Chapter 7 - investment funds

Question 1

what is an investment fund? how are they managed? what is the purpose?

Answer 1

Investment funds = vehicles that pool capital from numerous investors to collectively invest in diversified portfolios of securities
Managed = fund managers
Purpose = achieve capital appreciation, generate income

Question 2

what do investors typically consider?

Answer 2

• purpose of investment
• timescale
• risk
• types of assets

Question 3

what is a direct investment and what is an indirect investment

Answer 3

direct = when an individual invests directly into that company
indirect = individual buys a stake in an investment fund

Question 4

what are the advantages and disadvantages of investing in collective investment schemes

Answer 4

advantages
- economies of scale
- diversification
- access to geographical markets
- less risk as not individual company
- skills of fund managers
disadvantages
- fund managers may charge fees
- lack of control

Question 5

what does active management mean? what does top down and bottom up mean?

Answer 5

seeks to outperform a benchmark
top down - focuses on economic and industry trends rather than the company
bottom up = analysis of the company, such as future profits and company growth

Question 6

what investment styles are considered in bottom up approach

Answer 6

growth investing
value investing
momentum investing
contrarian investing

Question 7

what is passive management what is it often described as?

Answer 7

instead of trying to outperform, passive management focuses on replicating the performance of a benchmark.
often described as index-tracking or indexation

Question 8

advantages and disadvantages of passive management

Answer 8

advantages
- outperforming indices is rare
- fund charges typically lower
- passive portfolios are less expensive to run
disadvantages
- performance is affected by the need to manage cash flows
- may not meet investors objectives
- less high returns and less flexibility

Question 9

what is the term called when active and passive management is mixed

Answer 9

= core-satellite management
smart beta = tracks an index but considers alternative factors

Question 10

what is the role of investment association and the classification system

Answer 10

IA = trade body for UK authorized open-ended funds
classified systems = usually income or growth, but others are: capital protection, specialist funds, volatility managed, target return, unclassified

Question 11

What is the role of Association of investment and companies

Answer 11

Occupies a similar role for investment trusts (closed-ended)

Question 12

what is a collective investment in transferable securities

Answer 12

regulatory framework in European Union that allows for cross-border distribution of investment funds, allowing investments to be sold throughout the EU.

Question 13

After Brexit, how has the UK established a fund to be sold throughout the EU

Answer 13

UK fund managers have set up subsidiaries in Luxenberg, Ireland and other countries

Question 14

Purpose of UCITS (undertakings for collective investment transferable schemes)

Answer 14

• reduce costs involved, improve customer choice, investor protection

Question 15

What are non-UCITs retail schemes (NURS), purpose and features

Answer 15

Investment funds in the UK that do not fall under the UCIT framework but are still available to retail investors.
Purpose - provide investment opportunities that are not covered by UCITs framework and offer retail investors access to a broader range of asset classes and investment strategies.
features - flexibility, regulation by FCA who ensure investors protection

Question 16

what is a unit trust?

Answer 16

They pool money from multiple investors to invest in a diversified portfolio of assets. Described as open-ended because the trust can grow as more investors invest in the fund, or shrink if they pull out.

Question 17

What is the role of a unit trust manager?

Answer 17

decide within the rules of the trust and the various regulations which investments are suited to meet objectives, deciding what to buy/sell. ALSO DEAL WITH PRICING of units.

Question 18

role of the trustee

Answer 18

legal owner of the assets in the trust and they hold the assets for benefit of unitholder. They must protect the investors.

Question 19

what is the investors called in unit trusts

Answer 19

unit holders, are the beneficial owner.

Question 20

What is the difference with authorised unit trusts?

Answer 20

The trustees are company subject to special regulations, they are deemed as safer.

Question 21

what are open-ended investment companies?

Answer 21

Type of investment fund where the number of shares can be continuously created or redeemed based on investor demand, allowing the fund to grow or shrink.

Question 22

what is the structure of OEICS

Answer 22

Required to have an authorised corporate director (CD), who is responsible for day-to-day management, including valuing and pricing. they also maintain the register of shareholders.
ALSO required to have an independent depositary, who is responsible for looking after investments on behalf of the OEIC shareholders and overseeing activities of ACD.

Question 23

how are AUTs and OEIC bought and sold

Answer 23

based on the value of the funds underlying investments, also called Net asset Value

Question 24

what is single pricing

Answer 24

same price is used for both buying and selling based on the mid-market price (average value) to produce single price

Question 25

what is dual-pricing

Answer 25

involves using the markets bid and offer price of the underlying asset to produce separate prices when buying/selling

Question 26

what has AUTS and OEIC typically used to price

Answer 26

AUTs typically used dual-pricing, OEIC typically used single pricing, but whichever is chosen it must be disclosed.

Question 27

what is the issue with single-priced

Answer 27

Because it is based on average prices, it does not provide ability to recoup dealing expenses, such as costs of funds/transaction costs. To get past this, fund managers apply extra costs, known as dilution levy

Question 28

what are typical charges associated with Unit trusts and OEIC

Answer 28

initial charges, AMC, legal audit fees, broker commission, fees for taxation

Question 29

what are UCITs required to publish with charges? and other companies?

Answer 29

they are required to publish ongoing charge figures (OCF) and quote this in key investor information document (KIID). This includes all expenses costs, but does not include initial/exit and performance fees.
other companies = total expense ratio

Question 30

what are the ways investors can buy/sell units in a number of ways

Answer 30

• directly with fund managers, telephone, internet, post
• through Brokers or financial advisors
• fund supermarket or platform

essentially = always bought from FM

Question 31

what are fund supermarkets or platforms

Answer 31

organisations that specialises in offering investors easy access to a range of unit trusts and OEIC, which offer valuations, portfolio planning

Question 32

what is settlement in OIEC and AUT

Answer 32

Takes place directly with each fund group, who will record ownership of relevant number of units or shares in fund which have been registered. If the investor decides to sell, the FM has 4 days to settle this trade. Since 2009 managers have been able to accepted instructions on phone or internet.

Question 33

what is the system platform used with fund management groups

Answer 33

EMX - traditionally, used to enter customer orders, but was taken over by Euroclear UK and international, which is a company that owns CREST, and it now has an automated straight through platform for fund dealing and settlement.

Question 34

what is an investment trust

Answer 34

A company, commonly referred to as an investment trust company, which has a director and shareholder, and is different from AUT and OEICs as the shares remain fixed so close-ended.

Question 35

what is a real-estate investment trust REIT? its features (tax), how is it held

Answer 35

Investment company pools investors money into commercial or residential property and is close-ended and traded on LSE
features - no more double taxation (previously investors would have to pay corporation, income, and capital gains tax, but it now no property income/disposable or capital gains tax if 90% paid to shareholders.
form -It is held in individual savings accounts and self-invested pension funds.
It provides diversified, no liquidity risk as not holding actual property.

Question 36

what does gearing mean in terms of investment trusts

Answer 36

Amount of money borrowed to invest into securities. This is unlike AUT and OEIC

Question 37

How are investment companies priced?

Answer 37

unlike AUT and OEIC, these are priced on market demand. If the investment share price is above the NAV, it is a premium. If the investment shares price is below the NAV it is a discount.

Most trades are at a discount. A smaller discount means investments truss are nearing their winding-up or going through a corporate action.

Question 38

how are investment trusts usually traded

Answer 38

LSE, using the SETs trading system or via retail service providers

Question 39

what is an exchange-traded funds and its participants

Answer 39

EFT = type of investment fund which has shares that are tradeable on a stock exchange and designed to track performance of an index.
participants =
Authorised Participant = usually large financial institutions, who are authorised to create/redeem ETF
EFT Sponsor = entity that creates and managers EFTs. they design the investment strategy.
Custodian = safekeeping/holds the underlying asset
Market Maker = facilities the buying/selling of EFT on Lse

Question 40

What is the creation and redemption process of EFTs

Answer 40

Creation
- AP approaches custodians with large basket of assets (creation unit)
- creation unit is divided into individual EFT shares and sold on SE
Redemption
- if APs want to cash out they will give the EFT shares back to provider
- the provider gives AP underlying assets rather than cash

This process allows price efficiency and liquidity

Question 41

What are the two ways EFTs can be tracked

Answer 41

Physical replication - traditional form and favoured
full replication - tracks all areas of index, it is accurate but expensive
Stratified sampling - requires a represented sample of securities from each sector. It is less expensive, but could be bias
Optimisation - uses sophisticated computer modelling techniques to find representative which mimic the index

Synthetic replication - fund managers enter into a swap (OTC derivative) with a market counterparty to exchange the returns of the index for payments
+ passes responsibilities, costs cheaper
- risk the counter-party may fail

Question 42

what are the charges associated with ETF

Answer 42

• annual management charges
• stockbroker chargers
• difference in price brought and price sold

Question 43

key points of unit trusts, OEIC, IT, ETF

Answer 43

only AUT are referred to as trusts, everything else is company
supervision for open-ended IC and ETF are provided by depositary
only investment trusts are close-ended
trading with unit trusts and OEIC are done by investment manager
settlement is done on CREST with IT and ETF

Question 44

what is a hedge fund? the common aspects

Answer 44

Hedge fund is an investment fund that aims to make money in all market conditions and take use of short positions.
main aspects:
structure - not authorised, not for typical investors
investment entries = minimum usually of 50K, some being 1M
investment flexibilities = can investment in whatever
gearing - can borrow
prime broker
liquidity - usually has a “lock-in” period between 1-3 months
costs - charge performance fees

Question 45

what is private equity? how do they raise capital? how can they make money?

Answer 45

Involves companies that are not listed on the stock exchange. Investors (firms or wealthy indiv) put money into those companies to help them grow, aiming for future profits.
They raise capital by gathering wealthy investors which is then pooled into investing into private limited companies.
Private equity firms make money by: selling shares back to management of investee company, selling shares to another investor, trade sales, company achieving stock market listing