Chapter 18: Collective investment schemes 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
Open-ended CIS
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
- Share price often stands at a discount to net asset value (NAV) although it can stand at a premium
- investors buy shares in an ITC, priced by supply and demand
- Funds are closed-ended
- Public companies, governed by company law
- Gearing is allowed
Key parties involved in ITCs (3)
- board of directors,
- investment managers
- shareholders
5 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 law
- Limited power to use gearing (ie to borrow)
3 Key parties in unit trusts
- Trustees (eg insurance company or bank)
- Investment managers (eg merchant bank)
- unitholders
Differences between ITCs and UTs
- 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. UTs have limited power to gear.
- Increase volatility of ITCs implies higher expected return
- ITC shares are more volatile than underlying assets because of the size of any discount to NAV 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 possible to buy assets at less than NAV in an ITC
- May be subject to different tax treatment.
Advantages of indirect investment vs direct investment
- Access to larger / more unusual investment
- Discount to NAV - assets may be bought cheaply (ITCs only)
- Diversification
- Divisibility
- Economies of scale in the case of larger collective schemes
- Expected return higher due to the extra volatility associated with gearing
- Expected return higher due to extra volatility associated with the discount to NAV
- Expenses associated with direct investment avoided
- Expertise of investment managers
- Index-tracking of a quoted investment index is possible
- Marketability may be better than that of underlying securities (although they may also be less marketable than the underlying assets)
- Quoted prices, which make valuation easier
- Tax advantages possible
Disadvantages of collective investment schemes vs direct investment
- 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
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.
Role of Management Company in UT
- does all the work
- sets up the trust
- gets authorisation from relevant authorities
- advertises the trust
- carries out necessary administration
- invests the funds
- makes profits from charges levied
