Chapter 4 Flashcards
Unit Trusts
Legal structure
Trust in which trustee is the owner and the unit holders are the beneficiaries.
Management
Manager decides within the rules of the trust what investments are included and went to buy and sell. This can be outsourced.
Authorisation and supervision
Authorised by the FCA.
Supervised by the trustee and the FCA.
Pricing and Valuation
Most dual priced
Valued on a daily basis at the valuation point.
Can be valued on a forward pricing or historic pricing basis.
Charges
Initial fee may be incorporated into the offer price.
Dual priced unit trusts also apply ongoing annual management charges.
Taxation
Treated as a company.
Subject to a modified version of the corporation tax regime.
Dividends are exempt from corporation tax.
Fund can reclaim withholding tax in some instances.
Interest is taxable but tax deduction available where is distributed to investors.
Open Ended Investment Companies
Legal Structure
Company but not established under the companies act.
Authorise corporate director and depository are required and appointed at outset.
Management
Authorise carpet director is responsible for day-to-day management.
Depository must safeguard investments on behalf of shareholders and oversee the activities of the authorised carpet director.
Authorisation and supervision
By FCA and also supervised by the depository.
Pricing and valuation
Valued on a daily basis
Most are single priced using the midmarket price.
Charges
Initial charge is not included in the single price calculation.
Dilution levy may be charged on sales and purchases.
Types of shares
Can be an umbrella fund with different share classes.
Pricing
Can be on forward or historic pricing basis.
Most are forward priced.
Taxation
Authorised funds are exempt from CGT within the company.
Dividends also exempt via dividend exemption for corporations.
Interest is taxable but tax deduction available where it is distributed to investors.
Offshore Reporting and Non-reporting Funds
Offshore funds incur little to no tax at fund level. Withholding tax may apply. No VAT or SDRT.
Reporting Funds
Don’t have to distribute all income but must disclose it to HMRC.
Tax treatment same as UK fund.
If more than 60% of assets are in interest bearing securities distributions will be classed as interest payment.
Investors will be taxed on their share of income, even if it’s not distributed.
Sales of units are subject to CGT.
Non-reporting funds
Roll up where all income is accumulated and no dividends are paid.
Gains are calculated on CGT principles but a taxable as income. Personal savings and dividend allowances aren’t available.
Non-domicile investors gain IHT benefits by investing offshore.
ETFs
Type of passive investment designed to track an index.
Structured as a company.
Require authorisation from regulator in the country they are domiciled.
Value portfolios daily.
SDRT is not payable.
Market Makers quote two way pricing. Trade at very close to NAV. trades are settled the same as any other share using CREST or another central security depository.
Only major financial institutions known as authorised participants deal directly with ETFs.
They can only create a redeem shares in an ETF when the basket reaches a minimum size of between 50,000 to 100,000 ETF shares.
An investor with a large enough sum of money to trigger a creation event can contact specialist direct me through the ETF firm and get the trade executed at a price very close to net asset value.
Indexation methodologies
Physical replication
- Full replication - each constituent of the index is held in accordance with its index waiting. Expensive.
- Stratified sampling - representative example of the index is held. Less expensive.
- Optimisation - use a sophisticated computer modelling to find representative sample of securities that mimic the index.
Synthetic replication
Fund manager enters into swaps to exchange the returns on an index for a payment.
Sampling is used to identify the optimal range of securities.
Passes tracking error and rebalancing risk onto the counterparty.
ETCs
Track performance of underlying commodity or a basket of commodities.
Flight to quality.
Enter into a futures trading strategy.
ETNs
Type of bond issued by a bank.
Has maturity date but does not pay interest.
Traded on stock exchange throughout the day.
Tracks performance of an index using derivatives giving access to markets such as commodities and currencies.
Unsecured bonds so have an additional risk that their value may be affected by the credit rating of the issuer.
Fettered Funds
A fund of funds with one overall manager obliged to invest in funds run by the same management group.
Unfettered funds
The component funds are run by a number of external fund managers.
Investment management styles
Value
Identifying businesses whose value is greater than the price placed on them by the market
Growth at a reasonable price
Companies with long-term sustainable advantages
Momentum
Capitalise on a continuance of existing trends in the market
Contrarian ism
Going against the trend
Investment Trusts
Closed ended funds
Company structure
Have board of directors and shareholders.
Authorisation and supervision
Authorised by FCA. Approval also required by the stock exchange.
Pricing
Exempt from tax on capital gains within the fund. Portfolio is valued daily and NAV reported to stock market. Price also depends on supply of shares.
Types of shares
Ordinary, preference, zero coupon and warrants.
Categories
Conventional - single class of ordinary shares
Split capital - issue different classes of shares that appeal to different investors.
- Income shares - are entitled to all the income generated by the assets and a fixed amount when the trust is wound up.
- Zero dividend preference shares - pay no income but a fixed rate of capital growth until wind up.
- Capital shares - no income but entitled to all capital in the trust once the loans, income and preference shareholders have been paid out. Highest investment risk.
Tax
Companies so pay corporation tax on income. Not on dividends so long as they are passed onto investors. HMRC approved investment trusts pay no CGT on investment profits within the trust.
For the investor tax is the same as any other equity.
Gains on zero dividend preference shares are subject to CGT rather than income tax.
REITS
Closed ended funds
Pooled investments in commercial and residential property.
UK domicile REITS have to be UK tax resident and structured as closed ended companies.
Exempt from corporation tax when 75% of gross profits originate from property letting and interest on borrowing is covered 125% by rental profits.
Developed properties must be held for three years from completion to be exempt from corporation tax.
Property income distribution
Tax exempt element. 90% of net rental income has to be distributed. Can issue stock dividends in lieu of cash dividends to meet this requirement.
Payments from the tax exempt element are classed as property income for investors and paid net of 20% tax. Non-taxpayers can reclaim this tax.
Non-property income distribution
All other business activities fall into the taxable element and a subject corporation tax with net dividends paid to investors.
A dividend from the non-tax exempt element is taxed just as any other UK dividend.
Gains on REITS shares are subject to CGT.
Structured Products
Fixed term investments. Payout depends on performance of something else such as stock market index.
Structured deposit - savings account where interest depends on performance of stock market index. If the index falls the investor may get no interest at all.
This has FSCS protection.
Structured investments - investment returns depend on how the stock market index performs. There is risk of loss of the original investment. Contains derivatives. No FSCS protection.
Types of structured products:
- 100% capital protection
- partial capital protection - protected so long as index doesn’t fall below certain amount (barrier can be American or European)
- No protection - structured capital at risk products (SCARPs)
