C10 - Other Investment Classes Flashcards
Purpose of Collective investment scheme (Mutual Funds)
Purpose of Collective investment scheme (Mutual Funds)
From investor’s perspective:
1. Diversification
2. Access to expertise
3. Access to large/unusual investments
4. Economies of scale
5. Possible tax advantages
From management of collective investment vehicle’s perspective:
1. To follow the stated investment objective
2. To create a return for investors commensurate with the level of risk taken
Regulations covering collective investment schemes
- Regulations will vary from country to country
- Vary by type of scheme
Regulation will cover - Category of assets
- Unquoted assets
- max level of gearing
- Any tax relief
Features of Investment Trust Company (ITC)
- Stated written objective
- Closed ended
- Public company, governed by company law
- Often quoted on the stock exchange
- Can raise equity and debt capital
- Operated by company directors, investment managers and shareholders
- Directors and investment managers receive fees
- Investor buys ‘shares’ in ITC
- Share price determined by supply and demand
- The share price stands at a discount (or premium) to NAV
Discount reflects management charges, the marketability of the shares relative to the underlying assets and management quality
Discount = (NAV – market value)/NAV
Features of Unit Trust
- Stated written objective
- Open ended
- Trust, governed by trust law
- Limited powers to borrow (i.e. Gearing)
- Operated by trustees, investment managers and unit holders
- Trustees ensure UT is managed legally in accordance with the Trust Deed, hold the assets and oversee the calculation of the bid and offer prices and the admin of the UT
- Trustees and investment managers receive explicit fees
- Investor buys units in UT
- Unit price = NAV per unit = market value of assets/number of units
There is a bid price and an offer price
Bid and offer prices vary depending on whether UT is expanding (offer price basis) or contracting (bid pricing basis)
Differences between Investment Trust and Unit Trust
- ITC shares less marketable than underlying assets – UT units marketability guaranteed by managers
- Some UTs (eg property) need to hold cash for liquidity – lower returns but greater price stability
- ITCs can gear leading to extra volatility. UTs have limited gearing
- ITC shares more volatile than underlying assets because size of discount can change – UT units volatility similar to underlying assets
- Higher expected return for ITCs because of extra volatility
- May be uncertainty as to the true value of NAV per share of ITC, especially if investments are unquoted
- ITCs can invest in wider range of assets than UTs
- Management charges higher for UTs than ITCs
- May be possible to buy assets at less than NAV in an ITC
- May be subject to different tax treatment.
Advantages of Collective investment vehicles over direct investment
+ Access to larger/more unusual investments
+ Discount to NAV (ITC only)
+ Diversification
+ Divisibility
+ Economies of scale
+ Expected return high due to extra volatility associated gearing and discount to NAV (ITC only)
+ Expenses associated with direct investment avoided
+ Expertise of investment managers
+ Index-tracking of quoted index is possible
+ Marketability
+ Quoted prices making valuing easier
+ Tax advantages possible
Disadvantages of Collective investment vehicles over direct investment
- Lack of diversification from equities
- Loss of control
- Management fees to investment managers incurred
- Negative gearing due to holding some cash for liquidity (UT only)
- Extra volatility caused by gearing/discount to NAV (ITC only)
- Tax disadvantages possible
Difference between forward and future contract
Futures contract: a standardised, exchange traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future.
Forward contract : a non standardised, OTC traded contract to buy (or sell) a specified asset at a specified date on a specified date in the future.
Difference between long and short position
Long position – means having a positive economic exposure to the asset.
Long party is the one who has contracted to take delivery of the asset in the future
Short position – means having a negative economic exposure to the asset.
Short party is the one who has contracted to deliver the asset in the future
Main features of Call and put Options
Call option – the right, but not the obligation, to buy a specified asset for a specified price on a set date or dates in the future.
Put option – the right, but not the obligation, to sell a specified asset for a specified price on a set date or dates in the future.
Option writer – the seller of the option.
Option premium – the price paid for the option to the option writer.
Exercise price (strike price) – the price at which an underlying security can be sold to or purchased from the writer of the option.
Traded options – option contracts with standardised features actively traded on organised exchanges.
American option – an option that can be exercised on any date before expiry.
European option – an option that can be exercised only at expiry.
Warrant – option issued by a company over its own shares.
Reasons for Investing in Overseas Market
- Matching liabilities denominated in a foreign currency
- Diversification by country, economy, stock market, currency, industry, company, which serves to reduce portfolio risk
- Higher expected return:
as fair compensation for higher risks involved
as a result of exploiting inefficiencies undervalued stock, undervalued market or undervalued currency
Investment and Risk Characteristics of overseas Market (Considerations)
Extra Considerations when analysing Investment and 1. Risk Characteristics
2. Exchange rate risk
3. Recoverability of withholding taxes
4. Difference in risks e.g. volatility of market values, default risk
5. Extra expenses
Problems from investing in Overseas Market
MTV CATERPILLAR
- Mismatching domestic liabilities
- Tax
- Volatility due to exchange rate
- Custodian needed
- Additional admin requirements
- Time delays
- Expenses incurred / expertise required
- Repatriation of funds
- Political problems and poor regulation
- Information poorer
- Language difficulties
- Liquidity poorer
- Accounting differences
- Restrictions on ownership of assets
4 Ways to invest in overseas market
- Multinational companies based in the home market
- Companies with substantial export trade
- Collective investment vehicles specialising in overseas investment
- Derivatives based on overseas assets
