6 - Characteristics, risks, behaviours and tax considerations of investment products. Part 1 - Indirect investments - unit trusts, OEICs and investment trust companies Flashcards
Why are Collective investment schemes popular with investors?
They offer a good way to invest small sumds of money as investments are pooled into a larger fund
Professional fund managers make the underlying decisions
An investor can achieve a balanced portfolio as the fund managers invest in a spread
They offer the ability to persue particular objectives that an investor might otherwise avoid
Risk is reduced by the wide spread of the underlying portfolio
What are the characteristics of OEICs and unit trusts?
The allow an investor to participate in large portfolios or shares with many others
Units or shares are sold to investors, each is a small but equal fraction of a portfolio
Unit trusts are held for investors by trustees and invested by managers, OEICs are held by an indepedant depository
There is generally an initial charge and an annual management fee, or alternatively an exit charge may apply
What are the IA sector definitions? (Investment association)
Captial protection Income Growth Specialist fund Those principally targetting an outcome
How does the IA determine the different sectors?
Performance measurement companies (such as Standard and Poors) rank the performance of funds in each sector, published weekly and monthly
The fund must have at least 80% of its assets in the relevant sector
To qualify as an Income fund, achieve a yield of no less than 90% of the relevant index
Membership is constantly revised in light of developments and new types of funds
What do supporters of index tracking funds believe?
few managers outperform consistently the index
Outperformance generally means higher risks have been taken
Index tracking funds generally have lower charges
What are the general rules that restrict investment powers of authorised funds?
The FCA’s specialist handbook - sets out rules for establishing and operating schemes, minimum standards, proportion of transferable securities and derivatives
The trust deed must contain a statement that the fund can invest only in those eligible by the FCA, or narrower investment powers if required
The investment limits of the scheme or prospectus of the scheme, in accordance with the FCA
What percentage of securities in an fund, must be within approved securities?
90%
What are the four other standards that unit trust managers, directors and trustees must meet in addition to ensuring the market is liquid?
Regulated
Operating regularly
Recognised by a statutory body or government agency
Open to the public
How often must a firm carry out a review of non EU markets they consider eligible for each fund?
Annually
What are the diversification rules applicable to unit trusts and OEIC’s imposed by the FCA?
Non index tracker funds can only hold up to 10% of the total value in any one company
The fund can only hold an aggregate of 40% up to the maximum of 10% in four seperate shareholdings
Any other must not exceed 5% - i.e. a total of not less than 15 holdings
(UCITS funds which are replicating tracker funds can hold up to 20%, and 35% in exceptional circumstances)
UCITS are limited to 20% for securities or instruments by the same group
Funds investing 35% or more in government stock, are required to invest in 6 different issues, no single stock can exceed 30% of the total value of the fund
UCITS can hold up to 10% in unapproved securities, 20% can be in another collective investment scheme
Non UCTIS can hold up to 20% and 35 % in another collective scheme
Both can hold warrants without limits
Funds can only hold cash for liquidity and cash flow purposes , no more than 20% overall
What is the difference in borrowing limits for retail UCITS and non retail UCTIS schemes
A retail scheme can only borrow up to 10% on a temporary basis (but can borrow against its property fund)
A non retail is allowed to borrow up to 10% of the fund on a permanent basis
QIS may borrow up to 100% of shceme property
What is the difference between a UCTIS and UCIS?
UCTIS meets EU requirements and can be marketed across europe ro retail investors
UCIS is unregulated and cannot be marketed to retail investors in the UK
What investments are considered as Non mainstreamand subject to marketing restrictions?
Units in QIS (qualified investor scheme)
Traded life policy investments
Units in UCIS
Securities issues by special purpose vehicles, pooling investments in assets other than unlisted or listed shares or bonds
What investments are not considered NMPI’s and fall outside marketing restrictions?
Exchange traded products
overseas investment companies that would meet the criteria for investments if based in the uk
real estate investment trusts
venture capital trusts
enterprise investment schemes and seed schemes
SPV’s pooling investments primarily in shares and bonds
What type of fund sits within the AIFMD (alternative investment fund managers directive)?
Who are they aimed at?
hedge funds private equity funds retail investment funds investment companies real estate funds
Professional and institutional investors
What are the two key roles within a trust deed?
The trustee and the manager
What are the key elements of the trustee’s role?
Checking the managers actions
Ensures the manager invests in line with the objectives of the fund
Holding/controlling the assets to ensure they are held safely
In what circumstances could a trustee fire the manager?
If the manager goes into liquidation, insolvency, receivership
if the trustee believes the manager is not acting in the unit holders interest
If the majority of the unit holders voted for removal of the manager
Who is the legal owner of the trust and in whose name are the securities registered?
The trustee
What over jobs does a trustee have in relation to the trust?
Report to the FCA if its not being managed within regulations
Arranging an audit of the trust and issuing financial statements
Monitoring the calculation of unit pricefor sale and repurchase
Arranging unit holder meetings
Setting up the register of unit holders and issuing certs
Distributing the income
Making any additional provisions for the trust to be recognised as a pension scheme or charitable scheme
Trustees are usually what type of institution?
Large bank or major insurance company
What are the fund manager’s key responsibilities?
Be authorised
Have adequate financial resources
Manage the assets in accordance with regulations and the trust deed/scheme particulars
Supply information when requested
Maintain a record of units for inspection
Notify the trustee/FCA of any breaches
Promotion, advertising, administration
What is subcontracting of fund management?
The manager may select a third party to decide how the fund is invested who may then select a third party to handle admin.
The manager retains responsbility and compliance with regulations
What does the register of a unit holders need to contain?
Name and address of unit holders
Number of units held
Date of which the holder was registered
If a certificate is not issued, what else might a holder receive?
A periodic statement
What is required to be on a certificate?
Date
Name of the scheme
Names and addresses of the manager and trustee
Number and type of units held by the holder
Name of the holder
How often should a unit trust publish reports?
half yearly and annually
What are the three levels of protection for a unit holder?
Trustees Regulatory organisations (under Financial services and markets act 2000) Complaints and arbitration procedures
If a fund manager wishes to raise charges, how much notice would he need to give?
reasonable, not less than 60 days
Can a manager be removed without the approval of the FCA?
No.
How are unit trusts taxed and how is it important to investors?
Taxed as corporation tax on Income only.
Can allow annual management expenses to be offset against non-dividend income of rtax relief purposes
Do unit trusts pay tax on capital gains or options form futures?
No
What are the different tax regimes, depending on the composition of the investments in the fund?
Less than 60% of interest barring securities pay corporation tax at 20% in income on overseas income, rent or interest
Dividends are received as franked income and flow through to dividend distributions payable by the trust so have no tax liability
More than 60% in interest barring pay an interest distribution which is deductinle for corporation tax, i.e. there is no UK corporation tax liability
What is an equalisation payment?
A payment within the first distribution of income to a unit holder, which represents the income that was included within the price paid for the units.
How is an equalisation payment treated for tax purposes?
It must be deducted from the intial purchase price to confirm the aquisition value for CGT purposes
How often is income from a unit trsut distributed?
Monthly, quarterly, 6 monthly or annually depending on the type of trust
What are the rates on income tax on trust dividend distributions from equity trusts?
- 5% for basic rate
- 5% for higher rate
- 1% for additional rate
How are trustees taxed on funds held within a discretionary trust?
liable for tax of 38.1% on income received and 2K allowance does not apply, however dvidends that fall within the standard rate band of £1000 will only be taxed at 7.5%
what is the special rate of corporation tax for OEIC’s and unit trusts?
20%
In order to pay interest distributions from a non equity unit trust or OEIC, how much needs to be held in interest barring investments?
60%
How much tax liability would a gilt or corporate bond fund within a discretionary trust have?
45%
under £1000 would be 20%
If dividends or interest is reinvested in the trust, would there be a tax liability?
Yes as it still counts as income
If a unit trust disposed of investements within the trust, would they be subject to CGT?
No as they are exempt
Is a taxpayer who disposes of units from a unit trust, be subject to CGT? If so, how is this calculated?
Yes
Disposal proceeds, less aquisition costs, less any exempt amount = taxable gain
any equalisation payment would be deducted from the aquisition costs
What is bed and breakfasting?
selling units and buying back the following day to avoid changing units, used to realise gains or losses
Why is bed and breakfasting no longer effective?
there has to be an interval of at least 30 days
What are the alternatives for investors wanting to retain existing investments after realising a gain or loss?
selling units and buying back with a ISA
selling units and arranging for a spouse or civil partner to buy them back
Selling and repurchasing in a very similar unit trust
How are switching funds treated as part of an OEIC that is an unbrella fund?
Treated as a disposal, however exempt if it a fund of funds.
What is the intention of a TEF?
Moves the point of taxation from the TEF to the investor.
The are entitled to receive a deduction up to the same amount to offset the taxable income that would be ordinarily liable to income tax.
What is the most popular reason for investing in a unit trust?
Investors can benefit from capital gains and income, however the income largely comes from dividends
What are the options open to investors in terms of how they receive the income from a unit trust?
The income is added to the investors holding as accumulation units
They can receive as income units
However - some funds specify what is available - i.e. just income, just accumulation or a mix of the two, or the option of buying more units (however would be subject to intial charges)
What is the impact of allocations on unit prices and accounting periods?
As the fund approaches the accounting day, prices rise
Once passed the price falls by the amount of income
If unit holders buy during the ex-distribution period, the get the allocation attributable in the previous period, buyers will not.
Prices are marked xd for no more that 4 months after the end of the accounting period, be it annual or interim
What are the benefits of a unit trust being held in a ISA?
It means any realised gains are exempt from CGT
The full ISA allowance can be used within a stocks and shares ISA either as a lump sum or regular payments
Virtually all unit trusts qualify as investment. Cash funds also qualify as a cash ISA
All UCTIS schemes qualify for stocks and shares ISA
When buying units in a trust, what must be supplied before the purchase contract can be executed?
KID
How many days after recepit of signed documentation, does a manager have an obligation to make payment for a sale?
4 business days
If a certificate is issued by the trust and an individual sells a portion, would they expect to receive a new certificate
or an amended one?
New certificate
What is the benefit of a share exchange scheme and how do they work?
cheaper and simpler way of disposing of a small holding of shares.
Allow investors to swap PLC shares for an equivalent in a funds units
The manager may offer more advantageous terms
The manager may absorb the shares or sell them and invest the proceeds
What are the features of dual pricing?
The FCA formula determines
- The highest price the units can be sold to investors
- The lowest price the units can be repurchased from investors
The manager can create or cancel existing units depending on market conditions and therefore unlike an investment trust, a unit trust remains open ended
Offer price is the price at which an investor can buy
Bid price is the price at which the investor sells
When calculating the price of unit trusts, what do managers need to comply with?
FCA regulations - fair value pricing under COLL
What are the features of single pricing
Uses mid market price for all transactions
Charges are disclosed seperately
How does a manager calculate the offer price?
market value of underlying securities a valuation point
add costs of buying
add on other property of the trust - such as uninvested cash, any accrued income, less tax, fees, charges, expenses
divide by the total number of shares issued
add on the initial charge
express figure to four figures
How does a manager calculate the bid price?
value the securities at the best market selling price
deduct dealing costs
add an uninvested cash
add any income after usual deductions for fees and tax
divide by the number of units
express to four figures
What are the exceptions to the usual bid-offer spread of 5-7%?
no load trackers have a narrow spread of around 1%
smaller companies and emerging funds have a high spread of around 10%
Cash have no spread
What are the reasons why a bid offer spread may approach or exceed the permitted spread by the FCA?
when there is a buyer and seller on a fund and no underying assets need to be sold
If a manager is a net seller of units, they can be prices towards the offer end
If the manager is a net buyer, there will be costs and will be priced at the bid end of range
How does demand impact the bid and offer price?
If demand is high the manager will set the buying price at the offer end of the spectrum, investors will pay the amx price and sellers will get a good price
If demand is low, it will be set nearer the bid price, so sellers will get the minimum price and buyers will pay a low price
What is ‘Box’ management?
Is it the stock control applied by managers in buying and selling units, depending on market demand.
Managers may hold shares in the box, consisting of newly created units or repurchased units
It reduces the buying and selling costs for investors and no charges are incurred for cancelling or creating new units.
What time of day should a manager value the unit trust?
The manager decides, but the frequency is dictated by the scheme
What price does an investor pay, when a unit is forward priced and what must a manager ensure?
The price at the next valuation point.
The manager must create enough units to cover any deals since the last valuation point
When must a manager operating on historic pricing move to forward pricing?
If the value of the trust is believed to have changed by 2% or more since the last valuation
What happens if a manager who is using historic pricing runs out of units?
The must either move to forward pricing or risk losses if the market moves unfavourably as they must create units to cover the oversell at the next valuation point at which the price may have risen.
For an OEIC, what is the reason they are not established under the companies act?
Allows them to expand and contract to meet investor demand
What are the three ways an OEIC can be established?
Retail UCITS
Non retail UCITS
QIS
How is the ownership of a unit trust Different to an OEIC?
With a unit trust the beneficial ownership is conferred to the unit holders, with an OEIC they still hold shares in the company but do not own it.
What is the broad regulatory structure of an OEIC?
authorised by the FCA if marketed in the UK
Operating by a board of directors (which may comprise of one sign ACD (authorised corporate director)
Assets held by an independant depository
The ACD and depository must be authorised persons
Sales and marketing mostly regulated by the FCA
Additional regulations apply set out in the FCA handbook
How is an OEIC different to a trust?
Self contained company (with consittution and AGM)/audited accounts
stand alone or an unbrella company with sub funds
All sub funds of the umbrella must adpot the same pricing basis
Shares are issued rather than units and different classes and charges/currencies may apply
It appoints directors
Cost of creation is met by the fund
Single pricing is usually used (however dual can be adopted)
Limit on borrowinf to 10% of the fund, and cannot gear up
What is the OEIC equivalent to a unit trust manager?
ACD - authorised corporate director
What is the ACD responsible for?
compliance with investor protection set by the FCA
day to day management, such as pricing, valuation and dealing
Prep of accounts
Management of investments
What is the despository of an OEIC responsible for?
oversight of pricing, valuation and dealing
collection of income and authorising distribution
ensuring ACD operates correctly
safekeeping of assets
What must an OEIC scheme holder do?
report to holders twice per year
produce reports that comply with SORP
issue short form accounts
make full accounts available if requested
Can OEIC’s be held within ISA’s?
yes
When would a dillution levy be applied?
Applicable when single pricing is used
Paid to the OEIC to cover dealing costs and the spread between the buying and selling price of the underlying investments
If there are lareg flows in and out of the fund
The levy goes to the fund, not the managers
Details of the levy will be found in the prospectus
What is a swing adjustment?
It can be used as an alternative to a dillution levy to cover dealing costs on single priced shares.
What are the advantages of an OEIC?
Most widely recognised in europe and can be marketed internationally that is impossible for unit trusts
Regulations permit multiple share classes, flexible charging, and currency structures
Umbrella funds are available offering a range of objectives and classes, switches between funds are simple
The umbrella structure makes it easier to create new funds
What are the two types of multi manager categories?
Fund of funds - funds managed by other managers
Manager of managers funds - appoint specialist managers to look after parts of a portfolio to a brief
What is the difference between a fettered and un-fettered fund?
Fettered - only invests in funds run by the same management group
Un-fettered - can select any fund from any management group
What is the benefit of a fund of funds structure in terms fo CGT?
It creates a shelter as switching between funds does not create a CGT liability
How are the fees for a manager of manager funded clearer than a fund of fund?
The individual fees are not charges seperately but are paid for out of the annual management charge of the manager of managers fund as opposed to taking from the overall fund
How does a platform service simplify an advisers administration?
All of a clients portfolio is held in one account making it easy to view total investments, values and allocations
What are the three sections of the FSMA that the FCA recognises offshore funds?
Funds categorised as UCITS under EU legislation - receive automatic recognition by the FCA
Certain funds in designated territories - FCA is satisfied investors receive the same level of protection - Jersey, Guernsey, IOM, Bermuda. They are split into three
FCA recognised
Approved by local regulator
Neither apporved or regulated
Funds from outside the designated territories, but recognised in their won right - on an individual basis.
What is the impact for those funds who are not recognised by the FCA?
The are subject to severe market restrictions
What is a UCITS?
open ended collective investment schemes that comply with the UCTIS directive requirements
When can a UCTIS from another european country operate within the UK?
Once it has approval from the FCA it can operate within FCA marketing rules (after 2 month wait)
What further directives have been issued since inception of UCTIS?
3 - broadened range of assets
4 - allowed funds with authorisation in one country to operate throughut the EU
5 - Amendments to renumeration principles, transparency, regime for depositary
Why can’t overseas funds be sold via cold-calling?
Cancellation rules do not generally apply
Which type of fund are overseas investments usually similar to?
OEIC
Is there a tax advantage to switching funds in an overseas umbrella fund?
No, this was removed
What are the main tax advantages that make reporting funds preferable for UK resident and domiciled investors?
Dividends and interest are treated in the same way as UK funds
CGT is charged as usual on gains
Where an offshore fund holds 60% or more in interest bearing securities, it is treated in the same way as a UK investor, tax applicably and offset against individual PSA
Can gains from a non-reporting fund be used against UK allowances?
No
What do Non reporting funds usually consist of and what is the benefit?
Roll up funds - and therefore can be used to shelter accumulated income, meaning the investor can realise profits when their tax rate has dropped or become non-resident (but taxed in country of residence)
Non dom can benefit from escaping IHT as offshore funds are not liable.
How did the EUSD (european union savings directive) change in 2016?
It covered not only interest income but dividends and other types of capital income
What is the witholding tax rate?
35%
Who do you think runs an investment trust?
Board of directors runs the trust as self managed or by employing an external mangement company
How is the NAV of shares in an investment trust calculated?
total value of investments at mid-market price
plus inlisted investments
plus cash and assets
less loans, debenture stock and preference shares
Result known as shareholders funds
How is the dilluted NAV of a share calculated?
Shareprice plus warrants and convertible loans
Net assets plus money subscribed to warrant holders/number of ord shares in issue plus shares issued to warrant holders
If a share of an investment trust is 100p, but is trading at 86% - how much is it trading at a discount?
14%
NAV-trade price/NAV x 100 = discounted price
If an investment company wants to sell directly to the public, what do they need to do?
Seek authorisation to carry out investment business under the FSMA 2000
If a share price is 210p and the NAV is 200p is the share trading at a discount or a premium?
trading at a premium of 5%
What three rules does an investment trust need to satisfy to the HMRC to gain approval
Resident in the UK and not a close company (controlled by 5 or fewer)
Ord shares listed on the LSE
Does not retain more than 15% gross income
What is a conventional trust?
Issues only Ord shares
What is the benfit of a limited life trust?
It helps reduce any discount from NAV. As the winding up comes closer, any discount narrows as investors could retain the full value of a trusts assets.
If a trust has a negative hurdle rate, what does it mean?
If means the trust already has surplus assets so can afford to decline in value and still pay the current purchase price/redemption value/zero at wind up
What would asset cover of 1 mean?
The assets exactly cover the redemption price
What are the characteristics of zero dividend preference shares?
Limited life
Fixed redemption dates
Issued at an initial value
Taxed under capital gains and not income tax rules
What are the characteristics of Income shares?
Gives a right to a fixed redemption price (subject to suffcient assets) but may be well below market priced
May have a high income level but a nominal redemption value
Ordinary share income - no predetermind capital value, but receive all of the residual value after the holders of zero’s and borrowings are paid. Note - may risk zero capital being repaid
What is a warrant?
A right to buy shares at a fixed pre-determind price.
How are warrants usually priced?
Below the actual cost of a share
How would you calcuate if there is any gearing within an investment trust?
total gross assets/net assets x 100 =
How can a trust use gearing?
To borrow to fund an investment opportunity
What would an adviser need to do if it recommended an investment trust that is significantly geared? (above 30%)
Enhanced warnings need to be given
What are the three definitions of gearing?
Financial gearing (bank loans, debentures) Structural gearing (case of splits) Investing in geared instruments (warrants, derivatives)
If an investor borrows money to invest in equities in an investment portfolio, what is likely to happen to the size of the gains or losses?
The profits or losses will increase in proportion to the gearing ratio.
What does the OCF of a fund consist of? (ongoing charges figure)
annual management charge and all other expenses of running the fund
What must UCTIS regulated funds provide to customers regarding OCF?
A KID which displays OCF
What is the main difference beween an OCF and a TER (total expense ratio)?
The TER includes performance fees
What do OCF and TER both not include?
entry and exit charges paid directly by investors
interest on borrowing
brokerage charges
dealing costs
What is the tax status of an investment trust company?
not subject to tax of gains made through the sale of shares or other holdings in the portfolio
not subject to any tax on franked income (dividends received from shares held within the trust)
are subject to tax on unfranked income - i.e. interest from savings and gilts (but can offset expenses)
How are income and gains taxed for the investor?
in the same way as other income and gains from shares
first £2k is free
liable to CGT on profits (exceeding annual limit)
All tax free if held within an ISA
Is it cheaper to invest in an investment trust or a unit trust/OEICS?
Cheaper, as you are investing directly in shares in the trust rather than buying units
AMC are considered to be lower within a trust
Is it more risky to invest in an investment trust or a unit trust/OEICS? why?
More risky
Is it more risky to invest in an investment trust or a unit trust/OEICS? why?
More risky because
Shares often trade at a discount to NAV
Discounts can widen if the market doesnt like to way the fund is managed
Borrowing within investment trusts can increase volatility (much stricter with OEICS and Unit trusts)