9. Investment planning principles Flashcards
What is a Direct investment?
Invesestor buys securities or other assets themselves - in their name, without a wrapper or other investment vehicle
What are the advantages of Direct investments?
- Known expenses
- Bespoke investment
- Lower costs on a larger portfolio compared to a collective fund of a similar value
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What are the Disadvantages of Direct investments?
CGT?
- Less diversification unless large cash to invest
- Overall costs on smaller portfolios are likely to be higher than collective investments
- More volatile due to less diversification
- Lack of knowledge - investor led
- CGT may be payable on gains made or when switching from one investment to another. When collective fund managers do this, the fund is exempt from CGT
What is a Indirect investment? Examples?
Indirect investment is where an investor uses a wrapper, vehicle or financial products in order to invest.
Typical indirect investment…
* OEIC
* Unit trust
* Collective fund
* Stocks & shares ISA
What are the advantages of Indirect investments?
- Wide choice of investments
- Economies of scale
- Run by experts
- Greater diversification
- CGT on internal dealings, such as the manager switching assets, taking profits, and trading
CGT on indirect and direct investments
Direct
* CGT due on each switch, trade, and disposal
Indirect
* CGT exempt when fund manager switches assets, takes profits, and makes trades
* The investor only faces CGT when they ‘cash in’ and can control to mitigate liability, i.e. spread over multiple years to make use of CGT exemption
What are the Disadvantages of indirect investments?
- Less bespoke than direct investments due to the nature of collective investments.
- No control or influece over the management of the fund
- High management charges - tracker funds are less costly
- Switching from one fund to another is likely to result in a new initial charge of up to 5% on the new fund. Switching direct holdings of shares is likely to cost less. This is not the case when switching between investment trusts, where the spread between buying and selling prices is generally the same as shares.
Advisory management
9.4 The principles of portfolio construction
- Based on written client agreement
- Adviser recommends, client agrees or rejects
- Adviser must follow “know your client”
- Each transaction authorised by client
Discretionary management
9.4 The principles of portfolio construction
- Written discretionary management agreement - confirms client’s objectives and attitude to risk, and adviser’s remit and powers
- Adviser can make investment decisions on the clients behalf
- Discretionary management will incur greater fees above that of investing.
What is benchmarking in terms in portfolio creation?
9.4.3 Constructing the portfolio
With benchmarking, the manager uses ‘model’ portfolios to establish the asset mix for the client’s portfolio, in line with their attitude to risk and objectives.
The benchmark used could be a stock or bond index, LIBOR, or a growing number of model portfolios to help advisers.
What is strategic asset allocation?
What is it also known as?
- Manager established base mix of assets that aims to produce the require returns
- Can be seen as the portfolio’s statement of investment policy.
- Allocation may change as a result o fmarket moement, so the allocation should be reviewed on a regular basis
Also known as base policy mix
What is tactical asset allocation?
What is it also known as? Time period?
- manager makes short‑term tactical investments that may deviate
from the traditional asset mix. - Allows them to take advantage of certain situations in the market and make profits
- This approach relies on market timing
Also referred to as ‘active’ management
Passive investment portfolio management
What is it also referred to as?
9.6 Investment management styles
- Manager aims to match the market or sector rather than beat it
- Tries to replicate an index or benchmark
Also referred to as tracking
Active investment portfolio management
Otherwise called? Charges?
9.6 Investment management styles
The manager’s objective is to produce returns above the market, defined as
an index or benchmark, by actively analysing and selecting shares.
Active management relies on the manager to use their skill to analyse and select shares and other assets to beat the market.
Indexation, or tracking, comes in four main forms:
Full replication - A method where the fund buys every share in an index in the exact proportions as it appears. Mirrors index completely
Stratified sampling - buys a representative sample of shares from different categories within an index. Slight deviations form index
Optimisation - Fund uses statistical models to replicate the index based on past performance data. Cost-effective, but risks underperformance if models out-dated
Synthetic indexing - Instead of holding index shares, the fund takes long positions in index futures, forward contracts, and swaps, combined with low-risk assets like bonds, to replicate index performance.
