CH 10 - 1 Collective investment schemes

Question 1

1 Collective investment schemes

1. What is a Collective Investment Scheme?

Answer 1

Definition:
A structure for managing investments on a grouped basis.
Provides diversification and lowers portfolio risk.

Advantages:
Access to professional management expertise (e.g., overseas investments).
Ideal for first-time investors in shares.
Offers indirect investment: Investors purchase units instead of directly owning assets.

Key Features:
Each scheme has a stated investment objective (e.g., general investments or specialties like biotechnology companies).
Regulations vary by country and cover:
Asset categories allowed.
Whether unquoted assets can be held.
Maximum gearing limits.
Tax relief availability.

Investor Types:
Some schemes are exclusive to institutional investors (e.g., pension funds).

Question 2

1 Collective investment schemes

2. Types of Collective Investment Schemes

Answer 2

2.1 Closed-Ended Schemes
Example: Investment Trusts.
Features:
Fund is closed to new money after the initial tranche.
Investors buy/sell units like shares in a stock market.
Fixed number of units available.
Key Point: Share prices are determined by supply and demand.
2.2 Open-Ended Schemes
Examples: Unit Trusts and Open-Ended Investment Companies (OEICs).
Features:
Managers create or cancel units as investors buy or sell.
Unit price = (Market value of underlying assets) ÷ (Number of units).
Complexities in Pricing:
Bid or offer prices for assets.
Adjustments for transaction expenses.
Application of charges to investors.

Question 3

1 Collective investment schemes

3. Examples of Collective Investment Schemes

Answer 3

3.1 Investment Trusts (Closed-Ended)
Definition: Public companies managing shares and investments.
Key Features:
Capital structure includes loan and equity capital.
Shares are listed on stock exchanges and trade like other quoted shares.
NAV per share: Value of company’s assets ÷ Number of shares.
Parties Involved:
Board of Directors: Directs the company.
Investment Managers: Make day-to-day decisions.
Shareholders: Buy/sell shares.
Borrowing Powers:
Investment trusts can borrow, unlike unit trusts.

3.2 Unit Trusts (Open-Ended)
Definition: Investment vehicle allowing purchase of units in a pool of assets.
Key Features:
Trust managers can create or cancel units based on demand.
Legally structured as a trust, with limited borrowing powers.
Parties Involved:
Management Company: Sets up and administers the trust.
Trustees: Ensure managers follow the trust deed, oversee pricing, and hold assets in trust.
Investors: Purchase units, becoming unitholders.
Pricing:
Calculated daily, adjusted for expenses and charges.

3.3 Open-Ended Investment Company (OEIC)
Definition:
Combines corporate governance features of an investment trust with the open-ended nature of a unit trust.
Key Features: Flexible investment structure, allowing for scalability.

Question 4

1 Collective investment schemes

4. Key Distinctions

1 Collective investment schemes

Answer 4

Closed-Ended vs. Open-Ended:
Closed-ended funds have fixed units and trade like shares; prices depend on demand.
Open-ended funds create or cancel units based on investor activity; prices depend on NAV.
Investment Trust vs. Unit Trust:
Investment Trusts: Public companies with borrowing powers; share prices depend on supply/demand.
Unit Trusts: Legal trusts with limited borrowing; unit prices based on NAV with adjustments.

Question 5

1 Collective investment schemes

5. Important Concepts

Answer 5

Net Asset Value (NAV):
Represents the underlying value of assets per share/unit.
For Investment Trusts: Share prices may deviate from NAV based on market demand.
Key Metrics in Unit Pricing:
1. Underlying asset value.
2. Adjustment for expenses.
3. Application of investor charges.

Question 6

1 Collective investment schemes

6. Summary

Answer 6

• Collective investment schemes simplify diversified and professional investments.
• Closed-ended schemes fix the number of shares, while open-ended schemes adjust units dynamically.
• Investment Trusts are companies managing pooled funds, while Unit Trusts are legally structured trusts.
• NAV is a fundamental measure for pricing and evaluating investment units or shares.

Question 7

6 Indirect overseas investment

1. Ways to Achieve Indirect Overseas Exposure

Answer 7

Investment in multinational companies based in the home market:

Advantages:
* Easy to deal in the familiar domestic market.
* Companies have expertise and operate in the most profitable overseas areas, including those difficult for direct investment.

Disadvantages:
* Domestic earnings dilute overseas exposure.
* No control over where the company conducts its business.
* Example: A US-based investor holding shares in a domestic multinational like Coca-Cola, which earns significant profits overseas.

Investment in collective investment vehicles:
Specialize in overseas investments.
Provide diversified exposure to multiple overseas markets.
Investment in derivatives based on overseas assets:
Includes futures, options, or swaps linked to foreign markets.

Primary Advantage: Avoids many practical problems associated with direct overseas investments.
Suitability:
Small funds benefit most.
Large funds may also use these vehicles for specialist areas outside their expertise.

Question 8

6 Indirect overseas investment

2. Overseas Investment via Domestic Companies with Overseas Exposure

Answer 8

Significance: Many large domestic companies derive a majority of their profits internationally.
Example: Over 75% of profits for the largest 100 UK companies are earned overseas.

Question 9

6 Indirect overseas investment

3. Companies with Overseas Exposure in the Opposite Direction

Answer 9

**Type: **
Companies relying on imports.
Example: A domestic retailer heavily dependent on imported goods.
Impact of Domestic Currency Weakening:
Imports become more expensive, reducing company profits.
Passing higher costs to customers without losing sales is challenging.