Chapter 6: Collective Investment Schemes (THIS WILL INCLUDE NEW STUFF ONLY, COMBINE WITH R02) Flashcards
There are two main types: open-ended schemes and closed-ended schemes.
It is important for the J12 exam that you understand the difference between how these funds are structured and how you can trade their shares or units.
Unit trusts and OEICs are both a type of open-ended collective investment scheme.
THINGS IN THE CHAPTER TO LEARN OR FIND IN R02 FLASHCARDS
6.2: - Open-ended Schemes (Unit trusts and OEICs)
6.7: Closed-ended Funds / Investment Trust Companies (REITs, Investment trusts)
6.8: Exchange Traded Products (ETFs, ETCs & ETNs)
6.13: Private Equity Schemes -Enterprise Investment Schemes (EISs) and Venture Capital Trusts (VCTs)
6.14: 6.14: Life Assurance-based Investments (with-profits, unitised with-profits, and unit linked.
Units trusts & OEICs are very similar except: WHAT?
Unit trusts are set up under a trust where trustees hold the assets and a manger is responsible for the day to day running
Trustee must be regulated by the FCA and manager must be authorised by the FCA
for an OEIC; it is someone called the independent ‘depositary’( i.e. the person with whom the assets are deposited).
They are FCA-authorised and regulated, as ICVCs.
The OEIC must be incorporated and authorised
What is net asset value?
Unit trusts and OIEC trade at their NAV
Extra:
With a collective that trades at their NAV value, the value of the units you buy directly reflects the underlying value of the investments.
Effectively it is a measure of what each unit or share is worth.
Imagine that the fund were to be wound up and closed today. What would each unit or share holder receive?
We can work this out by calculating:
what each asset of the fund can be sold for.
how much it would cost in fees, etc.
how much money this would leave in the pot.
then divide that amount by the number of unit or share holder.
6.2.1b: What is Unit trusts box management and what is its benefit and risks
Any units that are sold are not cancelled but they are put in a ‘box’. They are then recycled and issued to new investors.
This is more efficient that selling a buying back the same units for new investors
This reduces dealing costs and charges.
There are risks associated with this approach though, particularly in times of high price fluctuation.
EXTRA:
A unit trust is ‘open-ended’. A manager creates new units to sell to new investors and cancels units when investors want to cash them in.
However, it might not always be efficient to cancel units when an investor wants to take funds out, only to have to create them again when a new investor comes along.
Therefore, they use a ‘box’ approach when dealing in their units.
In essence, any units that are sold are not cancelled but they are put in a ‘box’. They are then recycled and issued to new investors
‘Box management’ is the phrase given to the stock control mechanism that is needed to operate a box system
6.2.1c: Types of units
Accumulation Units
Income Units (distribution units)
Accumulation units…
o add all the income produced from the underlying investments back into the investor’s holding.
o the unit price increases to reflect the retained income.
Income units (sometimes called distribution units) …
o pay out the income to the investor.
o distribution funds can split out true income and distribute this, leaving the capital to grow.
EXTTA:
Even if accumulation units and income units in a given fund start off at the same price, as time goes by the income units will have a lower unit price than accumulation units.
This is because each non-distributed income is re-invested back into accumulation units, increasing their price.
To add to the confusion, there also can be income units that reinvest the income produced.
Mixed unit funds also exist. These hold some income and distribute some income.
What is a ICVCs (Investment Company with Variable Capital).
This is another name for an OEIC
Dual priced = Bid/offer spread (how units or shares are priced)
Single priced = Mid market rates
Many people have unit trusts and OEICs and do not know the difference. In fact, many OEIC features are ’as with unit trusts’
The capital is open ended so, (as with unit trusts), there is no secondary market. Shares are bought from and sold back to the provider company.
No stamp duty is paid on their purchase (as with unit trusts).
The investor owns their proportion of the shares within the wider fund (as with unit trusts).
The ACD and the depositary must be authorised / approved persons.
An OEIC is a company but not a normal trading company.
It is self-contained, so is not traded on the stock market like normal listed companies (as with unit trusts).
Most OEICs are single priced, albeit they can operate on a dual basis.
6.2.2a What is an Umbrella fund?
An umbrella fund is where an OEIC is split into a number of different sub-funds. Each sub-fund will have different investment objectives and strategies.
This allows the OEIC to benefit from economies of scale, as they can pool the assets from multiple sub-funds which can lead to lower transaction and operating costs.
6.2.2b Comparing OEICs and unit trusts
LEARN PRIOR TO EXAM
OEIC =
Assets looked after by independent depository
Fund managed by authorised corporate director
Often single priced
Unit trusts =
Assets looked after by trustees
Fund managed by a fund manager
Often Dual priced (bid/offer spread)
6.3: Additional Detail on the Pricing of Unit Trusts and OEICs
Most funds are priced at one point in the day. For unit trusts or OEICs this is done by calculating its NAV, say for example, at 12pm,
What is this part of the day called?
So, if you want to buy a unit in a unit trust or a share on an OEIC what price will you pay? The price from the previous valuation point or the newest one?
WHAT HAPPENS IF PRICES MOVE SIGNIFICANTLY?
valuation point
Both unit trusts and OEICs can be dealt on a forward or historic pricing basis.
Historic pricing is where investors buy at the last published price.
Forward pricing is where investors buy at the ‘yet-to-be-calculated’ price.
IMPORTANT:
If prices move by more than 2%, it will have to be calculated on a forward pricing basis
6.3.2: Dual priced basis
Tell me more about both the BID and OFFER price
BID TO GET RID
Investors buying units in the fund will pay more than investors selling units back to the fund
The higher price paid by investor buying units in the fund is the offer price
The lower price received by investors selling their units in the fund is the bid price.
The amount of the spread between the bid and offer price will be published in the fund prospectus.
two NAV-related prices that we need to consider:
One based on the bid prices of the underlying securities.
One based on the offer prices of the underlying securities.
Explain how dual priced funds set the price to buy or sell each unit/share
LOOK AT EXAMPLE 6.2 IN 6.3
The starting point will be the NAV, but there are two NAV-related prices that could be used
One based on the bid prices of the underlying securities. (used if the fund has more sellers than buyers to discourage further selling and encourage buying)
One based on the offer prices of the underlying securities. (used if the fund has more buyers than sellers to discourage further buying)
6.3.3: Single priced basis
Most OEICs operate on a single-priced basis, with the total value of all the shares matching the NAV of the fund.
Because of this, what do most single priced funds charge when someone sells their investment
A single priced fund with £30million portfolio of shares and £10million shares in existence will have a price of £3 per share
If an investor withdraws a large proportion of an OEIC’s funds, to the extent that the fund needs to sell some of its underlying assets a dilution levy is charged
This ensures fairness to all its shareholders. REMEMBER, WITH single priced funds there is no bid offer spread to absorb any losses on the fund. The levy, which is based on the actual costs involved in processing the deal, is charged directly to the ‘large’ investor or seller, whenever a trade is conducted that is so large that it adversely affects other investors.
Any dilution levy charge is usually factored in when calculating the buying or selling price of the specific large deal in question. The levy is received by the fund.
6.4: Charges
It is important that potential investors have these charges explained to then in a clear and comprehensive way.
Some funds such as UCITs funds (again, more on these later) are required to publish an Ongoing Charges Figure (OCF) so that investors are aware of the likely costs they will be incurring. This figure includes the annual management charge plus all other costs associated with running the fund and holding investments except initial and exit charges, transaction costs and performance fees.
Some funds still publish a Total Expense Ratio (TER) which includes the same items as the OCF plus performance fees. Costs included in both are: custodian fees, depository fees, audit fees, registration, regulatory fees and legal fees.
Are investments in unit trusts/OEICS tradeable?
No, you cannot trade unit trusts and OEICs, HOWEVER they can be transferred from one person to another e.g. as a gift or on death.
When you decide you want to sell the shares or units, the shares are cancelled by the fund provider, and they send you your money. You cannot sell them to anyone else or trade them on a stock market.
Unit trust/OEIC taxation
Main considerations:
Reporting or Non reporting (if offshore)?
Equity fund (less than 60% of its assets in interest-bearing securities) or non equity fund (60% +)?
At a fund level =
At the investor level =
If a collective has a UCITS designation, what does this allow it to do?
UCITS designation allows a fund to be marketed across the EU.
This is because the regulator considers there are sufficient protections available for the fund’s investors
Why do most UK residents prefer to invest in reporting offshore funds?
Most UK resident or domiciled people who invest offshore prefer reporting funds. That way, they are taxed like UK funds with dividends being paid gross, AND they can use their CGT exemption to cover / reduce gains.
REMEMBER: Non-reporting funds gains are known as roll up funds and are taxable to income tax rates on any capital gains. The investor CANNOT use their CGT allowance
Investors who are non-resident in the UK will only pay tax at the rates of the country they reside in, and will not pay any UK income tax or CGT.
Remember: DONT CONFUSE OFFSHORE FUNDS WITH OFFSHORE BONDS
The main closed-ended fund type that you need to understand for J12 is Investment Trusts.
An investment trusts shares are typically dual-priced with purchases at the higher offer price and sales at the lower bid price.
What is this known as?
(Clue: It is not the BID/OFFER spread as seen in dual priced Unit trusts or OEICs
With investment trusts, the difference is known as the ‘market makers spread or turn’.
because investment trusts are closed ended, this varies, depending on supply and demand of the shares. Ie, investments trusts DO NOT trade at their NAV
If investors see a value in the company over and above the sum total of its assets, then the capitalised share value will exceed the NAV.