Chapter 18: Collective Investment Schemes

Question 1

Collective investment scheme

Answer 1

Structure for managing investments on behalf of a group of people.

Question 2

2 Types of collective investment scheme

Answer 2

• closed ended (e.g. investment trust)

- open ended (e.g. unit trust)

Question 3

Closed ended investment scheme

Answer 3

Once a closed ended investment scheme is launched with an initial sum of money, it is closed to new money.
The number of shares / units available is fixed, so you can only buy into it if someone else is willing to sell.

Question 4

Open-ended investment scheme

Answer 4

Managers can create / cancel units as new money is invested / disinvested.

Question 5

Legal structure of an investment trust company

Answer 5

Public companies, usually listed on a stock exchange and governed by company law.
They can raise debt and equity capital.
Investors buy and sell shares in the company.
The company will have a stated investment objective.

Question 6

Legal structure of a unit trust

Answer 6

Unit trusts are trusts in the legal sense, with trustees and a trust deed.
They can only borrow against their portfolio to a limited extent.
Investors buy/sell units in the trust.
The trust will have a stated investment objective.

Question 7

How are shares in an investment trust company priced?

Answer 7

The market price of a share in an investment trust company is priced like any other share - by the forces of supply and demand.
That price would usually be less than the Net asset value per share.
This discount reflects the disadvantages of investing indirectly rather than directly, e.g. management charges, possibly worse marketability, or the perceptions of the investment managers.

The discount to net asset value may widen, or narrow over time introducing extra volatility.
The share may even stand at a premium to NAV, if the investment trust shares are more marketable than the underlying assets and the trust is well regarded by the market.

As with any share, at any one time, there will be a buying (offer) and a selling (bid) price available to the investor.

Question 8

How are units in a unit trust priced?

Answer 8

The underlying price is given by the net asset value per unit.
However, unit trust pricing is complicated. In practice, complications arise relating to expenses of buying and selling underlying assets, applying charges to investors, and rounding the answer.

Question 9

Factors to consider when comparing direct / indirect investment

Answer 9

• choice and control
• diversification
• divisibility
• expenses
• expertise
• exposure to unusual or large properties
• forced selling
• marketability
• quoted prices
• tax
• volatility

In addition discuss

• the net asset value,
• the possiblity of gearing
• and the extra volatility that these introduce.

Question 10

List 8 key differences between investment trust companies (ITCs) and unit trusts (UTs)

Answer 10

• Units in UTs tend to be more marketable than shares in ITCs
• ITCs can gear. UTs can only gear to a limited extent
• the gearing and the change in the discount to NAV can make ITC shares more volatile in price than the underlying assets. Volatility of units in UTs is similar to that of the underlying assets.
• the increased volatility of ITCs means that they should provide a higher expected return.
• at any point in time there may be uncertainty as to the true value of the NAV per share of an ITC, especially if the underlying investments are unquoted.
• ITCs can invest in a wider range of assets than UTs
• It may be possible to buy assets at less than NAV in an ITC
• They may be subject to tax at different rates.