13.) Operation of the Fund Flashcards
Define what funds are made up of
Assets and Liabilities
Note that all foreign assets and liabilities will be converted to the reporting currency of the fund using the latest available exchange rate.
Describe assets, one of the 2 features that makes up all funds
Investments are usually valued at market value and are the main asset of the fund. The method and timing of the valuation will depend on the type of asset, e.g. price for quoted stocks will be obtained from the relevant stock market using Reuters or other price providers, property will be valued using a professional valuation provider, unquoted investments will often be valued by the investment manager using the latest available accounts and other information available, etc
Cash will comprise of all the cash assets of the fund, which may be held in a number of currencies
Accrued income is income due to be received by the fund and would include investment income and bank interest
Monies due from managers would be funds due from the manager in settlement of outstanding subscriptions in the fund
Monies due from brokers or investments are proceeds due from the sale of the investments
Define what must first be calculated in order to calculate the price per unit/share of a fund
The NAV (Net Asset Value) of the fund
Describe liabilities, one of the 2 features that makes up all funds
Accrued expenses are expenses due to be paid by the fund but payment is yet to be made, e.g. management fees and custodian fees
Monies due to managers are funds due to the manager in respect of settlement on outstanding redemptions in the fund
Monies due to brokers are payments due to brokers for purchase of investments that have yet to settle
Distributions payable to shareholders are the payment of the dividend to the shareholders by the fund
Nominal shares and Founders shares are shares held by the Managers that if redeemed, the fund would have to pay the managers
Define and describe the process by which the dealing price of the shares/units of a fund are calculated
- ) Calculate the NAV of the fund, i.e. nets of total assets - total liabilities
- ) Establish the shares in issue
- ) Divide the NAV by the shares in issue to establish ‘NAV per share’
- ) Apply any pricing adjustments, e.g.
Initial charge is added to creation price
Exit charge is deducted from bid price
Roundings
- ) Shares are offered to the public at the offer price
- ) Shares are purchased from the public at the bid price
- ) The manager buys shares from the fund at the creation price and sells shares back to the fund at the cancellation price. This is always the price before any price adjustments or roundings, I.e. NAV per share
Define where the pricing policy of a fund must be disclosed
In the fund’s prospectus
Define and briefly describe the various methods of pricing policy for funds
A fund manager has a choice regarding the pricing policy of the fund. Most funds operate forward pricing, but there are some that operate under historic pricing.
1.) Forward pricing
Investors deal at NEXT valuation price
Investors deal at UNKNOWN price
2.) Historic pricing
Investors deal at LAST valuation price
Investors deal at KNOWN price
3.) Dual pricing
Investments priced at bid and offer prices
DIFFERENT bid and offer NAV
4.) Single pricing
Investments usually value at mid price
SAME bid and sale NAV
Buying/selling charges added to NAV to calculate bid and offer pricesh
Define and briefly describe Forward Pricing, one of the various methods of pricing policy for funds
Investors deal at NEXT valuation price
Investors deal at UNKNOWN price
Note that most funds operate forward pricing
Define and briefly describe Historic Pricing, one of the various methods of pricing policy for funds
Investors deal at LAST valuation price
Investors deal at KNOWN price
Define and briefly describe Dual Pricing, one of the various methods of pricing policy for funds
Investments priced at bid and offer prices
DIFFERENT bid and offer NAV
Define and briefly describe Single Pricing, one of the various methods of pricing policy for funds
Investments usually value at mid price
SAME bid and sale NAV
Buying/selling charges added to NAV to calculate bid and offer pricesh
Define the pricing adjustments that fund managers will make to the NAV of a fund in order to obtain the price at which they will buy and sell shares to the public
Initial charge
Exit charge
Define the features of the initial charge, on of the pricing adjustments that fund managers will make to the NAV of a fund in order to obtain the price at which they will buy and sell shares to the public
Added to NAV offer price
Can be used by managers to pay discounts to investors and IFAs (Independent Financial Advisers)
Paid by managers
Rate varies according to fund managers and fund types
Define the features of the exit charge, one of the pricing adjustments that fund managers will make to the NAV of a fund in order to obtain the price at which they will buy and sell shares to the public
Deducted from NAV bid price
Paid to managers
Rate varies according to fund managers and fund types
Acts as incentive to encourage investors to keep units
Define the similarities and differences between the initial charge and exit charge, the two pricing adjustments that fund managers will make to the NAV of a fund in order to obtain the price at which they will buy and sell shares to the public
Initial - ADDED TO NAV offer price
Exit - DEDUCTED FROM NAV bid price
Initial - Can be used by managers to pay discounts to investors and IFAs (Independent Financial Advisers)
Exit - Acts as incentive to encourage investors to keep units
Both - Paid by managers
Both - Rate varies according to fund managers and fund types
Define founders shares
Issued to the founders of a firm, these shares (stock) normally do not receive any return until dividend payable to common stock holders (ordinary share holders) is paid out. However, these shares are entitled to all of the remaining (after tax) profits, no matter how much.
Define the acronym IFA
Independent Financial Advisers (IFAs)
IFAs are professionals who offer independent advice on financial matters to their clients and recommend suitable financial products from the whole of the market.
Define the components of the Unit Cost Sheet of a fund
Market value of investments
Mid-market
Cash
Dividends receivable
Sundry debtors
Sundry creditors
Nominal shares
Dealing charge
Initial charge
Shares in issue
Define bid offer spread
(In the unit cost sheet of a fund) The difference between the bid and offer price, usually expressed as a % of the offer price
Define who is responsible for preparing the valuation of a fund
The manager of the fund
Defined the formula for calculating the NAV/Net Asset Value of a fund
NAV = total assets - total liabilities
Note that the method for calculating the NAV, and the frequency of the calculation, will be detailed in the key fund documentation and the prospectus.
Whilst the frequency and the method for valuing the assets will differ between funds, the principle of the calculation won’t change.
Describe the actions that the manager of a fund will take in order to ensure that the valuation of said fund is correct
In order to minimise the risk of incorrect valuations, managers ensure that procedures are put in place to check the accuracy of the valuations.
The procedures will vary according to the fund manager.
Many fund managers have a checklist that they use in order to check the valuation.
Each part of the valuation must be checked with the most detailed checks being performed on the investment portfolio, often using exception reports, which identify non-moving stocks, or stocks that have moved over a certain pre-set % rate, that carries out the checking.
Define the consequences of a manager over- or under-valuing a fund
The accuracy of a valuation is critical. If the fund is over or under valued, the consequences for the manager can be damaging, both to their own reputation and financially.
If the fund is OVER-valued - shareholders will be overpaid when they redeem units.
If the fund is UNDER-valued - shareholders buying shares will be undercharged.
In both cases, the manager must repay the fund for the loss.
Define the areas of a fund in which the main (valuation) checks would be performed
Investment portfolio
Cash movements
Debtors
Creditors
Shares in issue
Define the checks that would be carried out on the investment portfolio of a fund, one of the areas of a fund in which the main (valuation) checks would be carried out
Each aspect of the portfolio would be reviewed, including:
Purchases and sales of investments
Market movements of the portfolio
Currency of the stocks, including foreign exchange rates
Stock name and nominal (value?)
Define the check that would be carried out on the cash movements within a fund, one of the areas of a fund in which the main (valuation) checks would be carried out
The balances would be reviewed and checked to ensure that all payments and receipts since the last valuation have been processed
Define the checks that would be carried out on the debtors of a fund, one of the areas of a fund in which the main (valuation) checks would be carried out
Accruals movements since previous valuation
Dividends receivable
Accrued interest in fixed interest stocks
Bank interest
Receipts
Define the checks that would be carried out on the creditors of a fund, one of the areas of a fund in which the main (valuation) checks would be carried out
Accruals movement since previous valuation (as is also the case when checking the debtors of a fund)
Payments
Define the checks that would be carried out on the shares in issue of a fund, one of the areas of a fund in which the main (valuation) checks would be carried out
Foreign exchange rates
Dividend payable - fund XD
Overall price check from previous valuation:
Compare price of:
- ) Relevant index
- ) Previous valuation price
- ) Market
Note that it is important that the price is calculated using the correct shares in issue figure. The shares should be checked to ensure that all the creations and redemptions have been properly processed.
Define the possible reasons behind movements in the value of a fund, an important factor when performing valuation checks on a fund
Fund going XD - price will fall by the amount of the dividend
Movement in the market price of the investments
Movement in the fording exchange rates
Define the transactions that WON’T usually cause a major movement in the price of the shares/units of a fund, an important factor when performing valuation checks on a fund
Purchase of investments - cost price should be close to market value
Sale of investments - cash or brokers accounts will increase accordingly
Payment of expenses, receipt of income
Stock going XD - debtor will be set up for the dividend
Define the importance of taking into account the fees and expenses of a fund when performing valuation checks on it
Every fund is liable to pay all expenses that relate to the day to day running of the fund, e.g. audit fees, bank charges, management fees, custodian fees, etc. Details of the fees and expenses paid by a fund will be found in the fund’s prospectus
Fees and expenses outstanding at the valuation point are accrued and shown on the unit cost sheet as a creditor
It is necessary to accrue all fees and expenses in order to ascertain the correct NAV per share. If they weren’t accrued, the NAV would fall when expenses were paid, making it inequitable for shareholders buying or selling shares on that day
Define where details of the fees and expenses paid by a fund will be found
Details of the fees and expenses paid by a fund will be found in the fund’s prospectus
Define the importance of taking into account the fixed fees of a fund when performing valuation checks on it
Certain expenses are a fixed amount, meaning that the daily accrual will be the same unless the expense amount changes.
These fees, e.g. Audit fee, don’t change when the fund increases/decreases in size
Define the importance of taking into account the variable fees of a fund when performing valuation checks on it
Certain fees are charged as a % of the NAV and the daily accrual will charge accordingly.
Unlike the fixed fee, the accrual will increase as the NAV increases, and decrease when the NAV decreases
Define the acronym TERS
Total Expense Ratios
Define and describe the use of Total Expense Ratios (TERS)
The Total Expense Ratio is used to compare the performance of funds as it identifies the operating expenses (not including management and custodian fees) as a % of the NAV.
Whilst many investors look at the management fee paid by the fund, they don’t always look at the other costs.
The figures placed in the annual accounts are used to calculate the TERs.
Define what the manager of a fund is not allowed to deal in, as per the investment restrictions of the fund
Stocks
Define where the rules regarding the investment powers of a fund are set out
In the trust deed/memorandum and articles of association and prospectus
Define how the restrictions on a fund are determined
By the investment objective of the fund and by local legislation
Define why there are investment/borrowing restrictions on funds
For the protection of shareholders, and to ensure that the fund is liquid and sufficiently well diversified
Define what the range of limits on the rules of a fund are based on
A % of the NAV of the fund
Define the details of the rules of a fund
Different types of investments in which the fund is allowed to invest
Eligibility of markets in which the investments may be purchased
Define who the manager of a fund will consult with, when determining the eligibility of markets
The trustee/custodian
Define the characteristics that a market must have in order for the relevant fund to be eligible
Well regulated
Operate regularly
Be recognised as a market
Be open to the public
Define the difference in principal investment restrictions between Unclassified and Recognised funds
For an UNCLASSIFIED fund, the prospectus and fund documentation sets out investment restrictions, as opposed via the legislation
For a RECOGNISED fund, the investment restrictions are set out clearly
Note that legislation sets out the restrictions for each class of fund
Define the (principal investment) restrictions that legislation sets out for each class of fund (Recognised and Unclassified)
A maximum of:
10% of fund to be held in unquoted securities
5% of fund in transferable securities issued by one issuer
10% of share capital of an investment itself
10% of the total units in issue of a single collective investment fund
5% of fund in units of CIF (Collective Investment Fund)
5% of fund in warrants
10% of fund in transferable securities NOT on recognised stock exchange
Define the borrowing restrictions that legislation sets out for each class of fund (Recognised and Unclassified)
Maximum 25% of fund, for short term purpose of an UNCLASSIFIED fund
10% for a RECOGNISED fund, except a geared futures and options fund, which isn’t allowed to borrow
Define efficient portfolio management, and briefly describe its rules
Efficient portfolio management sets out the way in which a manager may use derivatives.
This will be done in accordance with any investment restrictions set out in the prospectus
The rules are that:
All transactions must be economically appropriate, e.g…
- ) Will reduce risk of costs, which are sensible to reduce
- ) Generate additional capital or income, with certain benefit to the fund
- ) Achieve a switch in exposure without having to buy/sell investments with a cost/low risk benefit
Define stock lending, and how it can be used by a fund
Shares owned by the fund are transferred to the borrowing institution in return for shares of the same kind and amount to be transferred back at a later date.
The borrower is also required to provide and transfer collateral to the fund to cover against risk that the transfer may not be completed
Funds can use stock lending to earn additional income for the fund, subject to certain conditions
