Chapter 11: Other investment classes Flashcards
What is a collective investment scheme
what do they primarily provide to investors
Provide structure for the management of investments on a group basis
diversification and expertise
Key distinction between a direct and indirect investment scheme
Whether and investor’s assets are segregated from other investors’ money
What are the benefits of using collective investment schemes (indirect investment) over direct investment
- Access to investment managetr expertise
- Access to a broader opportunity set
- Automatic diversification
- Potentially higher liquidity
- Indirct investment in the underlying asset
- The protection of regulators
- Cost efficiency
- Holdings are divisible
- There may be tax advantages
- There may be marketibility advantages
- They can be used to track the return on a specific index
Disadvantages of CISs vs direct investment
- Loss of control
- Management charges
- May be tax disadvantages suchas withholding tax
What aspects does the objective of a collective investment scheme typically cover
- The catergories of assets that can be held
- Whether unquoted assets can be held
- The maximum level of gearing
- Any tax relief available
- Only available to certain class of institutional investors
Two fundamental types of investment schemes
- Open-ended investment schemes
- Closed-ended investment schemes
Closed-ended investment schemes
- Investors cannot buy into the scheme after the intial opening
- They have to trade with other investors if they want to invest in the scheme, similar to investing in ordinary shares of a company
Open-ended investment schemes
Managers can create or cancel units of a fund as new money is invested or disinvested
Investment trusts
Public companies whose function is to manage shares and other investments
Characteristics of investment trusts
- Capital structure like other companies, with the ability to borrow
- Closed-ended
- Usually listed and subject to company law
- There must be a willing buyer or seller in order to enter or exit the scheme
- Priced by the market relative to net asset value
- Income via dividens
- Uusually trade at a discount to the underlying asstes
The main parties invlved in investment trust companies
- Board of directors
- Investment managers
- Shareholders
Unit trusts
An open-ened investment vehicle whereby investors can buy units in an underlying pool of assets from the terust managers
Charecteristics of unit trusts
- Open-ended
- Adminidtered/managed by a management company
- Has trustees and is managed under trust law
- Highly marketible (Guaranteed by manager)
- Managers can create units if there is a demand, and buy back units if the investor wants to exit
- Limited powers to borow against their assets
- Priced at market value of assets/number of units
Unit price
The price that has to be paid to purchase one unit
Market value of underlying assets/number of units
Complications in calculating unit price in practice
- Whether to use the bid or offer prices of the underlying assets
- How to allow for the expenses the unit trust incurs in buying and selling assets
- How to adjust the unit price to apply any charges to the investor
- How to round the answer
The main parties involved in a unit trust
- Management company
- Trustees
- Investors
Open-ended investment company (OEIC)
Investment companies that can create or cancel share capital
Subject to company law with rstrictions on assets
Priced relative to NAV
Single price added to the initial charge for purchase
Diferences between open-ended and closed-ended collective investment vehicles
- The marketibility of shares in closed-ended funds is usually less than that of their underlying assets, whereas the marketibility in open-ended funds is guaranteed
- Gearing in closed-ended funds can make their share price more volatile than that of their underlying assets, whereas the latter has limited gearing.
- May be possible to buy assets at less than NAV in a closed-ended fund
- The increased volatility in closd-ended funds means that they should provide a higher expected return
- Varying discounts imply more volatility in share price of closed-ended funds
- There may be uncertainty about the true level of NAV in a closed-ended funds, if the underlying assets are unquoted
- Closed-ended funds may be able to invest in a wider range of assets than unit trusts
- They may be subject to different tax rates
How can derivatives be used to control risk
- Reduce risk through hedging
- Increase risk (speculation) in order to enhance returns
Functions of the stock exchange in the context of derivatives
- Setting up stamdardised contracts
- Deciding which parties can buy and sell into derivative contracts
- Setting up clearing houses
Reasons for investing in overseas markets
- To match liabilities in foreign currency
- To increase expected returns
- To reduce risk by increasing the level of diversification
Drawbacks of investing overseas
- Different markety performance to home market, and therefore mismatching
- Currency fluctuation risk
- Cost of obtaining expertise
- Additional administration functions: custodian, dividend tracking and collection
- Possible tax disadvantages
- Different accounting practices
- Lack of good quality information
- Language problems
- Possible time delays
- poorly regulated markets
- political risks
- possible lack of liquidity
- restrictions on ownership of certain shares by foreigners
Ways of achieving indirect oveseas exposure
- Multinational companies based in the home market
- Domestic companies withb overseas exposure
- collective investment schemes based in the home market
- Derivatives based on overseas markets
Advantages and disadvantages of using multinational companies based in home amrket to gain exposure to overseas market
Advantages
* Easy tto deal with the familiar home market
* Companies will have expertise and tend to conduct their business in the most profitable areas overseas, including areas where dirct investment may be difficult
Disadvantages
* Earnings diluted by domestic earnings
* Investor will have no choice in where company conducts its business
Factors to consider before investing in emerging markets
Postive
* Current market valuation
* Possibility of high economic growth rate
* Range of companies available
Negative
* Level of marketibility
* Degree of political stability
* Market regulation
* Restrictions on foreign investment
* Communication problems
* Availability and quality of information
* Currency stability and strength
Attractions to emerging markets
- Current market valuation (efficiency and perceived riskiness)
- Rapid economic growth
- Better diversification
Drawbacks to investing in emerging markets
- Volatility
- Marketibility
- Political stability
- Regulation of the stock market
- Restrictions on foreign investment
- Communication and availability of info
