10. Collective investments - UT, OEIC, Investment trusts

Question 1

What are 4 benefits of collective investments?

Answer 1

• Economies of scale - lower costs than direct investments
• Expert-led - Managed by skilled and experienced managers
• Wider range of funds available due to pooled investment
• Liquidity

Question 2

Who regulates UTs & OEICs? Under which rules?

Answer 2

FCA under the Financial Services and Markets Act 2000

Question 3

UCITS and AIFM regulatory frameworks

Answer 3

Undertakings for Collective Investmenes in Transferable Secruities
* Allows for the cross-border marketing and distribution of investment funds within the European Economic Area
* Suitable for retail investors as funds under this provide high levels of protection
* Sets the rules for managing and marketing these funds
* Focused on retail investor-friendly funds

Alternative Investment Fund Managers
* Applies to AIFs not under UCITS
* Includes hedge funds, privatge equity funds, real estate funds
* Sets the rules for managing and marketing these funds
* Professional investor-focused funds.

UK domiciled UCITS are now classed as alternative investment funds (AIFs) due to brexit

Question 4

Key features of unit trusts

Roles? Created under? Organisation? Price? Open or closed? Obligation?

Answer 4

Three roles: Trustee, depositary, fund manager
Created under: Trust deed - sets out rules and obligations for the above.
Organisation - Divided into units, each representing an equal fraction of the total assets.
Four Prices:
* Creation price
* Offer price - Investors pay this for units
* Bid price - the lower price the manager buys units back from investors who wish to cash in
* Cancellation price - Rarely used, lower than bid price - used if little prospect of selling again in short term.

Open-ended - This means that new units can be created at any time
Buy-back obligation - manager is obligated to by back units from investors wishing to sell

Question 5

Trustee duties of a unit trust

Answer 5

• to hold and control trust assets;
• to approve proposed advertisements and marketing material;
• to collect and distribute income from trust assets;
• to issue unit certificates to investors;
• to supervise the maintenance of the register of unit holders;
• to ensure that the manager complies with the terms of the trust deed.

Question 6

Depositary responsibilities of a unit trust

Answer 6

• oversight of the sale, issue, repurchase, redemption, cancellation and pricing of units;
• carrying out the instructions of the fund manager (unless they conflict with laws, fund rules or the prospectus);
• ensuring consideration from transactions involving the fund’s assets are remitted in a timely manner and that income is applied correctly;
• monitoring cash flows concerning the fund’s assets, making payments and booking cash correctly;
• safekeeping the fund’s financial instruments in custody and verifying and recording the fund’s other assets.

Question 7

Fund Manager responsibilities of a unit trust

Answer 7

• managing the unit trust fund;
• valuing the assets of the fund on a daily basis;
• setting the price of units;
• offering units for sale;
• buying back units from unit holders who wish to sell;
• generating profit from charging management fees and dealing in the units.

Question 8

Fund charges for Unit trust

name 4

Answer 8

Initial charge - Cost of aquiring units, taken from the value of the units, forms part of the bid-offer spread and is typiclaly between 3-5%
AMC - Professional management fees, between 0.5-1.5%. Overseas more expensive, fixed-interest securities and tracker funds less so.
OCF - Ongoing charges figure - all other charges
Equalisation payments

Question 9

What is clear-pricing? Can an adivisor recieve commision for advising on investments?

10.3.4.2.1 Changes to fund charges and payments

Answer 9

• Clean pricing refers to investment funds that exclude commission payments to advisers or platforms from their charges. Introduced after April 2014, clean pricing results in lower initial and annual charges, making fund and adviser/platform fees transparent and separate. These funds are also called “unbundled” funds.
• No, an advisor cannot recieve commission. They may only take a percentage fee.

Question 10

What are “unbundled funds”

Answer 10

Investment funds that use the ‘clear pricing’ model.

Unbundled funds are investment funds where the charges for the fund management and any fees for advisers or platforms are separated.

Question 11

What are equlisation payments with unit trusts?

Think - purchasing equities

Answer 11

Equalisation payments occur when a new investor buys units in a fund between dividend payments. The unit price includes income accrued before their purchase.

At the next distribution, the dividend is split:

• Equalisation payment– Reflects the pre-purchase income and is treated as a return of capital (not taxed).
• Dividend payment – Reflects post-purchase income and is taxable as a dividend.

Equalisation payments only apply to the first dividend and should be recorded for capital gains tax purposes.

Equalisation payments are similar to the concept of purchasing equities “ex-dividend” or “cum-dividend

Question 12

What is an Open‑ended investment companies (OEICs)

Key features of OEICs

Answer 12

• Pooled investment
• A investment company that buys and sells the equities of other companies and deals with other investment vessels

Key features:
* Formed under Company law rather than a trust
* Two roles: Fund manager and depositary
* The rules (mandate) is outlined in it’s prospectus
* Investors buy shares in the OEIC. The authorised corporate director is able to create more shares on demand - open ended
* An OEIC may be structured as an ‘umbrella company’ that is made up of several sub‑funds. Different types of share can be made available within each sub‑fund.
* The value of each share is directly related to the value of the underlying assets.
* manager is obliged to buy shares back
* Shares are single-priced, unlike UTs that have bid and offer prices.
* Has an AGM.
* Equalisation payments may be made with the first income distribution, as with unit trusts.

Question 13

Charges for OEICs?

Answer 13

• Initial charge - Shares in OEIC are single-priced (I.e. no bid/offer spread) however, an initial charge of 3-6% will be charged
• AMC - for OEICs, typically 0.5 for index tracking, or 1.5% for actively managed
• anti-dilution levy - Made when a large amount of money comes in or out of the fund at the same time. Designed to protect the other investors. Acts in a similar way to the cancellation price of units in a UT
• OCF
• Total expense ratio

Question 14

OEICs and Unit trusts - common features?

Borrowing? Investment restrictions?

Answer 14

Both OEICs and UT cannot borrow on a long-term basis.
* they may borrow 10% of the funds value on a short-term basis

Investment restrictions:
* UT cannot hold more than 10% of the total fund value in the shares of any single unquoted company unless the fund is an index tracker
* Tracker funds can hold up to 20% of the fund value

….pg 300

Question 15

OEICs and Unit trusts - purchasing and selling?

minimum payment? regulars? Cancellation?

Answer 15

Investors can contribute to a unit trust or OEIC with a lump-sum payment, regular contributions, or a combination f the both:
* A minumum payment of £500-£1000 will normally be required
* Regular payments of £25-£50 per month

Investments into UT and OEIC can be actioned through:
* Financial adviser
* Fund supermarket
* Directly from the manager via the interest (this does not reduce charges)
* Via telephone/post

Cancellation?
* Investor has 14 days to cancel
* They will recieve the lower of their orginal ivestment and the offer price on the date of cancellation.

Put in place to restrict investors cancelling their investment purely because it has fallen in value.

Question 16

Share exchange

Answer 16

• Investors can exchange shares for unit trust investments, avoiding stockbroker fees.
• If shares aren’t attractive to the manager, they may sell them at reduced charges for reinvestment.
• Capital gains tax (CGT) liability remains since the sale and investment are treated separately.
• Fund managers may allow switching (converting) between sub-funds.

Question 17

Two broad categories of fund for OEIC and UT

Answer 17

Accumulation and Distribution

Otherwise known as growth and income

Question 18

Accumulation funds

Answer 18

Objective: Capital growth
Underlying investment: Equities
Key points: Unable to produce significant income - Income receoved is automatically reinvested into the fund, increasing the value of each unit

Question 19

Distribution funds

Answer 19

Objective: Income
Underlying investment: Fixed-interest securities
Income paid: As interest payments or as dividends

Key points: Investor can choose to take income or spend it by more units in the fund - more units but each unit does not increase in value.

Question 20

Equity income funds

Answer 20

aim to produce an income in excess of the yield from the
FTSE All Share index by distributing the bulk of income received to unit holders. The
underlying investment is primarily in shares, which means that the fund offers the
potential for capital growth as well.

Question 21

What is a Tracker fund?

Answer 21

Tracker funds aim to** track (match)** the performance of a stock market index, eg the FTSE
100. The manager attempts to buy the shares appearing in the index in the proportion
(weighting) in which they appear.

• These funds are not actively managed
• Charges lower because of this
• Three types of tracking - full replication, stratified sampling, optimisation

Question 22

Full replication - Tracker fund

Answer 22

• Matches the index as closely as possible
• This can be expensive
• Major indices face a limitation where no single share can exceed 10% of the portfolio, even if the share represents more than 10% of the index.

Question 23

Stratified sampling - Tracker fund

Answer 23

Manager divides the fund into categories then buys a representative sample in each category
* May not produce close tracking

Question 24

Optimisation - Tracker fund

Answer 24

Through use of technology/algorithms, manager produces an analytical model of the market based on past performance statistics.
* Can produce errors as market is always changing and models may not reflect this.

Question 25

Fund of Funds - explain its structure, uses, benefits, etc

Definition? Types? Benefits? Typical fees?

Answer 25

Definition: A fund that invests in a variety of other unit trusts to enhance diversification and spread risk.

Mandate: The FoF manager follows the trust’s mandate but has no control over individual fund strategies, only the option to switch funds if dissatisfied.
Types:
* Fettered: Invests only in internal funds of the host provider.
* Unfettered: Can invest in external funds from other companies.

Fees: FoF charges an additional management fee (typically 0.75%) on top of fees for the underlying funds, creating a double layer of costs for investors.

Question 26

Multi-manager funds - explain its structure, uses, benefits, etc

Answer 26

Multi-Manager Funds (Manager of Manager Funds) Summary:

Definition: A fund that hires multiple portfolio managers, each managing a separate portfolio to meet the fund’s mandate.

Mandate: Set by the multi-manager, outlining performance benchmarks, objectives, and asset allocation for each portfolio manager.

Portfolios: May not be available in the open market.

Role of Multi-Manager:
* Select competitive portfolio managers.
* Monitor and track their performance regularly (often daily).
* Replace underperforming managers as necessary

Question 27

Total return funds?

Def, benchmarking, risk, investment strategy, performance?

10.7 Types of unit trust and OEIC

Answer 27

Definition: Aims for long-term positive returns (3-5 years) through a mix of income and capital growth while minimizing capital losses by adopting long positions (buying assets expected to increase in value).

Benchmarking: Typically benchmarked against cash, with some against an index or peer group.
Cash Benchmarks:Aim for returns above cash (e.g., cash + 3%).
* Cautious funds: target cash + 2%.
* Adventurous funds: target cash + 6%.

Risk: Higher targets above cash imply greater risk; however, total return funds are generally viewed as cautious.

Charges: Tend to have relatively low fees.

Investment Strategy:
* Invest in a diverse range of assets to spread risk and capture different returns.
* May shift to defensive positions in declining markets (unconstrained approach).

Performance: In strong markets, total return funds may underperform compared to conventional funds.

Question 28

Absolute return funds?

Answer 28

Definition: Investment funds aiming for positive returns (income, capital, or both) in all market conditions, including falling markets, using an unconstrained approach and derivatives.
Also Known As: Often referred to as “hedge funds,” but distinct from traditional hedge funds.
Objectives:
* Achieve positive annual returns against a cash benchmark.
* Preserve investor capital with minimal volatility.

Investment Strategy:
* Utilizes both long and short positions.
* Long positions: Buying and holding shares for long-term gains.

• Short positions: Buying put options on shares (or shorting) to profit or limit losses in declining markets.

Risk Profile: Higher risk compared to total return funds, with potential for better performance in falling markets.

Performance: May not achieve the same growth as conventional funds in rising markets due to hedging strategies.

Global Fixed Interest Funds: Similar strategies applied to diversified fixed interest funds, targeting returns above cash (e.g., Libor plus a fixed percentage) while minimizing volatility. Managers use bond futures to speculate on interest rate changes

Question 29

Absolute vs Return funds

card to read

Answer 29

Investment Objective:

• Absolute Return Funds: Aim for positive returns regardless of market conditions, including falling markets.
• Total Return Funds: Seek long-term positive returns through a combination of income and capital growth over 3-5 years.

Benchmarking:

• Absolute Return Funds: Target positive annual returns against a cash benchmark while preserving capital.
• Total Return Funds: Usually benchmarked against cash, aiming for returns above cash (e.g., cash + a specified percentage).

Investment Strategy:

• Absolute Return Funds: Utilize an unconstrained approach, including derivatives and both long and short positions to manage risk and enhance returns.
• Total Return Funds: Primarily focus on long positions and invest in a diverse range of assets, with less emphasis on hedging.

Risk Profile:

• Absolute Return Funds: Generally have a higher risk profile due to the use of derivatives and short selling.
• Total Return Funds: Considered relatively cautious, focusing on minimizing capital losses.

Volatility:

• Absolute Return Funds: Aim to achieve returns with minimal volatility through hedging techniques.
• Total Return Funds: May experience greater volatility and do not specifically target low volatility.

Performance in Markets:

• Absolute Return Funds: Potential for better performance in falling markets due to hedging strategies.
• Total Return Funds: May underperform compared to conventional funds in strong markets due to a focus on capital preservation and cautious strategies.

Question 30

The yield is the prospective gross annual income - how is this calculated?

10.7.5 Yield

Answer 30

Example
If a unit trust shows earnings of 4p per unit (after management charges have been
deducted) and the offer price is £1.09 the yield will be:
4 ÷ 1.09 = 3.67%

Question 31

For tax purposes, Unit trusts and OEICs are seperated into Equity and Non-equity - Explain the distinction and how this affects the taxation of the income produced

Think: allowances?

taxation of unit trusts and OEICs

Answer 31

Equity - those with less than 60% of its assets in interest-bearing securities
* Income is distributed as dividends, which is elligble for the dividend allowance (£500)

Non-equity - at least 60% of its assets in nterest-bearing securities.
* Income is distributed as interest, which is elligble for the personal savings allowance and paid gross

Question 32

OEICs and UTs and CGT

Answer 32

Authorised OEICs and UT grow free of CGT
* When proceeds are taken, a CGT charge may apply
* Gains from gilts and corporate bond funds are subject to CGT, even those the underlying invvestments would be exempt if they were held directly by the investor.

Question 33

Risks of OEICs and UTs

Answer 33

Risk Mitigation: Unit trusts and OEICs carry lower risk than direct equity due to professional management and investment spread, but no capital or income guarantees.

Question 34

Things to know about offshore funds

card to read

Answer 34

Offshore Funds: Typically unit trusts and OEICs based in tax havens like the Channel Islands and Luxembourg, often linked to UK investment companies.

Promotion in the UK: Under FSMA 2000, offshore collective investment schemes cannot be promoted in the UK without FCA authorisation or recognition.

Recognised Offshore Schemes: Only FCA-recognised offshore schemes can be legally promoted in the UK.

• Undertakings for Collective Investments in Transferable Securities (UCITS) –
  these are funds formed in EU states and, post-Brexit, under the ‘UK UCITS’ regime.
• Certain funds authorised in designated territories– these are countries that the FCA is satisfied provide the same level of investor protection as an authorised fund. In reality, this means the Channel Islands, the Isle of Man and Bermuda.
• Funds recognised individually by the FCA – certain funds outside the EU and designated territories are recognised by the FCA on an individual basis.

Question 35

Offshore funds - the two categories

Answer 35

Reporting funds
* Tax regime is the same as onshore funds - icome subject to income tax as an interst distribution or dividen, gains subject to CGT

Non-Reporting fund
* Income distributed from the fund will be subject to income tax in the hands
of the investor in accordance with the normal rules applying to interest or dividend payments.
* The major difference from a reporting fund is that any gains made by the investor on disposal, including accumulated income, will be calculated in the same way as a capital gain under the CGT regime - known as ‘offshore income gain’
* Investor cannot use the Captial gains tax annual exemption or set losses against other capital gains.

Question 36

Investment trusts

Key features

Answer 36

Earliest form of Collective investment they are Public ltd. companies listed on stock market:

• Expert management and low costs comapred with direct investment and OEIC/UTs - because cost is borne by the trust itself.
• Investment trusts can borrow, or gear, to invest without restriction.
• Close-ended - number of shares cannot be increased.
• More flexibility in investment choice compared to OEIC/UT.
• Can run for a set term, with a predetermined wind-up date
• Investment trusts can retain up to 15% of income in reserves, allowing them to smooth or increase dividend payouts, even during periods of lower income.
• In contrast, unit trusts and OEICs must distribute or reinvest all income received.
• No more than 15% of the ITs investment funds can be with one company.

Question 37

Investment trusts sometimes have more than one type of share, these are known as Split capital trusts. Name and describe the type of shares held

5 types. The order listed is order repaid at wind-up. Important note?

Answer 37

1. Prior charges – not shares, but must be paid before capital can be distributed, such as loan stock and debts.
2. Zero‑dividend preference shares - offer a fixed capital return at wind-up, typically higher than the initial price. Subject to CGT
3. Income shares - Provide income from trust assets. Income paid as dividends. Subject to income tax, and CGT.
4. Ordinary income (income and residual capital) shares - these are designed to provide a rising income with the prospect of capital growth. Subject to income tax, and CGT.
5. Captial shares - provides no income, but investors are entitled to all of the captial gain after debts repaid. Subject to CGT

Note - it is important to remember that there is no guarantee that the capital will be repaid at the wind-up date. The risk is higher the further down this list.

Question 38

Three key factors to condisering the risk of a Split capital share

Answer 38

Gross redemption yield – this shows the annual return of a share if it is held to the wind‑up date.

Hurdle rate - The annual percentage growth required for a trust’s assets to meet the share redemption value at wind-up.
* Positive: Assets must grow to meet redemption value.
* Negative: Assets can fall by this rate and still repay.
* High Hurdle Rate: Indicates risk that the redemption price may not be achieved.

Cover - refers to how many times the current trust net assets can cover the share’s redemption value at wind‑up, after allowing for the repayment of liabilities and higher classes of shares.

Question 39

What is Net asset value? What does it show and how is it calculated?

Answer 39

Net Asset Value (NAV): The market value of a trust’s assets minus liabilities, divided by the number of shares issued.
What it Shows: The value per share if the trust were wound up. It helps determine if shares are trading at a discount or premium.
Calculation:
* Undiluted NAV: Does not factor in potential shares from warrants or convertible loan stock.
* Diluted NAV: Assumes all warrants and options are exercised, increasing shares but not assets, lowering the NAV.

Example:
There are 100,000 issued shares in the Acme Trust. The trust has assets of £1.5m and liabilities of £500,000. The net asset value of each share is:
£1.0m÷100,000 = £10

Assets less liabilities divided by number of shares

Question 40

What is gearing? What does it show? How is it calculated? What impact does it have?

Answer 40

Gearing (Leverage): The practice of a company borrowing funds to invest, expressed as a percentage of capital and reserves.

What it Shows: Indicates the level of debt relative to equity, affecting investment volatility. Higher gearing can lead to greater returns if asset growth exceeds interest costs, but can also increase risk.

Calculation:
Gearing = (Total Borrowing / Capital and Reserves) × 100%

Impact: If assets grow faster than the interest paid on debt, investors benefit through increased dividends, share price, or net asset value (NAV). If not, the NAV may decrease.

Question 41

Taxation of investment trusts

Answer 41

• Gains within the fund are exempt from corporation tax and capital gains tax.
• UK dividend income (“franked investment income”) is not subject to corporation tax.
• Non-UK dividends, interest, and rent (“unfranked income”) are subject to corporation tax, but expenses like management fees can reduce this liability.
• Companies can elect to treat interest received as** interest distribution, avoiding corporation tax on it;** taxed as interest in the hands of investors.
• Interest and dividends are paid separately and taxed under their respective regimes.
• Dividends are paid gross and eligible for the dividend allowance; any excess taxed based on income tax band.
• CGT applies on share disposal gains.

Question 42

Key differences between Investment trusts and OEICs/Unit trusts

Answer 42

Investment Trusts:

• Closed-ended: Fixed number of shares traded on the stock market.
• Manager works with initial capital, no new inflows.
• Not pressured by inflows/outflows, can plan long-term.
• Investors buy/sell shares; no need for manager to sell assets to meet redemptions.
• Can borrow (gearing) to enhance growth.
• Can retain up to 15% of income to smooth dividend payments.

OEICs/Unit Trusts:

• Open-ended: Manager can issue/redeem shares/units.
• Must invest new inflows quickly, potentially under pressure.
• Manager may need to sell assets to meet redemptions, causing delays (e.g., property funds).
• Cannot borrow (no gearing).
• Must distribute all income (unless accumulation fund).

Question 43

Key differences between Investment trusts and OEICs/Unit trusts

Answer 43

Investment Trusts:

• Closed-ended: Fixed number of shares traded on the stock market.
• Manager works with initial capital, no new inflows.
• Not pressured by inflows/outflows, can plan long-term.
• Investors buy/sell shares; no need for manager to sell assets to meet redemptions.
• Can borrow (gearing) to enhance growth.
• Can retain up to 15% of income to smooth dividend payments.

OEICs/Unit Trusts:

• Open-ended: Manager can issue/redeem shares/units.
• Must invest new inflows quickly, potentially under pressure.
• Manager may need to sell assets to meet redemptions, causing delays (e.g., property funds).
• Cannot borrow (no gearing).
• Must distribute all income (unless accumulation fund).

Question 44

What are ETFs? Key Features?

What are the key benefits?

Answer 44

Exchange-traded Fund is an investment fund that trades on a securties exchange, similar to stocks. EFT stocks can be bough and sold throughout the trading day.

ETFs:

• Traded on securities exchanges, allowing intra-day buying/selling.
• Most ETFs follow passive strategies (index or benchmark tracking).
• Some ETFs offer active strategies, leverage, or inverse strategies (but fewer in number/AUM).

Index-Tracking Methods:

1. Physical ETFs: Hold all or a sample of the index’s underlying securities.
2. Synthetic ETFs: Use derivatives (swaps) to mirror index performance (with counterparty risk).

Two-Tier Investor Structure:

1. Primary Market: Authorised participants (APs) create/redeem ETF shares.
2. Secondary Market: Retail and professional investors trade ETF shares on exchanges or OTC.

Question 45

Key Benefits and Features of ETFs:

Answer 45

Key Benefits and Features of ETFs:
* Traded like stocks on exchanges, allowing intra-day trading.
* Low fees (annual charges typically 0.20-0.75%) and lower total expense ratio compared to unit trusts, OEICs, and investment trusts.
* No stamp duty on ETF shares in the UK (but dealing charges apply).
* ETFs provide liquidity and easy access to a broad range of asset classes.
* Dividends taxed under the dividend income tax regime; capital gains subject to CGT.
* Managed by authorized participants (APs) who create and redeem shares using baskets of securities.
* Supported by official liquidity providers (OLPs) to ensure market liquidity.