Collective Investment Schemes Flashcards
(15 cards)
Describe characteristics of collective investment schemes
Indirect ways of accessing investments
* Pooled investment vehicles
* Provide structures for management of investments on group basis
* Provide opportunity for investors to achieve wide spread of investments and therefore
* Lowers portfolio risk ( increasing diversity )
* Will have stated investments objective
* Provides investment expertise from managers of the scheme and diversification
* Commonly used by individuals with smaller sums to invest or wanting to invest in shares for
the first time
* There is regulation on these schemes which vary country by country and different schemes
are subject to different rules
Regulation of CIS include:
- The categories of assets that can be held
- Whether unquoted assets can be held
- The maximum level of gearing
- Any tax reliefs available
- Maximum that can be invested in particular assets – exposure to one counterparty
Name institutional investors
Institutional investors include big companies such as pension funds, banks, insurance companies
that invest money on behalf of other people.
Two types of collective investment schemes:
Closed ended schemes
* Such as investment trusts
* Once the initial tranche of money has been invested , the fund is closed to new
money
* After launch, the only way of investing here is through buying units from a willing
seller
* Total number of shares or units available to the investor via the marketplace is fixed
Open-ended Schemes
* Such as unit trusts
* Managers can create and cancel units as new money is invested or disinvested
Properties of investment trusts
- Closed-ended fund
- Public company whose function is to manage shares and other investments
- Can raise both capital and debt - have similar capital structure like other public
companies - Have unlimited ability to borrow and hence allow gearing
Most are quoted on the stock exchange and shares are bought and sold in similar
ways as other quoted shares - The price of shares of investment trusts is determined by the supply and demand
in the market - A guide to the what the price of the share may be is the NAV
Parties involved in close-ended investment trust
o Board of directors- direction of the company
o Investment manager – day to day investment decisions
o Shareholders – buy and sell shares in the same way as other companies
Properties of unit trusts
- Open ended investment vehicle
- Investors can buy units from the trust managers
- If there is demand for more units, managers can create more units and if there are
redemptions, managers will buy back the units offered to them - These are trusts and operate under the trust laws
- They have limited power for gearing against their portfolio
Unit price for unit trusts
market value of underlying assets/number of units
Main parties involved with unit trusts
o Management company
▪ Sets up the trust
▪ Gets authorisation from relevant authorities
▪ Advertises trusts
▪ Carries out all necessary admin stuff .
▪ Makes profit from charges levied
o Trustees
▪ Ensures that the managers obey the trust deed
▪ Hold the assets in trust for the unit holders
▪ Oversee the pricing of units
▪ Examples of trustees include insurance companies, and banks
o Investors
▪ Buy units in the trust ( become unit holders )
Complication in Practical uses in calculation of the unit price
- Whether to use the bid or offer price in calculation of market value of underlying assets
- How to feature in the expenses associated with buying and selling underlying assets
- Adjust unit prices to apply any charges to investors
- Rounding off answers
Properties of open-ended investment companies
- Similar corporate governance features to an investment trust but with the open ended
characteristics of unit trusts - Managers create shares when investors invest new money and must redeem these shares
when shareholders request to sell their shares - There is a single price to which is added initial charge of purchase, unlike the two prices
with the unit trust
Differences in open-ended and closed-ended cis considering marketability, gearing and buying price
- Marketability
o Closed-ended schemes
▪ The marketability of shares is often less than the marketability of
underlying assets
▪ But may have higher marketability if underlying assets are highly
unmarketable – shares in small company or property investments
o Open- ended schemes
▪ Marketability of units is guaranteed by the fund managers - Gearing
o Close ended
▪ Have unlimited gearing
▪ more risky, high expected returns to shareholders
▪ which could make the share price of these highly volatile than that of
underlying equity assets held
o Open ended
▪ Limited or no gearing at all - NAV vs Buying price
o closed- ended funds:
▪ it may be possible to buy shares at a value less than the NAV
▪ This acts as a source of extra volatility in returns of investment trusts
▪ Trading at a discount gives investors opportunity to increase returns - Buy the assets at a value less than those that purchased the share
directly - Can sell when the discount has narrowed
▪ Increased volatility means there should be higher expected returns
▪ The share price is more volatile than the price of underlying equities as the
discount can change
o Open ended schemes
▪ Discount to NAV does not apply here
▪ Unit price is fixed by direct reference to asset values
▪ Volatility of the unit price should be similar to that of the underlying
assets - Closed- ended funds may be able to invest in a wider range of assets than unit trusts
- They may be subjected to different tax rates
- Closed ended funds are expected to offer high expected r eturns than open ended schemes
- Differences in volatility of shares vs that of the underlying assets
o Closed-ended
▪ Share prices are more volatile than the prices of the underlying equities-NAV
o Open-ended
▪ Volatility of unit prices are similar to that of the prices of the underlying
assets
Possible reasons for differences in share price of investment trust companies and nav
- Management charges
o the value of the ITC may be thought of as present value of the dividends that the
investor will receive
o but the investor will receive the dividends net the deductions of management
charges of the ITC
o the management charges will therefore lower the value of the share, causing it to
stand at a discount - Marketability concerns
o A small ITC investing in large companies will be less marketable than underlying
assets held - Quality of Management
o Depends on how the managers are rated
o if the managers are poorly rated, the investors will not be prepared to pay as much
for each share - Market sentiments / fashion
o The ITC may be out of fashion with the investors
o Resulting in less demand and then lower share price than underlying assets held
Advantages of CIVS over direct investments
- They are useful for obtaining specialist expertise
- They are an easy way of obtaining diversification
- Some of the costs of direct investments are avoided – which costs are these
- Holdings are divisible – part of a holding in trust can be sold
- There may be tax advantages
- There may be marketability advantages ( but may also be less marketable than underlying
assets ) - They can be used to track the fund of a specific index
Disadvantages of CIVs over direct investments
- Loss of control
▪ the investor has no control over the individual assets chosen by managers - Management charges are incurred
- There may be tax disadvantages
▪ such as withholding tax that cannot be reclaimed - Exposed to risks associated with the company
▪ Mismanagement issues
▪ Risk of default of companies - High regulation
▪ Limiting risk taking and possibility of higher returns
