Chapter 3 - Indirect Investments Flashcards
What are indirect investments?
This is where an individual doesn’t actually own the underlying investments themselves. Instead they will own shares or units in a collective fund, and it is the fund that is the direct owner of the individual assets.
These collective funds can be set up in different ways, using different tax arrangements
Benefits of indirect investment
1) Investment expertise
2) Diversification
3) Reduced dealing costs
4) Wide choice of fund options
What protection is there for unit trusts and OEICs?
Unit trusts - protected by the trust deed and the trustees acting on their behalf
OEIC - investors protected by company law and the independent depositary
Both are protected by the regulator as these are regulated products
Both are protected by the FSCS for up to 100% of their investment, capped at £85,000
Buying and selling unit trusts and OEICS
For both, you buy units and shares from the fund provider.
Fund provider takes your money and creates some units or shares for you. You do not buy them off anyone else as you would with normal shares
They are open ended, this means fund manager does not have to wait until someone sells before they free up new units
NAV position of Unit Trusts and OEICs
- Always trade at NAV
- direct relationship between the price of the units / shares and the value of the underlying assets
Rules for funds to be included in a sector
1) Generally the fund must have 80% or more of its assets invested in the relevant sector
2) To qualify as an income fund, the fund must aim to produce a yield of not less than 90% of the relevant index
IA Four broad categories
1) funds principally targeting capital protection
2) funds principally targeting income
3) funds principally targeting growth / total return
4) specialist funds
What are index tracker funds?
- aim to align performance as closely as possible to performance of a selected index
- aim to mirror what the index is doing
3 types of ethical screening
1) negative screening - funds avoid certain unethical practices or companies, such as avoiding tobacco
2) positive screening - here there is a tolerance to unethical practice, but fund will actively seek out firms that make an effort to be as ethical as possible
3) neutral - lighter touch screening, involves choosing firms considered socially responsible
Explain three components of ESG with examples
Ethical - pollution, climate change
Social - relationship with employees, attitudes to social diversity, human rights, charities
Governance - leadership pay, shareholder rights, openness and transparency, bribery / corruption
What are UCITS
- funds that are freely available, and can be marketed throughout the EU
- must be sufficiently diverse to be a UCITs fund
UCIT diversification rules
1) no more than 10% of the fund in one share
2) only four companies can have the maximum 10% holding
3) any other shares holding must not exceed 5%
4) therefore means minimum holding of 16
Only exceptions are:
- replicating tracker funds, which can hold maximum of 20% in any one company (max 35% in extreme conditions)
- a lower limit of 6 securities apples to funds holding government bonds from a single issuer
What is a QIS?
- Qualified investor schemes
- A type of authorised investment fund
which is only open to qualified investors.
•Has widerinvestment and borrowing powers than UK UCITS
•Subject to lighter regulation because
investment in a QIS is open only to qualified investors.
•Cannot be freely marketed other than
to professional investors.
•QISs ARE subject to regulation by the FCA
What are traded life policy investments?
•Most people take out life policies with
the intention of keeping them for their full term.
•However, some people, particularly
those who want to surrender before the end date, may decide to trade them on the open market instead.
•Retail investors wouldn’t generally trade life policies.
What are UCIS
- unregulated collective investment schemes
- Higher risk investments; not covered by FSCS
What are special purpose vehicles
•A pool of money from a group of investors that is invested in to a single company.
•separate legal entity from the ‘host’ company.
•securities are issued in assets other than listed or unlisted shares or bonds.
•SPVs are created for a specific purpose,
such as a single project or transaction
•This ‘isolates’ the risk of the underlying
assets away from the host company.
Difference between UCITS and UCIS
• UCITS
- fully comply with EU UCITS directive
- can be freely marketed and sold to retail clients across europe
- lower risk of loss
- protected under FSCS for 100% of investment per individual per company capped at £85k
• UCIS
- does not comply with EU UCITS directive
- cannot be marketed and sold to retail clients in the EU
- greater risk of loss
- not protected by fscs
UCITS gearing position
Gearing on a permanent basis, is not allowed within retail UCITS schemes.
The rules state that UCITS funds can only borrow short-term, and this is restricted to 10% of the value of the fund backed against known future cash flows, such as dividends about to be received.
Non-UCITS can borrow up to 10% as well, but on a permanent basis. QISs can borrow freely, up to 100% of net asset value.
Compare UCITS, non UCITS and QIS
UCITS:
- maximum 10% invested in alternative investments such as unapproved / unlisted securities
- maximum borrowing limited to 10% of fund value on a temporary basis
- repayment must be clearly set out from against future cash flows
Non- UCITS:
- maximum 20% invested in alternative investments such as unapproved/unlisted securities
- maximum borrowing limited to 10% of fund value on permanent basis
QIS:
- few restrictions on exposure to alternative investments such as unapproved / unlisted securities
- borrowings must be paid on demand
- only suitable for professional investors
state four advantages of investing in a collective investment fund as opposed to direct investment
1) more diversity
2) professional fund management
3) access to some investments or markets that can’t be bought directly
4) provides investor protection as heavily regulated
5) lower dealing costs
state four disadvantages of investing in a collective investment fund as opposed to direct investment
1) additional layer of ongoing costs
2) no ownership rights
3) no individual control of companies
4) less transparency and less knowledge of which shares you hold
Explain the main differences between undertakings for collective investment in
securities (UCITS) and unregulated collective investment schemes (UCIS) that can
result in UCIS having higher risk
• UCITS are authorised and regulated by the FCA and recognised by the EU.
• They can be marketed to retail clients.
• UCIS are not regulated and are unable to be marketed to retail clients.
• UCITS give greater compensation and investor protection as they are protected through the FSCS / FOS whereas UCIS are not.
• UCITS benefit from greater liquidity.
• There are greater borrowing restrictions on a UCITS fund, and higher levels of gearing result in higher risk.
• There is a greater transparency regarding the underlying assets with full literature available.
• A UCITS fund must meet diversification rules, so benefits from greater diversity than UCIS. This means that a UCIS fund can invest in a narrower range of assets and therefore be higher risk.
State five types of investor to whom UCIS may be promoted
• Existing holders
• High net worth investors
• Professional or institutional clients
• Sophisticated investors
• Employees of the fund
Explain the safeguarding regulations in place that govern UCITS in respect of:
a. Diversification
• Not more than 10% value of fund;
• In any one company.
• No more than four companies at maximum
• Remainder, maximum 5% of fund value;
• Resulting in minimum of 16 holdings
• Maximum 10% in unquoted companies.
Explain the safeguarding regulations in place that govern UCITS in respect of:
b. borrowing
• Borrowing is restricted,
• Only allowed up to 10% of the fund value,
• On a temporary basis,
• If supported by expected receipts, such as dividends coming into the fund.
what is a unit trust?
- it is a collective investment set up under trust rules
- With a unit trust, a fund manager buys bonds or shares in companies on the stock market on behalf of the fund.
- The fund is split into units, and this is what investors buy.
- The fund manager creates units for new investors and cancels units for those selling out of the fund.
- The creation of units can be unlimited, which is why the fund is deemed to be ‘open-ended.’
What is the FCAs role in relation to unit trusts
• authorise the fund.
• regulate the trustees and the managers.
• regulate the advisers who recommend them.
• regulate the marketing of UCITS funds.
Trustees roles in a unit trust
The trustee is responsible for holding or controlling the holding of the assets.
o They are the legal owners of the trust’s assets and keep a record of unit trust holders
o They have a duty to ensure that the manager conducts themselves in keeping with the trust deed, regulations and scheme particulars.
o They can replace the manager if they wish, and must remove them if a majority
unit holder vote is cast in favour of the manager’s removal.
They are responsible for:
•Auditing the fund and issuing information to unit-holders, who must be registered.
•Arranging meetings of unitholders.
•Distributing the income of the trust to unit holders.
what is the managers role in a unit trust
• The manager agrees to manage the trust in return for an annual management fee.
o They must be authorised, i.e. hold part 4a permission, and manage the trust in
accordance with the regulations, scheme particulars and trust deed.
Managers responsibilities:
•Supplying information to the trustees.
•Maintaining records of transactions.
•Notifying the trustee and/or FCA if it has breached any rules within the trust.
•Usually responsible for promoting the trust.
Unit trust tax (taxation of internal fund)
Authorised unit trusts:
• do not pay tax on gains within the fund
(Any potential CGT is only due when the gain is ‘realised’ by the investor. This allows investors to utilise their own CGT exemption).
• are subject to the corporation tax regime in respect of any unfranked income.
• do not pay income tax on gains from Derivatives.
Equity fund taxation
• Equity funds pay corporation tax internally at 20% on income received in
• Foreign dividends subject to 20% internal corporation tax, but often offset by double-taxation rules.
• UK dividends received as franked income and flow through to the investor as dividend distributions, with no tax liability for the fund.
• The tax is on the individual at their marginal rates.
• Usual dividend rules apply for the individual.
Non-equity fund taxation
• pays distributions gross to investors
• The fund itself can suffer corporation tax at 20% on income from interest bearing securities.
• However, if the interest is distributed to investors, then all of the interest is relievable as an expense against income of the fund.
• This ensures that there’s no double taxation of interest.
• The interest is then taxable on the individual at their marginal rates.
what is equalisation?
When an investor buys units, the price they pay includes the right to income that has
accrued in the fund from the previous
distribution date up to the date of purchase,
i.e. income from the time they didn’t hold
the units!
So on first income payment date would receive interest plus an “equalisation payment” which represents the other few months interest
equalisation payment is a return of capital so not subject to income tax
however when calculating the capital gain, the equalisation payment will be deducted from the purchase price, thus lowering the purchase price in the calculation making the taxable gain higher
what is equalisation?
When an investor buys units, the price they pay includes the right to income that has
accrued in the fund from the previous
distribution date up to the date of purchase,
i.e. income from the time they didn’t hold
the units!
So on first income payment date would receive interest plus an “equalisation payment” which represents the other few months interest
equalisation payment is a return of capital so not subject to income tax
however when calculating the capital gain, the equalisation payment will be deducted from the purchase price, thus lowering the purchase price in the calculation making the taxable gain higher
what is bed and breakfasting
- in the past people would sell their shares on a monday for example to use their CGT allowance and buy them back on the tuesday
- this would allow them to dispose of the asst to realise gains upto their unused allowance, thereby resetting the acquisition price
- HMRC did not like this so changed their rules, from 1998 any sale a repurchase within 30 days is ignored in a CGT calculation
what is dual and single pricing
dual price - different prices to buy and sell. difference often represents initial charge of the fund provider
single price - use midmarket rates, charges will still be made but declared separately
what is box management
In essence, any units that are sold are not cancelled but they are put in a ‘box’.
• These are then recycled and issued to new investors, reducing dealing costs and
charges.
• ‘Box management’ is the phrase given to the stock control mechanism that is
needed to operate a box system.
Two types of pricing forward and historic basis
• Historic pricing is where investors buy at the price published at the most recent mid-day. That could
be yesterday, or this morning (if buying in an afternoon).
• Forward pricing is where investors buy at the next ‘yet-to-be-calculated’ price.
So, with historic pricing the investor knows the price they will get, or pay, and with future pricing they don’t.
Different charges of a fund
1) Initial charges - often covered in bid / offer spread. can be paid separately on single priced funds
2) annual management charges - paid as a percentage of the funds under management, the more successful the fund, the higher the monetary charge paid
3) exit charges - usually paid if the investment is sold within a given period of time. charges are taken as a percentage of the value when exiting
4) performance management fees - mainly in derivative funds
What are OEICS
They are FCA regulated and authorised as an investment company with variable capital
company must be incorporated and authorised to comply with ICVC regulations
Assets are protected by an Independent depositary
and the fund is managed by authorised corporate directors
often single priced
unlike Unit trusts, structure well recognised throughout the EU
what is a dilution levy?
- charged directly to seller whenever a trade is conducted that is so large that it adversely affects other investors
- levy is received by the fund, more often charged in large institutional investors
Advantages of investing in an OEIC over a unit trust
1) more EU friendly, unit trusts have added complication of trust law so not easily marketed throughout EEA
2) OEICs have more flexible charging structures, as they can invest in multiple share classes
3) easier to run under an umbrella structure, which gives more choice and more freedom to managers to create more funds
difference between manager of managers fund and fund of fund
- “manager of managers” (MoM) fund is an investment strategy where a single fund hires multiple specialized investment managers to oversee different parts of its portfolio, essentially allowing investors to access expertise in various asset classes through one fund;
- “fund of funds” (FoF) is a fund that invests directly in shares of other existing funds, essentially buying into multiple managed portfolios to diversify exposure across different strategies
what is a fund of fund
- put the money from your fund into other funds managed by other people
- can be fettered or unfettered
what is fettered fund
- uses only funds of host provider
- would only be able to use in house funds
- no additional annual charge is allowed in addition to fund charges
what is unfettered fund
- not as common and more expensive than fettered funds
- don’t have to invest in just in house fund managers but can use other providers too
- means extra charges
what is a S.270 designated territories fund
- A designated territory is one which the FCA view as providing UK investors with protection equivalent to that applicable to UK-authorised funds.
what is a section 272 “non designated territories fund”
•These are not recognised by the FCA, so their marketing is prohibited in the UK.
what is a reporting fund?
•Income is reported to HMRC.
•Dividends and interest taxed as in the UK, with the same rules as UK.
•Normal CGT rules apply (use of CGT exemption and taxation at 10% or 20%).
•Income must be declared (reported) to ‘HMRC and other participants’ whether distributed or not.
what is a non-reporting fund?
•These are often ‘roll-up’ funds, i.e. no income is distributed and no dividends are paid out.
•Gains calculated on CGT principles, but chargable to income tax rates (20%, 40%, 45%).
•Investors cannot use their CGT exemption to offset gains from non-reporting funds.
•Nor are they allowed to use their personal savings allowance or starting rate band.
What is the European Union Savings Directive
- provides automatic exchange of information between member states
- set up to counter cross-border tax evasion on savings income
- states can either fully declare income and growth to other states or adopt withholding tax method (35% currently)
Explain briefly the terms fettered and unfettered (4 marks)
Fettered - This is when a fund only invests in the in-house fund range
Unfettered - This is where funds from other managers can be used as well as the in-house range
Explain how a manager of managers fund arrangement works (4 marks)
• There is an overall fund manager who decides on the asset allocation of the fund.
• They appoint managers for various proportions of the fund, for example asset class, sector or objective.
• The overall fund manager will monitor the performance.
• They are able to replace managers and get a new manager to take over the decisions about the assets in that part of the fund.
• Funds do not need to be sold when a manager changes as they are already, and will remain, in the main fund.
State and explain one relative advantage of each of the fettered and unfettered
approaches (4 marks)
Fettered advantage:
- can be cheaper to run as costs lower
- no additional charge over the underlying fund charges allowed
Unfettered advantage:
- the fund choice is not restricted as the investor has a broader choice of funds, managers and sectors
- if one fund fails to perform, many more options to replace it with
Identify two advantages and two disadvantages of the manager of managers
arrangement in comparison to the fund of fund arrangement. (4 marks)
Advantages:
• Bespoke mandate, the overall manager has a say in the investments .
• No requirement to sell a fund and buy a new one.
• Can replace the managers should they underperform against their mandate.
Disadvantages:
• The new manager, would start with the assets that their predecessor had chosen to buy;
• There are a limited number of managers who will be willing to work to the mandate so may be hard to find new managers.
• There are CGT benefits to switching
Investment options for an investment trust
Their Articles of Association will state if any restrictions apply, but
in general they can:
• invest in any kind of company, whether or not it is listed on
the stock exchange.
• invest in any country in the world.
• invest in emerging markets.
• provide venture-capital to new firms, or firms that are expanding.
• cater for extremely adventurous investors.
what is an Investment trust
- Investment trusts are traded as Public Limited Companies (PLCs).
- They have a fixed number of shares and are therefore described as ‘closed-ended funds’.
- Unlike unit trust and OEICs, their shares are traded on the London Stock Exchange like other companies.
Benefits of investment trusts over OEICS/Unit trusts
• The fund managers can take a longer-term view with their assets. They are not forced to sell assets to pay back investors.
• This is because there is a secondary market. You are investing into a listed company, so can trade your fund on the stock market like any other company’s shares.
• This also means they can borrow or ‘gear’ their portfolios without the restrictions that apply to unit trusts and OEICs.
NAV Premium / Discount formula
market price / NAV - 1 x 100
Principles for companies wanting to become an investment trust
• investment managers must have adequate experience.
• there must be an adequate spread of risk.
• the company cannot control any of the assets within the portfolio.
• the trust must have a board that can act independently of its management.
• the company must seek Income and Corporation Tax Act (ICTA 1988) approval from HMRC (all investment firms must do this. It means that no CGT or Corporation tax is payable on gains made within the fund).
• To qualify under ICTA 1988, the firm must not be a ‘close’ company, must be listed on the LSE and not retain more than 15% of gross income.
A ‘close’ company is one which is owned and controlled by five or fewer individuals. This usually relates to
small, family run companies.
Two types of investment trusts
1) conventional
2) split capital
what is a limited life trust
- With these, the trust sets out with the intention of maximising returns over a specific period, perhaps in order to benefit from a specific investment opportunity.
- Then, on ‘maturity’, investors vote whether to wind up the trust or continue it,
typically for another three years. Their decision will usually be based on whether the potential for profit still exists. - On wind up, the NAV is distributed, so limited life trusts normally return to trading around their NAV as they approach maturity, similar to the way that a GILT or Corporate bond returns to trading close to its par value,
as it approaches redemption.
what is a split capital investment trusts
These can have multiple classes of shares, entitled to different returns, with different
priorities on wind up, which investors can combine to meet their objectives.
what is the hurdle rate?
the rate an investment must grow at to repay each class of share at the wind-up date.
It is the growth rate that the price has to ‘get over the hurdle’ and hit its target.
what is asset cover?
asset cover can be used to calculate the percentage of liabilities covered at
any moment.
• An asset cover of ‘1’ means that investment trust assets exactly match the money required to repay all share classes at trust wind-up.
• A figure higher than 1 means that assets are more than liabilities.
• A figure of less than 1 means that liabilities are greater than assets.
what are warrants?
- They are not shares, but are a ‘right to buy’ shares at a fixed price at a
pre-determined date or with a range of dates. - They are often issued to new investors as a bit of a marketing tool to encourage them to invest
- They produce no income, and are an investment with a potentially high level of risk and reward.
- The price of a warrant is only a fraction of the price of the shares, but movements in the price of the warrant tend to magnify changes in the share price.
- Warrants are tradable on the stock exchange.
- They are usually worth exercising if the price they allow investors to purchase shares is lower than the shares’ market value at any one time. Gains made when exercising warrants are taxed to CGT.
- When warrants are exercised, this is said to dilute the NAV of the trust. Before they are exercised, the NAV
is undiluted.
what is gearing?
- Managers of investment trusts can borrow money to buy shares and other assets.
- Gearing is expressed as:
total gross assets / net assets x 100
stamp duty position of OEICs/Unit trusts and investment trusts
- OEICs / Unit trusts - no stamp duty
- investment trust - 0.5%
why might investment trusts trade below NAV
- share value is determined by supply and demand
- ability of manager can affect share price
- poor performance can affect share price
- shares could be trading lower to encourage investment
Explain four advantages of investing in commodities
• It may provide diversification,
• and may not be correlated with existing investments.
• Does not proved an income, as it generates all returns by capital growth;
• which may be more tax efficient
• Commodities have the potential for greater returns,
• returns, have often exceeded inflation, so could provide a real return.
• Commodities are high risk / more volatile than other assets.
Explain what is meant by the terms ‘capital cover’, ‘hurdle rate’, and ‘negative hurdle rate’
• Capital Cover
• Measure the assets ability
• To meet the redemption price of zeros
• Cover greater than 1 indicates that the zeros are covered and there are sufficient assets available.
• Hurdle Rate (to redemption)
• Is annual growth required in the assets;
• To cover the zeros;
• Hurdle Rate (to wipe-out)
• amount Assets can fall before zeros get nothing
• Covers costs and charges.
• Negative Hurdle Rate
• Amount the assets can fall each year;
• And still be sufficient to repay the zeros in full.
What is the general principle of a with profit bond?
• With-profits do not expose the investor to these fluctuations in value. Instead they aim to ‘smooth-out’ fluctuations, by keeping the investment stable and adding bonuses each year.
• No bonuses are guaranteed, but once added, they typically cannot be removed.
• This should create a stepped year-on-year increase, with the fund manager keeping back some of the growth in good years to supplement the bad years.
• Because not all of the underlying profits are shared as bonuses, the provider may offer a final or terminal bonus at maturity or when cashed in.
• The investment is not guaranteed, and can return less than invested if more bad years are experienced than good
what is an annual / reversionary bonus
• Based on the year by year performance of the with-profit fund, declared annually.
• Usually expressed as a percentage, which is then applied to the sum assured.
• Can be calculated on a simple or compound basis.
• Compound bonuses will receive ‘bonuses on the bonuses’, in the same way that
compound interest gets ‘interest on the interest’.
what is a terminal bonus?
• fund manager takes a retrospective look at the performance of the with-profit fund for the entire period then adds a one-off bonus to ‘sweep-up’ any missed bonuses along the way.
• used to be a key factor in how a with-profit product was priced, often with
terminal bonuses making up a major part of a client’s overall return.
what is low cost with-profit
- These were introduced to keep premium costs down, as the full with-profits policy option is not cheap.
- They work on a concept of lowering the sum assured on which bonuses are calculated but adding an element of life cover.
- Annual bonuses are added to this basic sum assured which then increases each year.
- Life cover would be provided through a
combination of a basic sum assured (increasing gradually each year
as bonuses are added) plus ‘decreasing term assurance’ (DTA) to bring the death benefit up to the agreed amount
what are Low-start, low-cost with-profit policies
- These are a variant on the low-cost concept.
- The only difference is that premiums start off lower, and then increase gradually over a (usually) five-year period.
- This was designed to help individuals who needed the cover, but were struggling with affordability.
- As you can imagine, with the introduction of MMR changes, this policy type is now rarely used.
Conventional with-profit advantages
•They may be suitable for risk-averse investors.
•Bonuses can be paid from a firm’s reserves, therefore are less ‘directly-linked’ to market performance.
•Their ‘smoothed’ nature means they feel safer and less of a rollercoaster.
•Terminal bonuses can be very attractive.
•Final returns often out-perform inflation.
Conventional with-profit disadvantages
•They can be difficult to understand.
•It is difficult to appraise the underlying investment performance.
•MVRs can be in place for long periods reducing liquidity for the investor.
•Bonus rates have declined of late as funds recover from previous losses
What is the concept of pound cost averaging
• When someone is buying something with regular premiums, they will pay the market price on the day each purchase is made.
• If prices have fallen on the day of purchase, then the buyer will get more of the asset for their money than they would if prices have risen.
• If you buy lots of something whilst the price is low then when you come to sell it again at the end, if prices eventually rise you get back more than you paid.
Main qualifying rules
- minimum 10 year term (or surrender after 3/4 of original term)
- premiums must be paid at least annually
- any one years contribution must not exceed 2 x premium in any other year
- no premium can be more than 1/8 of total premiums paid
- policy must include a level of life assurance equal to at least 75% of premiums paid
- maximum contribution £3,600 per annum
chargeable events
Death
Assignment for moneys worth
Maturity
Partial surrender
Surrender
Definition of investment bond
Single premium, non qualifying, whole of life policy
what are guaranteed income bonds?
- in return for a single premium, bond provides guaranteed income each year for specified term
- income generally paid at the end of each year
- at the end of the term, original premium returned to investor
what is segmentation?
- This means that, rather than have different parts of the bond allocated to the different fund choices, the bond is split up into lots of individual policies, a bit like segments of an orange, with each segment being
split across the funds chosen by the investor.
what are high income bonds
- High Income Bonds (HIBs) have emerged to satisfy those investors
prepared to accept an element of risk to their capital, in exchange for higher returns
what are guaranteed growth bonds
- These are similar to GIBs, except no income is paid out. They are often set up for relatively short terms, such as three, four or five years. The income is simply added to capital at maturity, and distributed out in full.
what is a distribution bond?
- Distribution bonds split the income received and distribute this separately, leaving the capital intact.
what is a personal portfolio bond?
- These are effectively bond wrappers, into which investors place their own portfolio of shares, rather than a bond bought from a life company.
- They have never been looked on favourably by HMRC who have imposed some unusual taxation:
• They assume an annual gain of 15% for tax purposes.
• So, tax can be due, even if no growth has actually been achieved.
- This has made Personal Portfolio Bonds almost redundant onshore, but they remain available offshore.
what is traded endowment policy
- The original owner can permanently assign the product (sell it in all but name) to someone else, in return for a cash payment that will probably be higher than the surrender value.
- The bond remains in the policyholder’s name (life assured) but the benefits are assigned to the buyer, who
can keep the investment until maturity and be rewarded with the final proceeds, which may include the
potential of a terminal bonus for with-profit funds.
taxation of traded endowment policy on seller
Income tax = if qualifying, no income tax. if non qualifying, sale will constitute a chargeable event and is taxed according to their circumstances based on sale price minus total premiums paid
CGT = no cgt payable so long as they were the original owners
taxation of traded endowment policy on buyer
Income tax = if qualifying, no income tax. If non qualifying, maturity is a chargeable event but gain is based on maturity value or surrender value immediately before maturity minus total premiums paid by seller and buyer
CGT = buyer has potential CGT liability, as they were not original owners. Same gain will not suffer income and CGT
Main features of friendly societies
Investment choice = pretty much invest where they like
Investment limits = annual premium £270, regular premiums £25 per month
tax = no internal taxation on the fund, so it should grow well. No tax on investors up to the limit
what is tracking error?
- This is the distortion between the fund
performance and that of the index, caused in part by the charges in the fund. - note that no tracker funds will beat the index they track because of these
tracking errors. - Replicating trackers often experience lower tracking errors than synthetic versions, as holding the shares in direct proportion to the index reduces the chances of a distortion occurring.
what are exchange traded commodities
- Exchange traded commodities (ETCs) work on the same principle as ETFs but
track the performance of an underlying commodity or basket of commodities. - ETCs can be highly volatile, as their prices can be affected by factors such as drought, natural disasters and
political unrest.
Risks of ETCs
- counterparty risk as many funds synthetic
- gearing risk
- highly volatile due to supply and demand
what are exchange traded notes?
- fixed-interest security issued by banks.
- track a currency.
- pay no interest, bought below PAR
- no portfolio of investments always use derivatives.
- tend to be exposed to higher counterparty risk than ETFs and ETCs and, as unsecured bonds, their value will be affected by the credit rating of the issuer.
How are ETFs created
- created by market makers who create and redeem units
- they assemble required portfolio of underlying assets
- they transfer these assets over to the fund in exchange for newly created ETF shares - done at high volume so lowers costs
- once they have ETF shares, can then either hold shares or trade them on an exchange
What are shares in listed property companies?
- cheaper and more liquid way to invest in property
- you simply buy shares in one of the property companies listed on the stock market
- these firms hold and buy properties all over the UK
Risks of shares in listed property companies
- reliant on fortunes of the company you choose, so diversification tempered
- value of companies assets will not be directly linked to its share price
- housing companies can run into difficulties and will have periods of losses and gains
- company could hold houses for rent and these can be hit by void periods
what are insurance company property funds
- life insurance funds that specialise in direct holdings of commercial property
- value of units is directly linked to value of property held
- funds cannot borrow
- encashment can be deferred in difficult conditions
- any income and gains subject to 20% tax within fund
what are offshore property companies
- set up as unauthorised investment trusts
- this allows them to hold 100% of assets directly in property
- often list themselves on stock market
- benefit from lower corporation tax, however any rental income subject to UK income tax
- all dividends from offshore property are received gross with liability resting with investor
What are REITs
- Investment trusts set up as closed ended companies
- listed on stock market
- issue only one share class
- stamp duty payable
- two elements - ring fenced exempt element (property letting) exempt from income tax , this income traded as PID income and paid net of 20% tax.
- Non-ring fenced element - all other activities, dividend payments, paid gross
REIT qualification criteria
• At least 75% of the company’s total gross profit must be from the ring-fenced tax-exempt element.
• At least 75% of entire assets must be in the ring-fenced element.
• Interest on borrowings must be at least 125% covered by rental profits, i.e. they must have enough income to cover borrowing plus a safety margin.
• At least 90% of the profits from the ring-fenced element (income not gains) must be distributed within 12 months of the end of any accounting period.
- Property development is allowable but must be intended to generate future income. If it isn’t, then it will be classified as non-ring-fenced activity and liable to corporation tax.
PAIF Criteria
- At least 60% of the net income in a must be from exempt property investment business.
- At the end of each accounting period, the value of assets involved in the property investment business must be at least 60% of the total assets held by the PAIF
- shares must be widely held, with no corporate investor holding 10% or more of the fund’s NAV.
- Pays out three types of income
Tax benefits of EIS
• Income tax relief at 30% of the amount invested is given to investors for qualifying investments.
• Relief is available on investments up to a maximum of £1,000,000 in most cases and £2,000,000 in knowledge-intensive companies in EIS shares providing a maximum tax relief of £300,000 and
£600,000 respectively
.
• The relief is given by way of a tax reducer i.e. you must have a tax bill equal to that of the relief to gain fully in the scheme.
• An investor may carry back income tax relief to the previous tax year by claiming that the shares were issued in the previous year, provided sufficient income tax was paid to be offset by the relief.
• You can also defer a capital gain by reinvesting it into an EIS company. If you are only claiming this relief, there is no upper limit.
• Relief from gains made by the EIS
• BR relief if held for at least 2 years
Tax benefits of SEIS
• Income tax relief is given at 50% on the cost of the shares with a maximum annual investment of £200,000 for shares issued on or after 6 April 2023. (Previously £100,000).
• re-investment relief for CGT is more generous than on an EIS. 50% of
any gain becomes CGT exempt when the SEIS shares are acquired. The other 50% is payable immediately.
BR Relief
Qualifying Company Rules SEIS
• The maximum number of employees is 25, not 250.
• The business must be less than 3 years old.
• With gross assets of less than £350,000.
• The qualifying trades are pretty much the same, no banks allowed nor property development companies or renewable energy.
Tax benefits of VCT
• Income tax relief, as a tax reducer, is at 30% up to a maximum investment of £200,000 in new issues of ordinary shares in VCTs.
• Dividends received are tax exempt, as long as the original investment was within the permitted maximum of £200,000 per year.
• Tax relief is withdrawn if shares are not held for 5 years.
• You get immediate CGT exemptions on any growth in the VCT without the need to wait 3 years. It is instant. Due to this, no losses are allowable or claimable.
• No CGT deferral relief is given
qualifying VCT criteria
- H - Approved by hmrc
- A - all money must be used in 2 years
- L - Listed on stock exchange
- L - Limited to no more than 15% in one company
- O- at least 10% in ordinary shares
-R- cannot retain more than 15% of income it generates - M - Maximum £5 million raised under VCTs in past 12 months (£10 million for knowledge intensive industries).
- E - employees less than 250
what are PLA?
- paid for from any lump sum at any time of annuitants life
- the income they provide is split into capital and interest elements
- essentially the capital element is deemed to be a part return of capital so tax free
- interest element paid in addition - taxed as savings income with tax deducted at source
what is a future?
- a legally binding agreement to buy or sell an asset at a specified future date
- price is agreed when the contract is made
- contract imposes open ended obligation on both parties
- buyer has long position, seller has short position
- margin is paid by both parties to the london clearing house
- it is revalued daily and daily profits change hands between the parties via the LCH
- the current price is paid at the end and the margin will take the price back to the contract price
what is an option?
- gives the buyer an option but not the obligation to buy or sell an asset before a certain date
- price is fixed when contract is made
- price is called strike price or exercise price
what are swaps?
- similar to a futures contract
- agreement between two parties to exchange a series of cash flows over a period of time
- most common type is an interest rate swap
2 different options
Call option = gives the buyer of the option the right to buy the underlying asset
Put option = gives the buyer of the option the right to sell the underlying asset
CGT position of derivatives
Calculating CGT
• If a call option is exercised, the cost of the option is treated as part of the total cost of purchase.
• If a put option is exercised, the cost of the option is treated as an allowable deduction from the sale proceeds.
• If the option expires worthless, this is treated as a disposal for CGT purposes, giving a capital loss on the date of expiry
what are hedge funds?
- Hedge funds are pooled investments, whereby a number of investors entrust their money to a fund manager, who invests in various traded securities.
- They are mainly actively-managed investments that are far from traditional, and aim to make the investor money even at times of turmoil and general downturn.
They seek to:
• hedge against market downturns.
• invest in currencies or shares they believe are trading cheaply.
• use derivatives, arbitrage and gearing to move money quickly, cheaply and easily.
Four hedge fund strategies
Long/Short funds:
•Combining equities in a neutral approach.
•Hold long positions in some holdings and short positions in others.
Relative value funds:
•Uses arbitrage (the simultaneous buying and selling of assets or derivatives in different markets to take advantage of
differing prices for the same asset) to try to identify market price anomalies.
Event driven funds:
•Use corporate events to make their growth e.g. exploiting profit warnings.
Tactical trading funds:
•Trade in currencies, bonds, equities and commodities.
Absolute return funds
- Absolute return funds try to make a profit regardless of market conditions. Think of them as the hedge fund of the UK.
- Fund managers’ skills are tested to their limit here, and they are measured and compared using their Alpha
- They use derivatives and all the asset classes with a focus on gaining growth in adverse times.
- In good times, they tend to underperform traditional funds.
Structure of structured products
they have two component parts:
• A zero-coupon bond: provides the guarantee as the return is in the form of a capital return (with no
income).
• A call option
They are typically fixed term products. In many cases, early withdrawal is not allowed.
What is a PAIF
- elects for tax treatment to be moved from fund to investor
- rental profits and other property related income is exempt from tax within the fund
- other taxable income is subject to corporation tax
- property income usually paid net of 20% tax
- distributions of interest paid gross
- dividends paid gross
