

Answer 7

90%

Question 8

What are the four other standards that unit trust managers, directors and trustees must meet in addition to ensuring the market is liquid?

Answer 8

Regulated
Operating regularly
Recognised by a statutory body or government agency
Open to the public

Question 9

How often must a firm carry out a review of non EU markets they consider eligible for each fund?

Answer 9

Annually

Question 10

What are the diversification rules applicable to unit trusts and OEIC’s imposed by the FCA?

Answer 10

Non index tracker funds can only hold up to 10% of the total value in any one company

The fund can only hold an aggregate of 40% up to the maximum of 10% in four seperate shareholdings

Any other must not exceed 5% - i.e. a total of not less than 15 holdings
(UCITS funds which are replicating tracker funds can hold up to 20%, and 35% in exceptional circumstances)

UCITS are limited to 20% for securities or instruments by the same group

Funds investing 35% or more in government stock, are required to invest in 6 different issues, no single stock can exceed 30% of the total value of the fund

UCITS can hold up to 10% in unapproved securities, 20% can be in another collective investment scheme

Non UCTIS can hold up to 20% and 35 % in another collective scheme

Both can hold warrants without limits

Funds can only hold cash for liquidity and cash flow purposes , no more than 20% overall

Question 11

What is the difference in borrowing limits for retail UCITS and non retail UCTIS schemes

Answer 11

A retail scheme can only borrow up to 10% on a temporary basis (but can borrow against its property fund)

A non retail is allowed to borrow up to 10% of the fund on a permanent basis

QIS may borrow up to 100% of shceme property

Question 12

What is the difference between a UCTIS and UCIS?

Answer 12

UCTIS meets EU requirements and can be marketed across europe ro retail investors

UCIS is unregulated and cannot be marketed to retail investors in the UK

Question 13

What investments are considered as Non mainstreamand subject to marketing restrictions?

Answer 13

Units in QIS (qualified investor scheme)
Traded life policy investments
Units in UCIS
Securities issues by special purpose vehicles, pooling investments in assets other than unlisted or listed shares or bonds

Question 14

What investments are not considered NMPI’s and fall outside marketing restrictions?

Answer 14

Exchange traded products
overseas investment companies that would meet the criteria for investments if based in the uk
real estate investment trusts
venture capital trusts
enterprise investment schemes and seed schemes
SPV’s pooling investments primarily in shares and bonds

Question 15

What type of fund sits within the AIFMD (alternative investment fund managers directive)?

Who are they aimed at?

Answer 15

hedge funds
private equity funds
retail investment funds
investment companies
real estate funds

Professional and institutional investors

Question 16

What are the two key roles within a trust deed?

Answer 16

The trustee and the manager

Question 17

What are the key elements of the trustee’s role?

Answer 17

Checking the managers actions
Ensures the manager invests in line with the objectives of the fund
Holding/controlling the assets to ensure they are held safely

Question 18

In what circumstances could a trustee fire the manager?

Answer 18

If the manager goes into liquidation, insolvency, receivership
if the trustee believes the manager is not acting in the unit holders interest
If the majority of the unit holders voted for removal of the manager

Question 19

Who is the legal owner of the trust and in whose name are the securities registered?

Answer 19

The trustee

Question 20

What over jobs does a trustee have in relation to the trust?

Answer 20

Report to the FCA if its not being managed within regulations
Arranging an audit of the trust and issuing financial statements
Monitoring the calculation of unit pricefor sale and repurchase
Arranging unit holder meetings
Setting up the register of unit holders and issuing certs
Distributing the income
Making any additional provisions for the trust to be recognised as a pension scheme or charitable scheme

Question 21

Trustees are usually what type of institution?

Answer 21

Large bank or major insurance company

Question 22

What are the fund manager’s key responsibilities?

Answer 22

Be authorised
Have adequate financial resources
Manage the assets in accordance with regulations and the trust deed/scheme particulars
Supply information when requested
Maintain a record of units for inspection
Notify the trustee/FCA of any breaches
Promotion, advertising, administration

Question 23

What is subcontracting of fund management?

Answer 23

The manager may select a third party to decide how the fund is invested who may then select a third party to handle admin.

The manager retains responsbility and compliance with regulations

Question 24

What does the register of a unit holders need to contain?

Answer 24

Name and address of unit holders
Number of units held
Date of which the holder was registered

Question 25

If a certificate is not issued, what else might a holder receive?

Answer 25

A periodic statement

Question 26

What is required to be on a certificate?

Answer 26

Date Name of the scheme Names and addresses of the manager and trustee Number and type of units held by the holder Name of the holder

Question 27

How often should a unit trust publish reports?

Answer 27

half yearly and annually

Question 28

What are the three levels of protection for a unit holder?

Answer 28

``` Trustees Regulatory organisations (under Financial services and markets act 2000) Complaints and arbitration procedures ```

Question 29

If a fund manager wishes to raise charges, how much notice would he need to give?

Answer 29

reasonable, not less than 60 days

Question 30

Can a manager be removed without the approval of the FCA?

Answer 30

No.

Question 31

How are unit trusts taxed and how is it important to investors?

Answer 31

Taxed as corporation tax on Income only. Can allow annual management expenses to be offset against non-dividend income of rtax relief purposes

Question 32

Do unit trusts pay tax on capital gains or options form futures?

Answer 32

No

Question 33

What are the different tax regimes, depending on the composition of the investments in the fund?

Answer 33

Less than 60% of interest barring securities pay corporation tax at 20% in income on overseas income, rent or interest Dividends are received as franked income and flow through to dividend distributions payable by the trust so have no tax liability More than 60% in interest barring pay an interest distribution which is deductinle for corporation tax, i.e. there is no UK corporation tax liability

Question 34

What is an equalisation payment?

Answer 34

A payment within the first distribution of income to a unit holder, which represents the income that was included within the price paid for the units.

Question 35

How is an equalisation payment treated for tax purposes?

Answer 35

It must be deducted from the intial purchase price to confirm the aquisition value for CGT purposes

Question 36

How often is income from a unit trsut distributed?

Answer 36

Monthly, quarterly, 6 monthly or annually depending on the type of trust

Question 37

What are the rates on income tax on trust dividend distributions from equity trusts?

Answer 37

7. 5% for basic rate 32. 5% for higher rate 38. 1% for additional rate

Question 38

How are trustees taxed on funds held within a discretionary trust?

Answer 38

liable for tax of 38.1% on income received and 2K allowance does not apply, however dvidends that fall within the standard rate band of £1000 will only be taxed at 7.5%

Question 39

what is the special rate of corporation tax for OEIC's and unit trusts?

Answer 39

20%

Question 40

In order to pay interest distributions from a non equity unit trust or OEIC, how much needs to be held in interest barring investments?

Answer 40

60%

Question 41

How much tax liability would a gilt or corporate bond fund within a discretionary trust have?

Answer 41

45% under £1000 would be 20%

Question 42

If dividends or interest is reinvested in the trust, would there be a tax liability?

Answer 42

Yes as it still counts as income

Question 43

If a unit trust disposed of investements within the trust, would they be subject to CGT?

Answer 43

No as they are exempt

Question 44

Is a taxpayer who disposes of units from a unit trust, be subject to CGT? If so, how is this calculated?

Answer 44

Yes Disposal proceeds, less aquisition costs, less any exempt amount = taxable gain any equalisation payment would be deducted from the aquisition costs

Question 45

What is bed and breakfasting?

Answer 45

selling units and buying back the following day to avoid changing units, used to realise gains or losses

Question 46

Why is bed and breakfasting no longer effective?

Answer 46

there has to be an interval of at least 30 days

Question 47

What are the alternatives for investors wanting to retain existing investments after realising a gain or loss?

Answer 47

selling units and buying back with a ISA selling units and arranging for a spouse or civil partner to buy them back Selling and repurchasing in a very similar unit trust

Question 48

How are switching funds treated as part of an OEIC that is an unbrella fund?

Answer 48

Treated as a disposal, however exempt if it a fund of funds.

Question 49

What is the intention of a TEF?

Answer 49

Moves the point of taxation from the TEF to the investor. The are entitled to receive a deduction up to the same amount to offset the taxable income that would be ordinarily liable to income tax.

Question 50

What is the most popular reason for investing in a unit trust?

Answer 50

Investors can benefit from capital gains and income, however the income largely comes from dividends

Question 51

What are the options open to investors in terms of how they receive the income from a unit trust?

Answer 51

The income is added to the investors holding as accumulation units They can receive as income units However - some funds specify what is available - i.e. just income, just accumulation or a mix of the two, or the option of buying more units (however would be subject to intial charges)

Question 52

What is the impact of allocations on unit prices and accounting periods?

Answer 52

As the fund approaches the accounting day, prices rise Once passed the price falls by the amount of income If unit holders buy during the ex-distribution period, the get the allocation attributable in the previous period, buyers will not. Prices are marked xd for no more that 4 months after the end of the accounting period, be it annual or interim

Question 53

What are the benefits of a unit trust being held in a ISA?

Answer 53

It means any realised gains are exempt from CGT The full ISA allowance can be used within a stocks and shares ISA either as a lump sum or regular payments Virtually all unit trusts qualify as investment. Cash funds also qualify as a cash ISA All UCTIS schemes qualify for stocks and shares ISA

Question 54

When buying units in a trust, what must be supplied before the purchase contract can be executed?

Answer 54

KID

Question 55

How many days after recepit of signed documentation, does a manager have an obligation to make payment for a sale?

Answer 55

4 business days

Question 56

If a certificate is issued by the trust and an individual sells a portion, would they expect to receive a new certificate or an amended one?

Answer 56

New certificate

Question 57

What is the benefit of a share exchange scheme and how do they work?

Answer 57

cheaper and simpler way of disposing of a small holding of shares. Allow investors to swap PLC shares for an equivalent in a funds units The manager may offer more advantageous terms The manager may absorb the shares or sell them and invest the proceeds

Question 58

What are the features of dual pricing?

Answer 58

The FCA formula determines - The highest price the units can be sold to investors - The lowest price the units can be repurchased from investors The manager can create or cancel existing units depending on market conditions and therefore unlike an investment trust, a unit trust remains open ended Offer price is the price at which an investor can buy Bid price is the price at which the investor sells

Question 59

When calculating the price of unit trusts, what do managers need to comply with?

Answer 59

FCA regulations - fair value pricing under COLL

Question 60

What are the features of single pricing

Answer 60

Uses mid market price for all transactions | Charges are disclosed seperately

Question 61

How does a manager calculate the offer price?

Answer 61

market value of underlying securities a valuation point add costs of buying add on other property of the trust - such as uninvested cash, any accrued income, less tax, fees, charges, expenses divide by the total number of shares issued add on the initial charge express figure to four figures

Question 62

How does a manager calculate the bid price?

Answer 62

value the securities at the best market selling price deduct dealing costs add an uninvested cash add any income after usual deductions for fees and tax divide by the number of units express to four figures

Question 63

What are the exceptions to the usual bid-offer spread of 5-7%?

Answer 63

no load trackers have a narrow spread of around 1% smaller companies and emerging funds have a high spread of around 10% Cash have no spread

Question 64

What are the reasons why a bid offer spread may approach or exceed the permitted spread by the FCA?

Answer 64

when there is a buyer and seller on a fund and no underying assets need to be sold If a manager is a net seller of units, they can be prices towards the offer end If the manager is a net buyer, there will be costs and will be priced at the bid end of range

Question 65

How does demand impact the bid and offer price?

Answer 65

If demand is high the manager will set the buying price at the offer end of the spectrum, investors will pay the amx price and sellers will get a good price If demand is low, it will be set nearer the bid price, so sellers will get the minimum price and buyers will pay a low price

Question 66

What is 'Box' management?

Answer 66

Is it the stock control applied by managers in buying and selling units, depending on market demand. Managers may hold shares in the box, consisting of newly created units or repurchased units It reduces the buying and selling costs for investors and no charges are incurred for cancelling or creating new units.

Question 67

What time of day should a manager value the unit trust?

Answer 67

The manager decides, but the frequency is dictated by the scheme

Question 68

What price does an investor pay, when a unit is forward priced and what must a manager ensure?

Answer 68

The price at the next valuation point. | The manager must create enough units to cover any deals since the last valuation point

Question 69

When must a manager operating on historic pricing move to forward pricing?

Answer 69

If the value of the trust is believed to have changed by 2% or more since the last valuation

Question 70

What happens if a manager who is using historic pricing runs out of units?

Answer 70

The must either move to forward pricing or risk losses if the market moves unfavourably as they must create units to cover the oversell at the next valuation point at which the price may have risen.

Question 71

For an OEIC, what is the reason they are not established under the companies act?

Answer 71

Allows them to expand and contract to meet investor demand

Question 72

What are the three ways an OEIC can be established?

Answer 72

Retail UCITS Non retail UCITS QIS

Question 73

How is the ownership of a unit trust Different to an OEIC?

Answer 73

With a unit trust the beneficial ownership is conferred to the unit holders, with an OEIC they still hold shares in the company but do not own it.

Question 74

What is the broad regulatory structure of an OEIC?

Answer 74

authorised by the FCA if marketed in the UK Operating by a board of directors (which may comprise of one sign ACD (authorised corporate director) Assets held by an independant depository The ACD and depository must be authorised persons Sales and marketing mostly regulated by the FCA Additional regulations apply set out in the FCA handbook

Question 75

How is an OEIC different to a trust?

Answer 75

Self contained company (with consittution and AGM)/audited accounts stand alone or an unbrella company with sub funds All sub funds of the umbrella must adpot the same pricing basis Shares are issued rather than units and different classes and charges/currencies may apply It appoints directors Cost of creation is met by the fund Single pricing is usually used (however dual can be adopted) Limit on borrowinf to 10% of the fund, and cannot gear up

Question 76

What is the OEIC equivalent to a unit trust manager?

Answer 76

ACD - authorised corporate director

Question 77

What is the ACD responsible for?

Answer 77

compliance with investor protection set by the FCA day to day management, such as pricing, valuation and dealing Prep of accounts Management of investments

Question 78

What is the despository of an OEIC responsible for?

Answer 78

oversight of pricing, valuation and dealing collection of income and authorising distribution ensuring ACD operates correctly safekeeping of assets

Question 79

What must an OEIC scheme holder do?

Answer 79

report to holders twice per year produce reports that comply with SORP issue short form accounts make full accounts available if requested

Question 80

Can OEIC's be held within ISA's?

Answer 80

yes

Question 81

When would a dillution levy be applied?

Answer 81

Applicable when single pricing is used Paid to the OEIC to cover dealing costs and the spread between the buying and selling price of the underlying investments If there are lareg flows in and out of the fund The levy goes to the fund, not the managers Details of the levy will be found in the prospectus

Question 82

What is a swing adjustment?

Answer 82

It can be used as an alternative to a dillution levy to cover dealing costs on single priced shares.

Question 83

What are the advantages of an OEIC?

Answer 83

Most widely recognised in europe and can be marketed internationally that is impossible for unit trusts Regulations permit multiple share classes, flexible charging, and currency structures Umbrella funds are available offering a range of objectives and classes, switches between funds are simple The umbrella structure makes it easier to create new funds

Question 84

What are the two types of multi manager categories?

Answer 84

Fund of funds - funds managed by other managers Manager of managers funds - appoint specialist managers to look after parts of a portfolio to a brief

Question 85

What is the difference between a fettered and un-fettered fund?

Answer 85

Fettered - only invests in funds run by the same management group Un-fettered - can select any fund from any management group

Question 86

What is the benefit of a fund of funds structure in terms fo CGT?

Answer 86

It creates a shelter as switching between funds does not create a CGT liability

Question 87

How are the fees for a manager of manager funded clearer than a fund of fund?

Answer 87

The individual fees are not charges seperately but are paid for out of the annual management charge of the manager of managers fund as opposed to taking from the overall fund

Question 88

How does a platform service simplify an advisers administration?

Answer 88

All of a clients portfolio is held in one account making it easy to view total investments, values and allocations

Question 89

What are the three sections of the FSMA that the FCA recognises offshore funds?

Answer 89

Funds categorised as UCITS under EU legislation - receive automatic recognition by the FCA Certain funds in designated territories - FCA is satisfied investors receive the same level of protection - Jersey, Guernsey, IOM, Bermuda. They are split into three FCA recognised Approved by local regulator Neither apporved or regulated Funds from outside the designated territories, but recognised in their won right - on an individual basis.

Question 90

What is the impact for those funds who are not recognised by the FCA?

Answer 90

The are subject to severe market restrictions

Question 91

What is a UCITS?

Answer 91

open ended collective investment schemes that comply with the UCTIS directive requirements

Question 92

When can a UCTIS from another european country operate within the UK?

Answer 92

Once it has approval from the FCA it can operate within FCA marketing rules (after 2 month wait)

Question 93

What further directives have been issued since inception of UCTIS?

Answer 93

3 - broadened range of assets 4 - allowed funds with authorisation in one country to operate throughut the EU 5 - Amendments to renumeration principles, transparency, regime for depositary

Question 94

Why can't overseas funds be sold via cold-calling?

Answer 94

Cancellation rules do not generally apply

Question 95

Which type of fund are overseas investments usually similar to?

Answer 95

OEIC

Question 96

Is there a tax advantage to switching funds in an overseas umbrella fund?

Answer 96

No, this was removed

Question 97

What are the main tax advantages that make reporting funds preferable for UK resident and domiciled investors?

Answer 97

Dividends and interest are treated in the same way as UK funds CGT is charged as usual on gains Where an offshore fund holds 60% or more in interest bearing securities, it is treated in the same way as a UK investor, tax applicably and offset against individual PSA

Question 98

Can gains from a non-reporting fund be used against UK allowances?

Answer 98

No

Question 99

What do Non reporting funds usually consist of and what is the benefit?

Answer 99

Roll up funds - and therefore can be used to shelter accumulated income, meaning the investor can realise profits when their tax rate has dropped or become non-resident (but taxed in country of residence) Non dom can benefit from escaping IHT as offshore funds are not liable.

Question 100

How did the EUSD (european union savings directive) change in 2016?

Answer 100

It covered not only interest income but dividends and other types of capital income

Question 101

What is the witholding tax rate?

Answer 101

35%

Question 102

Who do you think runs an investment trust?

Answer 102

Board of directors runs the trust as self managed or by employing an external mangement company

Question 103

How is the NAV of shares in an investment trust calculated?

Answer 103

total value of investments at mid-market price plus inlisted investments plus cash and assets less loans, debenture stock and preference shares Result known as shareholders funds

Question 104

How is the dilluted NAV of a share calculated?

Answer 104

Shareprice plus warrants and convertible loans Net assets plus money subscribed to warrant holders/number of ord shares in issue plus shares issued to warrant holders

Question 105

If a share of an investment trust is 100p, but is trading at 86% - how much is it trading at a discount?

Answer 105

14% NAV-trade price/NAV x 100 = discounted price

Question 106

If an investment company wants to sell directly to the public, what do they need to do?

Answer 106

Seek authorisation to carry out investment business under the FSMA 2000

Question 107

If a share price is 210p and the NAV is 200p is the share trading at a discount or a premium?

Answer 107

trading at a premium of 5%

Question 108

What three rules does an investment trust need to satisfy to the HMRC to gain approval

Answer 108

Resident in the UK and not a close company (controlled by 5 or fewer) Ord shares listed on the LSE Does not retain more than 15% gross income

Question 109

What is a conventional trust?

Answer 109

Issues only Ord shares

Question 110

What is the benfit of a limited life trust?

Answer 110

It helps reduce any discount from NAV. As the winding up comes closer, any discount narrows as investors could retain the full value of a trusts assets.

Question 111

If a trust has a negative hurdle rate, what does it mean?

Answer 111

If means the trust already has surplus assets so can afford to decline in value and still pay the current purchase price/redemption value/zero at wind up

Question 112

What would asset cover of 1 mean?

Answer 112

The assets exactly cover the redemption price

Question 113

What are the characteristics of zero dividend preference shares?

Answer 113

Limited life Fixed redemption dates Issued at an initial value Taxed under capital gains and not income tax rules

Question 114

What are the characteristics of Income shares?

Answer 114

Gives a right to a fixed redemption price (subject to suffcient assets) but may be well below market priced May have a high income level but a nominal redemption value Ordinary share income - no predetermind capital value, but receive all of the residual value after the holders of zero's and borrowings are paid. Note - may risk zero capital being repaid

Question 115

What is a warrant?

Answer 115

A right to buy shares at a fixed pre-determind price.

Question 116

How are warrants usually priced?

Answer 116

Below the actual cost of a share

Question 117

How would you calcuate if there is any gearing within an investment trust?

Answer 117

total gross assets/net assets x 100 =

Question 118

How can a trust use gearing?

Answer 118

To borrow to fund an investment opportunity

Question 119

What would an adviser need to do if it recommended an investment trust that is significantly geared? (above 30%)

Answer 119

Enhanced warnings need to be given

Question 120

What are the three definitions of gearing?

Answer 120

``` Financial gearing (bank loans, debentures) Structural gearing (case of splits) Investing in geared instruments (warrants, derivatives) ```

Question 121

If an investor borrows money to invest in equities in an investment portfolio, what is likely to happen to the size of the gains or losses?

Answer 121

The profits or losses will increase in proportion to the gearing ratio.

Question 122

What does the OCF of a fund consist of? (ongoing charges figure)

Answer 122

annual management charge and all other expenses of running the fund

Question 123

What must UCTIS regulated funds provide to customers regarding OCF?

Answer 123

A KID which displays OCF

Question 124

What is the main difference beween an OCF and a TER (total expense ratio)?

Answer 124

The TER includes performance fees

Question 125

What do OCF and TER both not include?

Answer 125

entry and exit charges paid directly by investors interest on borrowing brokerage charges dealing costs

Question 126

What is the tax status of an investment trust company?

Answer 126

not subject to tax of gains made through the sale of shares or other holdings in the portfolio not subject to any tax on franked income (dividends received from shares held within the trust) are subject to tax on unfranked income - i.e. interest from savings and gilts (but can offset expenses)

Question 127

How are income and gains taxed for the investor?

Answer 127

in the same way as other income and gains from shares first £2k is free liable to CGT on profits (exceeding annual limit) All tax free if held within an ISA

Question 128

Is it cheaper to invest in an investment trust or a unit trust/OEICS?

Answer 128

Cheaper, as you are investing directly in shares in the trust rather than buying units AMC are considered to be lower within a trust

Question 129

Is it more risky to invest in an investment trust or a unit trust/OEICS? why?

Answer 129

More risky

Question 130

Is it more risky to invest in an investment trust or a unit trust/OEICS? why?

Answer 130

More risky because Shares often trade at a discount to NAV Discounts can widen if the market doesnt like to way the fund is managed Borrowing within investment trusts can increase volatility (much stricter with OEICS and Unit trusts)