topic 8 - collective investment schemes

Question 1

Forms of collective investment vehicles

Answer 1

• Unit trusts
• Investment trusts
• Investment bonds
• OEICs

Question 2

advantages of collective investments

Answer 2

• Expert management - Services of a skilled investment manager are obtained at a cost that is shared among the investors
• Diversification - Risk can be reduced by diversification of investments
• Reduced dealing costs - Fund managers handling investments of millions of £ can negotiate reduced dealing costs
• Fund choice - Wide choice of investment funds
• Enable investors to gain exposure to assets they would not otherwise be able to access

Question 3

Actively managed funds

Answer 3

use the services of a fund manager to make decisions on asset selection and when holding are bought and sold

Question 4

Passively managed or tracker funds

Answer 4

seek to replicate the performance of a particular stock market index

Question 5

unit trusts

Answer 5

• Pooled investment - A pooled investment created under trust deed.
• Contributions - Can invest a lump sum in the unit trust, make regular contributions, or a mixture of both

Question 6

equity trust

Answer 6

where the underlying assets are mainly shares – pays dividends

Question 7

fixed-interest trust

Answer 7

where investment is mainly in interest-yielding assets – pays interest

Question 8

units

Answer 8

unit trusts are divided into units, each unit representing a fraction of the trust’s total assets.

Question 9

accumulation units

Answer 9

automatically reinvest any income generated by the underlying assets. Suit someone looking for capital growth

Question 10

distribution or income units

Answer 10

splits off any income received and distribute it to unit holders. Units may increase in value in line with the value of underlying assets

Question 11

Creation price

Answer 11

the price at which the unit trust manager creates units

Question 12

Offer price

Answer 12

the price at which investors buy units from the managers

Question 13

Bid price

Answer 13

price at which the managers will buy back units from investors who wish to cash in all or part of their unit holding

Question 14

Cancellation price

Answer 14

minimum permitted bid price, considering full costs of buying and selling

Question 15

Bid-offer spread

Answer 15

the difference between the price at which a unit is offered to an investor (offer price) and the price at which the fund manager will buy it back (bid price)

Question 16

how unit trusts are bought and sold

Answer 16

• Unit trust managers are obliged to buy back units

o The contact note – specifies the fund, no. of units, unit price and amount paid. Importance for CGT purposes
o The unit certificate – specifies the fund and no. of units held. Also, proof of ownership

Question 17

how unit trusts are regulated

Answer 17

• In the UK, primarily regulated under the terms of the Financial Services and Markets Act 2000 and must be authorised by the FCA

o Must be suitably diversified
o Cannot borrow an amount more than 10% of the fund’s net asset value

Question 18

If more than 60% of the underlying investments within a unit trust are cash or fixed-interest securities (UK gilts or corporate bonds)

Answer 18

o Will be classed as a fixed-interest or non-equity fund
o Interest payments
o Income is classed as savings income, paid gross, without deduction of tax.
o Only taxpayer who have used their PSA are taxed on the excess income

Question 19

If less than 60% of the underlying investments are cash or fixed-interest securities

Answer 19

o Classed as an equity fund
o Dividends
o Tax treatment is the same as for shares
o Where dividend income is in excess of the DA, then it is taxed at different rates depending on the tax band

Question 20

What are investment trusts?

Answer 20

• Public limited companies whose business is investing in the stocks and shares of other companies.
• An investment trust is established under company law and operates as a listed plc
• Listed company - Must meet FCA requirements to gain a stock market listing, and is governed by rules in its memorandum and articles of association
• Closed-ended - no. of shares available remains constant

Question 21

Net asset value per share (NAV)

Answer 21

total value of the investment fund’s assets less its liabilities, divided by the no. of shares issued.

Question 22

Gearing

Answer 22

• The level of debt as a % of a company equity. Way of measuring the extend to which a company’s operations are funded by borrowing rather than by shareholder capital.
• The ability to gear up is the reason why investment trusts are viewed as being riskier than a similar unit trust or OEIC

Question 23

How investment trusts are taxed

Answer 23

• At 85% of income received by the fund manager of investment trusts must be distributed as dividends to shareholders
• Taxation is the same as for equity trusts
• Fund managers are exempt from corporation tax on capital gains

Question 24

A split-capital investment trust

Answer 24

• fixed-term investment trusts offering 2 or more different types of share
• income shares – receive the whole of the income generated by the portfolio but no capital growth
• capital shares – receive no income. When the trust is wound up at the end of the fixed term, share all the capital growth remining after fixed capital requirements have been met

Question 25

Real estate investment trusts (REITs)

Answer 25

* tax efficient property investment vehicles allowing private investors to invest in property * stamp duty reserve tax is charged at 0.5% on purchase, much cheaper than if purchasing a property * REITs pay no corporation tax on income or growth for the property rental portion of their income

Question 26

qualifying features of REITs

Answer 26

* At least 75% of their gross income derived from property rent * At least 90% of their profits distributed to their shareholders * Dividends can be paid in cash or as stock dividends * No individual shareholder can hold more than 10% of the shares

Question 27

What is an OEIC?

Answer 27

* **Open-ended investment company** * Pooled investment - Limited liability company that pools the funds of its investors to buy and sell the shares of other companies and deal in their investments * To invest in an OEIC, investors buy shares in the company * No limit to the no. of shares issued * Means the fund can expand or contract according to demand

Question 28

How are OEICs regulated and managed?

Answer 28

* Must be authorised by the FCA * A depositary overseas the operation of the company * An authorised corporate director manages the OEIC **A dilution levy** – may be added to unit price on purchase of shares or deducted from the price on sale

Question 29

Endowments

Answer 29

* Investment based on life assurance * Combine life assurance and regular savings * Lump sum paid if the life assured dies during term or if they survive to the end of term, it is paid at maturity

Question 30

with-profits endowments

Answer 30

low risk as they offer the guarantee of at least a minimum value at maturity

Question 31

unit-linked endowments

Answer 31

do not guarantee this and the value depends on how underlying investments perform

Question 32

Friendly society plans

Answer 32

* Able to market a tax-exempt savings plan, effectively an endowment with tax benefits * Has a **maximum annual savings limit of £270**

Question 33

Investment Bonds

Answer 33

* Collective investment vehicles based on unitised funds * Single-premium whole-of-life assurance policy - Available from life assurance companies * Individuals invest a single (lump sum) premium to the life company. * Fund income reinvested – no dividends * Can give a guaranteed level of income * In the event of death, the policy ceases and a slightly enhanced value (usually 101% of bid value) is paid out

Question 34

Regulation of cryptoassets

Answer 34

* The FSMA 2000, which came into effect in Oct 2023, brought qualifying cryptoassets within the FCA’s remit for financial promotions * Qualifying cryptoasset – any digital representation of value or contractual rights that is cryptographically secured, transferable and fungible. * Firms wishing to promote cryptoassets in the UK to retail customers must be authorised or registered by the FCA * Firms must implement a 24-hour cooling off period for first time investors

Question 35

What potential benefit does gearing offer to an investment trust that is not available to a unit trust or OEIC?

Answer 35

An investment trust can borrow in order to take advantage of investment opportunities. Unit trusts and OEICs cannot do this

Question 36

How are shares in an open ended investment company priced?

Answer 36

There is one price, based on the value of the assets divided by the number of shares.

Question 37

Investment bonds are attractive to investors because withdrawals are tax free. True or false?

Answer 37

False. The investor may withdraw up to 5 per cent of the value of the original investment per annum without paying tax at the time of withdrawal but a tax liability may arise when the bond matures, on encashment of the bond or on death of the bondholder.