Chapter 7 - Money markets and foreign exchange Flashcards
Summarise the key differences between Unit Trusts and Investment Trust Companies
Unit Trusts:
Legal Structure - Trust
Key Documents - Trust Deed
Key Parties - Trustees and Fund Manager
Open or Closed Ended - Open Ended
Nature of Investor’s holding - Units
Value - Based on underlying NAV of supply and demand for the units
Investment Trust Company:
Legal Structure - Company
Key Documents - Articles of Association
Key Parties - Directors
Open or Closed Ended - Closed
Nature of Investor’s holding - Shares
Value - The (bid/offer spread) shares on the LSE
What is UCITS?
UCITS stands for Undertaking for Collective Investment in Transferable Securities. It is an EU directive which was originally adopted in 1985.
UCITS III provided an update in 2001 and was importantly split into two directives known as the Management directive and Product directive.
The Management Directive enables fund management companies to obtain a European passport which in turn enables them to operate throughout the European Economic Area (EEA).
The Product Directive allows funds sold throughout Europe as covered by the directive to cover a range of different investor offerings including Money Market Funds, Derivative Funds, Index Tracker Funds and Funds of Funds.
UCITS IV became effective in July 2011 and aims to enhance the scope of UCITS further. Its principle areas were Key Investor Information (KII), Notification procedure and improved cooperation between member states.
In the context of Collective Investment Schemes explain the terms “Open- Ended” and “Closed - Ended”
Open - ended refers to a type of fund structure where units or shares can be created by the fund on
an ongoing basis. Such funds can therefore continually advertise to potential investors.
The value of the units or shares dealt will be calculated by direct reference to the value of the funds
underlying assets. Unit Trusts typically trade with a different prices for investors buying from (offer)
and selling back to (bid) the fund. Open Ended Investment Companies (OEICs) trade at a single
price with investors being charged separately.
Closed-Ended refers to a type of fund structure where the number of shares issued is fixed at the
outset of the investment period.
The original investors in the fund therefore either continue to hold their shares until the fund is
wound up (typically years later) or sell via the secondary market (eg London Stock Exchange
LSE). If they sell on the LSE the price they receive will typically be different to the underlying net
asset value of the fund. This is because share prices on the London Stock Exchange are determined
by supply and demand. The difference is referred to as a “premium” or “discount” to the net asset value per share.
Outline the typical capital structure of a Split Capital Investment Trust. In your answer highlight the respective rewards to investors.
Split Capital Trusts tend to generally issue three types of shares all within the one company
structure:-
Zero dividend preference shares - These are issued at a discount to their face value and do not receive a dividend during the lifetime of the trust. They are the first class of share to be redeemed at redemption (hence the term “preference”) but only receive their nominal (face) value
Ordinary Income Shares - These pay income to investors whilst the fund is running ( at least 85% of
investment income received by the fund will be distributed to this class of shareholder). Upon
redemption investors are paid after the zero dividend preference shares referred to above but
investors only receive the nominal (face) value.
Capital shares - These pay no income during the lifetime of the fund and are the last share class to be redeemed at maturity. Assuming the other share classes have been paid their respective entitlements in full the Capital Shareholders will receive the residual monies available. They are therefore the riskiest share class within the structure.
What is a Venture Capital Trust?
Venture Capital Trusts (VCTs) invest across a portfolio of new and growing smaller companies.
This enables investors to diversify across a range of small companies thereby reducing the risk they would otherwise face if investing direct into one company.
Investors in VCTs receive income tax and capital gains tax incentives.
The investment portfolio is will be professionally managed.
The manager will be overseen by the VCT’s directors, thereby protecting the investor’s interests.
What is a Private Equity investment company?
An investment company run by a professional manager that enables investors to gain exposure to a portfolio of mainly privately owned shareholdings.
The companies the investment company invests into are often newly formed or existing companies that need restructuring.
The private equity investment company will often provide knowledge and expertise to the companies it invests in.
Investor’s monies are often supplemented by bank borrowings thereby increasing the potential returns but also the risk.
When the private equity company has achieved the goals originally set the investment will either be sold or the company floated on a stock exchange.
Private equity investment companies tend to be closed ended and take a long term investment approach.
What are Hedge Funds?
The term “Hedge Fund” covers a variety of different funds which can use an array of different investment strategies and asset classes to achieve their objectives.
Hedge Funds do have two key areas generally in common:
They are “absolute return” funds which aim to make positive returns regardless of the underlying market conditions. Unlike other funds hedge funds do not appraise or compare their performance to benchmarks.
In addition to a flat fee (typically 2%pa) investors will also pay a performance fee (typically 20% of gains) to the hedge fund manager if the fund does make money.
Hedge funds may also have the following features:-
May use short selling/derivatives/high levels of borrowing (gearing/leverage) to achieve
investment objectives.
Lighter regulatory requirements on fund compared with normal retail funds.
Less transparency than with normal retail funds (in Europe the EU Alternative Investment Funds
Management directive (AIFM) is seeking to address this).
