Chapter 11 - Other Investment Classes Flashcards
Other investments include investments in:
- Collective investment schemes
- Exposure to movements in investments ,commodities , indices , etc through Derivatives
- Investment in Overseas and Emerging Markets
Collective Investment Schemes
- Provide structures for the management of investments on a grouped basis
- Can achieve wide spread of investments and therefore to lower portfolio risk
- Managers of such schemes are likely to have management expertise in the underlying investments or asset classes, which is otherwise available only to the largest institutional investors.
CIS Scheme Types
Closed scheme:
In a closed-ended scheme, such as an investment trust, once the initial tranche of money has been invested, the fund is closed to new money. After launch, the only way of investing in an investment trust is to buy units from a willing seller (exactly as investing in ordinary shares in a trading company)
Open Scheme:
In an open-ended scheme such as a unit trust, managers can create or cancel units in the fund as new money is invested or disinvested
eg. Investment Trust ( closed )
Unit Trust ( open )
Differences between closed and open schemes
Marketability
- The marketability of the shares of closed-ended funds is often less than the marketability of their underlying assets.
- marketability of units in an open-ended fund is guaranteed by the managers
Gearing
- Gearing of closed-ended funds can make their share price more volatile than that of the underlying equity.
- Most open-ended funds cannot be geared and those that can may only be geared to a limited extent
NAV Per share
- May be possible to buy assets at less than net asset value in a closed-ended fund
Returns
- The increased volatility of closed-ended funds means that they should provide a higher expected return
Assets
- Closed funds can invest in a wider range of assets
Tax
- They may be Subject to different taxation rates
Differences between closed and open schemes
Marketability
- The marketability of the shares of closed-ended funds is often less than the marketability of their underlying assets.
- marketability of units in an open-ended fund is guaranteed by the managers
Gearing
- Gearing of closed-ended funds can make their share price more volatile than that of the underlying equity.
- Most open-ended funds cannot be geared and those that can may only be geared to a limited extent
NAV Per share
- May be possible to buy assets at less than net asset value in a closed-ended fund
Returns
- The increased volatility of closed-ended funds means that they should provide a higher expected return
Assets
- Closed funds can invest in a wider range of assets
Tax
- They may be Subject to different taxation rates
Differences between closed and open schemes
Marketability
- The marketability of the shares of closed-ended funds is often less than the marketability of their underlying assets.
- marketability of units in an open-ended fund is guaranteed by the managers
Gearing
- Gearing of closed-ended funds can make their share price more volatile than that of the underlying equity.
- Most open-ended funds cannot be geared and those that can may only be geared to a limited extent
NAV Per share
- May be possible to buy assets at less than net asset value in a closed-ended fund
Returns
- The increased volatility of closed-ended funds means that they should provide a higher expected return
Assets
- Closed funds can invest in a wider range of assets
Tax
- They may be Subject to different taxation rates
CIS vs direct investment
Advantages
- The advantages of collective investment vehicles are greater for small investors than for large ones.
- useful for obtaining specialist expertise
- easy way of obtaining diversification.
- Some of the costs of direct investment management are avoided.
- Holdings are divisible – part of a holding in any particular trust can be sold.
- may be tax advantages.
- may be marketability advantages (but they may also be less marketable than the underlying assets).
- They can be used to track the return on a specific index
Disadvantages
- Management charges are incurred
- may be tax disadvantages such as withholding tax which cannot be reclaimed
- Loss of control
Derivatives
Forwards
- A forward contract is a contract to buy (or sell) an asset on an agreed basis in the future.
Futures
- Like a forward contract, a futures contract is a contract to buy (or sell) an asset on an agreed basis in the future. However, futures contracts are standardised contracts that can be traded on a recognised exchange
Options
- An option is the right, but not the obligation, to buy or sell an asset.
Warrants
- A warrant is an option issued by a company over its own shares. The holder has the right to purchase shares at a specified price at specified times in the future from the company.
Direct Overseas Investment
Why invest overseas ?
- match liabilities in the foreign currency
- increase the expected returns
- reduce risk by increasing the level of diversification
Problems of overseas investment
- timing issues
- language/communication issues
- additional admin functions such as custodianship, dividend tracking and collection
- currency fluctuation risk
- mismatching risk
- different tax practices/standards
- different accounting practices
- poorly regulated markets in some regions
- adverse political developments ( political risk )
- ownership restrictions on certain shares
Indirect Overseas Investment
- Investment in multinational companies based in the home market.
advantages are that:
- easy to deal in the familiar home market
– companies will have expertise and tend to conduct their business in the most profitable areas overseas, including areas where direct investment may be difficult.
disadvantages are that:
– such a company’s earnings will be diluted by domestic earnings
- investor will have no choice in where the company transacts its business.
- Investment in collective investment vehicles specialising in overseas investment.
- Investment in derivatives based on overseas assets
Factors to consider before investing in overseas/emerging markets
- current market valuation
- possibility of high economic growth rate
- currency stability and strength
- level of marketability
- degree of political stability
- market regulation
- restrictions on foreign investment
- range of companies available
- communication problems
- availability and quality of information
