Chapter 11: Other Investment Classes Flashcards
What is a collective investment scheme?
o Structure for the management of investments on a grouped basis
- Structure is split between a trust (trust deed) and a company (articles), each of which can be open- or closed ended
o Will have a stated investment objective
Purpose (of CIS’s from the investor’s perspective)
- Diversification and lower portfolio risk
- Access to expertise
- Access to larger / unusual investments
- Economies of scale (reducing investment expenses)
- Possible tax advantages
Purpose (of CIS’s from the managers of the CIS’s perspective)
- To follow the stated investment objective
- To create return for investors commensurate with the level of risk taken
Define closed-ended in the context of CISs
In a closed-ended scheme once the initial tranche of money has been invested the fund is closed to new money. After launch, the only way of investing in the ITC is to buy shares from a willing seller.
Define open-ended in the context of CISs
In an open-ended scheme managers can create or cancel units in the fund as new money is invested or disinvested.
Open-Ended Unit Trusts
“trust” in the legal sense =>
o Governed by trust law: trust deed, trustees, management company, unit-holders
o “Open ended” form of fund so units are created and cancelled daily as needed
- This makes marketability of unit trusts very good
- But the fund must keep some assets as cash to meet unit redemptions (and may not be able to invest new cash quickly) => returns impacted by “cash drag”
- Maybe a forced seller of assets to meet unit redemptions => impact on returns
o Unlikely to be able to borrow => impact on returns (lower expected returns, but also less volatile)
o Unit price based on NAV = MV of assets / number of units, but issues include:
- Market value of underlying assets based on bid or offer prices?
- How are costs recouped by the UT fund e.g. may have a bid and offer price (but in SA they usually don’t anymore)
o Unit price is calculated and published daily – allows investors to track performance and easy to determine asset valuation (e.g. for solvency purposes)
Investment Trust Companies
Not a “trust” but a public company =>
o Governed by company law: board of directors, management team, shareholders
o “Closed ended” form of fund where units/shares are not created/cancelled daily:
- Marketability for investors is not guaranteed
- ITC does nAot need cash to redeem units => no “cash drag”
- Less likely to be a forced seller of assets to redeem units => higher expected returns
o Capital structure consists of equity and possibly debt
o Debt or gearing => impact on returns (higher expected returns but can be volatile)
o Shares may be listed on a stock exchange (so listing requirements must be met)
- Results (and NAV) only published as required, normally twice a year => more difficult for
investors to monitor performance and makes asset valuation more difficult.
o Share price unlikely to be the same as NAV
Open Ended Investment Companies (OEIC)
Not a “trust” but a public company =>
o Governed by company law: board of directors, management team, shareholders
o “Open ended” form of fund so shares are created and cancelled daily as needed
- This makes marketability very good
- But the fund must keep some assets as cash to meet unit redemptions (and may not be
able to invest new cash quickly) => returns impacted by “cash drag”
- May be a forced seller of assets to meet unit redemptions => impact on returns
o Capital structure consists of equity and possibly debt
o Debt or gearing => impact on returns (higher expected returns but can be volatile)
o Shares may be listed on a stock exchange (so listing requirements must be met)
- NAV must be calculated and published daily – allows investors to track performance and easy to determine asset valuation (e.g. for solvency purposes)
- Share price = NAV
ToDo and Do slide 19 - 22
ToDo
Derivatives
A derivative is a financial instrument whose value is dependent on – or derived from – the value of another underlying asset.
The asset may be a financial asset such as an equity or a commodity such as grain.
A derivative can be thought of as a contract (ie a legal agreement) between two parties to trade an underlying asset at a date in the future.
Define a futures contract
A standardized, exchange-traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future
Define a forward contract
A non-standardized, OTC traded contract to buy (or sell) a specified asset at a specified price on a specified date in the future
Exchanges: Clearing house functions
facilitate trade (matching long, shorts; counterparty to all)
* stand as guarantor to both parties, removing credit risk*
* provide facility to close out positions
* admin: registrar of deals, holder of margin, facilitator of mark to market process
*Mechanism for removing credit risk:
* initial margin
* maintenance/variation margin
* daily mark to market allows clearing house to manage credit risk
Do profitability and graphs
Do it
Define the term ‘warrant’
A warrant is an option issued by a company over its own shares. The holder has the right to purchase shares at a specified price at specified times in the future from the company.
Outline the main uses of derivatives
- Providing protection against the risk of adverse market movements:
- using futures contacts to set the price of input goods in advance
- E.g. using a put option to protect asset portfolios against significant market value falls - Aiming to achieve higher returns / profits through speculation
- Allowing financial institutions to alter the structures of their portfolios without needing to trade in the underlying assets
Outline three main reasons for investing overseas
- Matching liabilities dominated in a foreign currency
- Diversification by:
- Country
- Economy
- Stock market
- Currency
- Industry
- Company - Higher expected return:
- As fair compensation for higher risks involved
- As a result of exploiting inefficiencies
