Chapter 11 pt. 1 - Other Investment Classes: CIS Flashcards
Collective investment schemes (CIS)
Provide structures for the management of investments on a grouped basis.
Provide opportunity for investors to achieve a wide spread of investments and therefore to lower portfolio risk.
2 Types of CIS
Close-ended
Open-ended
Close-ended CIS
Once the initial tranche of money has been invested, the fund is closed to new money
(Only way to invest after launch, is to buy units from willing seller)
Open-ended CIS
New money can enter the fund, money can leave as well
-ex. unit trust
Managers can create / cancel units in the fund as new
money is invested / divested
4 Regulation aspects of CISs
- Categories of assets held
- Whether unquoted assets can be held
- Maximum level of gearing
- Any tax reliefs available
6 Features of Investment trust companies (ITCs)
- Stated investment objectives
- Funds are closed-ended
- investors buy shares in an ITC, priced by supply and
demand - Public companies, governed by company law
- Gearing is allowed
- Share price often stands at a discount to net asset
value (NAV) although it can stand at a premium
Key parties involved in ITCs (3)
- board of directors,
- investment managers
- shareholders
6 Key features of Unit Trusts
- Stated investment objective
- investors buy units in a UT, priced at a net asset value
(NAV). - Funds are open-ended
- They are trusts, governed by trust law
- Limited power to use gearing (ie to borrow)
- Guaranteed marketability
3 Key parties in unit trusts
- Trustees (eg insurance company or bank)
- Investment managers (eg merchant bank)
- unitholders
Differences between ITCs and UTs (8)
closed-ended vs open-ended
- Shares in ITCs are often less marketable than the underlying assets, whereas the marketability of units in UTs are guaranteed by the managers
- Some UTs (eg property) need to hold cash to maintain liquidity, which implies lower expected returns but greater price stability
- ITCs can gear, leading to extra volatility than that of underlying equity. UTs have limited power to gear.
- Increase volatility of ITCs implies higher expected return
- May be possible to buy assets at less than NAV in an ITC
- ITC shares are more volatile than underlying assets because of the size of any discount to NAV can change. Volatility of units in a UT should be similar to that of underlying assets.
- May be uncertainty as to the true level of NAV per share of an ITC, especially if the investments are unquoted.
- ITCs can invest in a wider range of assets than UTs
- May be subject to different tax treatment.
Disadvantages of collective investment schemes vs direct investment (5)
- Lack of diversification away from equities
- Loss of control
- Management charges incurred
- Extra volatility caused by gearing / discount to NAV (ITCs only)
- Tax disadvantages are possible
Discount band compared to NAV
- ITC’s out of favour => discount range wide
- ITC’s in favour => discount range narrow
Reasons for discounted NAV in ITC’s
Management Charges, and…
- Concerns over marketability
- Concerns over quality of managers
- Market fashion or sentimentality
Role of Board of directors in ITC
Responsible for direction of the company
Role of investment managers in ITC
Day-to-day investment decisions are usually taken by investment managers, such as merchant banks or specialised investment trust managers.
