Chapter 7 - Unit Trusts, OEICs & Investment Trust Companies

Question 1

Collective Investment Schemes - popular with investors as;

• small sums, fund managers, balanced portfolios, pursue what, risk

Answer 1

Popular with investors as;

• good way to invest small sums of money as cash is pooled into large fund
• professional fund managers make underlying investment decisions
• investors can achieve balanced portfolio because fund managers invest in spread of investments
• ability to pursue specific objectives or specialise in particular market e.g. income or growth
• investment risk reduced by wide spread of investments.

Question 2

Unit trusts & OEICs - Characteristics;
- allows investors to participate in what, each unit represents (portfolio and shares), assets of UT held by who and same q for OEICs and charges

Investment Association sectors

• what do they determine
• ranking performance
• must have at least how much of its assets in that sector to be included
• how to qualify for income fund (yield and index)
• membership criteria

Answer 2

Characteristics are;

• allow investor to participate in large portfolio of shares with others
• each unit represents small but equal fraction of a portfolio of numerous different shareholding’s
• assets of UT are held be trustees and invested by managers whereas assets of OEIC held by an independent depositary.
• Generally initial charge or exit fee and management fee

IA Sectors;

• Investment Association determines sectors (income, growth, specialist funds etc.)
• Performance measurement companies rank the performance of funds in each sector.
• Fund must have at least 80%+ of its assets to be included in that sector.
• To qualify as an income fund, each fund must achieve a yield of no less than 90% of the relevant index. If not, removed from income sector.
• Criteria for membership of particular sector regularly reviewed.

Question 3

UTs & OEICs - Investment Strategy - supporters of index trackers ague
- managers and outperformance, outperformance due to and charges

Investment powers and restrictions;

• designed to ensure each fund has what (spread and demand)
• FCA specialist sourcebook - sets out rules for, these rules help protect consumers how and in particular proportion of what (2) and why (liquidity)
• trust deed must contain statement detailing fund may invest in what if eligible under what and other investments inclusion in this?
• trustee or deposit must monitor what to ensure fund being managed as per (3, deed rules and regs)

Answer 3

Supporters of index trackers argue;

• few managers consistently outperform the index against which they measure their performance.
• outperformance generally achieved by taking higher risk
• index-tracking funds have lower charges

Investment powers and restrictions;

• designed to ensure each fund has proper spread of investments and they are realisable on demand.
• FCA’s specialist sourcebook sets out rules for establishing and operating authorised schemes in the UK. Rules help protect consumers by laying down minimum standards for investments. In particular, proportion of transferable securities or derivatives as these are not liquid.
• Trust deed must contain a statement that the fund may invest any securities or derivatives eligible under FCA regs. No other investments need to be included unless narrower investment powers (set out in regs).
• Trustee or depository must monitor investment limits to ensure fund being managed as per trust deed, scheme rules and FCA regs.

Question 4

UTs & OEICs - Approved securities and eligible markets - securities on EU official list are whilst those on list must meet criteria to qualify as what, FCA places duty on trustees to ensure (liquidity and four standards) and firms must carry out what for non-eu markets

Borrowing

• retail UCITS not permitted to borrow on what basis to do what (gear)
• but can borrow how much against what
• non-retail can borrow how much on what basis
• QIS can borrow 100% of what as long as what in place

Answer 4

Securities on EU official list are approved and one can invest freely - about 90% of securities. Those not on this list must meet criteria to qualify as an eligible market for fund. FCA places duty of trustees to ensure market is liquid and meets four standards;

• regulated, operating regularly, recognised and open to the public
• must carry out an annual review of non-eu markets

Borrowing;

• retail UCITS is not permitted to borrow on permanent or continual basis to gear up port.
• can borrow up to 10% of its value against known cash flow such as divs
• non-retail UCITS can also borrow 10% but an a permanent basis
• Qualified Investor Scheme (QIS) can borrow 100% of net asset value if arrangements are in place to ensure can be repaid on demand.

Question 5

UT & OEICs - Diversification Rules - what are UCITS’

Portfolio diversification rules;

• retail UCITS fund investing in what and not is prohibited to hold no more than what in shares from one company and max amount of companies they can hold this on then max percentage for rest of shares.
• Funds minimum amount of shareholding’s
• UCITS established as trackers can hold up to how much in one company and how much for justifiable circumstances
• UCITS cannot hold more than what % of securities issue by who
• cannot aggregate voting shares if?
• Funds investing >35% in FIS via single issuer must invest in how many stocks min and no single stock can exceed what %
• UCITS schemes % of unapproved securities and other CI schemes
• as above for Non-UCITS
• Why can UTs hold cash (liquidity and cash flow) and max %

Answer 5

Undertakings for Collective Investment in Transferable Securities (UCITS) are investment funds established in accordance with EU directive and can be freely marketed to other EU states. Rules in place to ensure that they provide prudent spread of risk. Portfolio diversification rules as follows;

• retail UCITS fund investing in securities and not an index tracker is prohibited from holding no more than 10% in shares from one company.
• Max four separate shareholding’s up to 10% and then others cannot exceed 5%.
• Fund must have minimum of 16 holdings but usually have more.
• UCITS schemes established as trackers can hold up to 20% in one company and 35% in justifiable circumstances.
• Cannot hold more than 20% of securities or money markets issued by same group (i.e. big company).
• Cannot aggregate voting shares if allows them to significantly change the way a business is run.
• Funds investing more than 35% in FIS via single issuer must invest in at least 6 different issues of stock. No single stock value can exceed 30%
• UCITS schemes can hold up to 10% in unapproved securities and 20% in another collective investment scheme.
• Non-UCITS schemes can hold up to 20% in unapproved securities and 35% in another collective investment scheme.
• UCITS & Non-UCITS can hold warrants without limit.
• UTs can hold cash for liquidity and cash flow purposes only.Cannot hold more than 20% in cash.

Question 6

Unit Trusts - Managers and trustees - their roles are to? And includes;
- protection ensure by and only constituted by, trustee holds what whilst manager runs, authorisation and reg and if UT is marketed must be what

Trustees ensure interests are protected by;
- managers are acting in line with, fund manager investing as per, replacement of manager when (2) and have to remove when and holding assets done by

Trustees responsibilities;
- registration in whose name, reporting manager when, audit and financial statements, calculation, meetings, registering and certificates, distributing what, additional provisions

Answer 6

They must protect the investor;

• protection ensured by legally binding trust deed and a UT can only be constituted by the signing of a trust deed.
• trustee legally holds assets whilst manager runs day to day
• manager must be authorised and trustee regulated by FCA
• to be marketed, UT must be authorised by FCA

The trustee must ensure investors interests are protected by;

• checking managers are acting in line with deed, rules and regulations.
• ensuring fund manager invests as per investment objectives
• can replace the manager if insolvent or if not acting in best interests and would have to remove if majority of unit holders voted for it.
• holding of assets are held by competent custodian

Trustee continued;
- securities registered in name of trustee + income held by them
- must report if not being managed as per regulations
Responsibilities include;
- arranging auditing of trust and issuing financial statements
- monitoring calculation of unit prices
- arranging meetings for unit holders
- registering unit holder and issuing certificates
- distributing income of trust to unit holder
- making additional provisions necessary for trust to be recognised as pension or charitable scheme.

Question 7

Unit Trusts - Manager - required to;
- authorisation, financial resources, asset management, supply info, record keeping, notification and responsible for (4 think marketing and basic)

Registration
- task of who, shows evidence of what and must include (4) and inspection (to who and max period closed)

Unitholders rights - protected on three levels;
- trustees, act and complaints

Answer 7

Manages trust for management fee and are required to;

• be authorised
• have adequate financial resources
• manage assets in accordance with regulations, trust deed and rules
• supply info to trustee when requested
• maintain a record of units
• notify trustee or FCA if any rules breached
• usually responsible for promotion, advertising, selecting investments and administration

Registration;

• task of trustee but can delegate to manager or third party
• evidence of unit holders title to units and must include name, address, number of units and date registered
• must make register available for inspection by unit holders free of charge and cannot be closed for period of more than 30 days a year

Unit holders rights (protected on three levels);

• trustees - safeguard assets and ensure manager is complying
• FSMA 2000
• complaints and arbitration procedures - redress through regulators or FOS

Question 8

Unit trusts - general - change to deed needs to be approve by who, change in charges notice and who notified if manager removed.

Taxation of unit trusts;

• interest and rental income taxed at what rate and type
• dividends and tax (and when are)
• funds distributing interest rather than divs can deduct what and why

Equalisation;
- first distribution represents (think clean price)
- taxation and CGT
Aims - income apportionment and pence per unit payments

Income allocations and distributions;
- most distribute when, income funds when and why may income be retained in fund (capital)

Answer 8

• A changes to trust deed must be approved at meeting of unitholders.
• charges change must be given reasonable notice (not less than 60 days)
• manager cannot be removed without FCA approval.

Taxation of unit trusts;

• interest and rental income corp taxed at 20%
• dividends aren’t taxable unless foreign divs
• funds distributing interest rather than divs can deduct interest as expense from corp tax so not taxed twice.

Equalisation;
- first distribution represents income accrued from date of purchase and payment that represents income included in price paid (equalisation)
- not subject to income tax but deducted from price for CGT purposes.
Aims of equalisation are;
- achieve broad fairness between unitholders in apportionment of income received by trust.
- allow the same pence per unit dividend payment to be made to all unitholders

Income allocations and distributions;

• most distribute income biannually
• income funds can be monthly
• income may be retained in fund and added to capital for the benefit of the holders accumulation.

Question 9

Unit Trusts - taxation treatment of the investor;
> income tax on dividend distributions from equity UTs;
-to pay divs must hold less than what in what and self assessment

> dividend distribution paid to trustees
- if held on what trust liable for what amount of tax and what allowance doesn’t apply - divs that fall within £1k taxed at what amount

> interest distributions from non-equity trusts;

• to pay interest distributions must hold at least what in what
• is interest paid net or gross

> interest to trustee
- if held now what trust liable for what tax and if £1k?

Reinvestment of either of these still count as what and subject to what
CGT payable when

Answer 9

Income tax on dividend distributions from equity UTs;

• to pay divs must hold less than 60% in cash, gilts and corp bonds.
• taxpayers must use self assessment

Dividend distribution paid to trustees

• if equity funds held in discretionary trust, trustees liable for tax at 38.1% and £2k tax free does not apply.
• divs that fall within £1k only taxed at 7.5%

Interest distributions from non-equity trusts;

• to pay interest dis, must hold at least 60% in above investments
• interest paid gross

Interest to trustees
- if held in discretionary trust, liable for 45% income tax (if £1k then 20%)

Reinvestment of divs or interest still counts as income and subject to same tax treatment than if distributed.

Capital Gains Tax is payable on profits when disposing of units.

Question 10

Unit Trusts - tax elected funds allow what

Distributions - why are UTs popular, how can spread income dates and income paid what of expenses

Impact of allocations on unit prices;
- accounting date and unit price - accounting date passes price is marked as what and price of income unit does what

Process of buying and selling
- purchased in whose name, min holding requirement and document pre trans

Selling;
- when order is placed manager issues what, if holding certificate must do what and if no may have to sign what and manager must make payment in what period

Answer 10

Tax elected funds allow income to be split into both options

Distributions - UTs popular as can offer income and capital growth. By investing in numerous funds, can have a spread of distribution dates. Income paid net of expenses.

Impact of allocations on unit prices;

• as accounting date approaches, unit price rises to reflect this
• when accounting date passes, price marked as ex distribution and then price of income units fall by amount of income.

Process of buying and selling;

• can be purchased in single or joint names
• min holding requirement of £500 or £1k
• must supply KIID before transaction executed.

Selling;

• order placed to sell then issue a contract note
• if investor holds certificate, must sign renunciation form on back and return to manager and if not, may have to sign separate form if written one not sent
• manager must make payment no later than 4 days after receipt of signed doc

Question 11

Unit Trusts - Share exchange facilities - allows investors to exchange what for what and is cheaper than selling through a stockbroker as;
- manager can accept what in lieu of what and shares are what into fund or can do what (sell) - minimum amount - tax

Dual priced unit trust features - formula determines what (price sold and bought) and can do what with units depending on demand

Single pricing features;
- uses what to price and buying and purchasing price are what

Bid offer spread - what has narrow, wider and no spread

Forward pricing - price at what point
Historical - as above

Answer 11

Allow investors to exchange existing shareholding’s for equivalent value in funds units. Can be cheaper than selling through a stockbroker as;

• unit trust manager may accept shares in lieu of payment and absorb shares into a fund or dispose of them and apply to buy units in fund
• SE scheme usually has minimum around £1k
• not exempt from CGT

Dual priced unit trust features;

• formula determines highest price units sold and lowest price bought from investors.
• can create or cancel units depending on demand

Single pricing features;

• uses mid market prices for underlying investments
• incoming and outgoing deal at same price

Bid offer spread;

• no-load index trackers have narrow spread
• smaller companies and emerging markets have wider spread
• some cash no spread at all

Forward pricing - pay price of unit trust at next valuation point
Historic pricing - price at last valuation point

Question 12

Open ended investments - characteristics;
- how valued, can be established as what, fund represented by what, authorisation and operated by who

Differs to UTs;
- self contained company that has what and holds, fund can be what (2), sub funds and pricing basis, issue what rather that what, appoints who, assets held where, audited accounts, cost of fund creation met by who, what type of pricing used and borrowing

Answer 12

Characteristics;

• valued on NAV basis
• can be established as retail and non-retail UCITS and as QIS
• fund represented by shares
• must be authorised by FCA if marketed in the UK
• operated by board of directors

Differs to UTs;

• self-contained company which has own demands and holds meetings
• fund can be stand alone or umbrella (sub funds with diff objectives)
• sub funds must adopt same pricing basis (forward or historic)
• issues shares rather than units
• appoints directors
• assets held in independent depository
• annual audited accounts are issued
• cost of creation can be met by fund
• single pricing usually used
• limit on borrowing (like unit trust)

Question 13

OEICs - fund management and administration - who is OEIC equivalent of unit trust manager and responsible for;
- compliance, register, day to day, accounts, management of what

The Depository is who and responsible for overseeing what (management and investor protection) which includes;
- doing what with OEIC shares, income (collections and payment), investment and borrowing powers and asset keeping

Reporting;
- how often, reports that comply with, short-form accounts and full accounts

Answer 13

OEIC equivalent of unit trust manager is authorised corporate director who is responsible for;

• investor protection compliance as set out by FCA
• maintaining register of shareholders
• day to day management (valuation, pricing and dealing)
• preparation of accounts
• management of investments

The depository is an independent authorised person responsible for overseeing management of OEIC in relation to investor protection which includes;

• valuing, pricing and dealing OEIC shares
• collection of income and authorising payment of income distribution
• ensure ACD correctly exercises investment and borrowing powers
• safekeeping assets

Reporting to holders;

• reports twice a year (one audited and other unaudited)
• produce reports that comply with Statement of Recommended Practises
• may issue short-form accounts
• must make available full accounts, if requested

Question 14

OEIC - single pricing - how are assets valued, either;
- mid-market or relevant marketer

Makes no allowance for what (costs)and what is shown separately, pay single price + what to cover what

Dilution levy
- paid to cover what, payable if (flows into fund), levy goes to who and FCA rules

Dealing;
- ACD issues what for each trade and may issue what

Dual pricing is same as for what

Answer 14

Assets contained in OEIC are valued at;

• mid-market price where there are spreads on shares
• the only price if that is all that is available from relevant market.

Makes no allowance for market dealing costs and charges are shown separately.
Where single pricing used, pay single price plus initial charge to cover sales and management. Dilution levy may also be payable and this;
- is paid to cover dealing costs
- payable if unusually large in and outflows into fund
- levy goes to fund not the managers
- no FCA rules

Dealing;
- ACD issues contract note for each trade and may issue share certificate

Dual pricing same as UT.

Question 15

OEIC advantages - recognised type of what where, marketed internationally and compared to UTs, regs permit what (share classes) which allow for what (charging and currency), umbrella funds and means what (objectives, simple and cost) and creating new funds.

OEIC taxation;

• same as what and this means;
• corp tax, dividends and income paid how, internal gains and CGT when

Answer 15

• most widely recognised type of collective investment in Europe
• OEICs marketed internationally in a way that is impossible for UTs
• OEIC regs permit multiple share classes which allow more flexible charging and currency structures than UTs.
• allows use of umbrella funds which gives choice of funds covering range of investment objectives and switches simpler and cheaper (can be nil)
• umbrella structure makes it easier to create new funds

OEIC taxation;

• same as UT i.e.;
• pay corporation tax on income received less expenses of management
• dividends paid without deduction of tax (taxed at normal rates) and income paid gross
• Internal gains exempt from corp tax
• CGT liability when selling or switch

Question 16

Unit Trust and OEIC management services - multi manager products - allows for what (spread money how and diversity)

Fund of funds - what is it (simple) and can be either;
Fettered or unfettered - investment in funds that are what (group)
- additional levy charge for in house and external funds and where taken if external
- management groups can do what with charges or get what
- provider selects funds with aim of (simple)

Manager of managers funds - appoints who
- who decides asset allocation for fund, who runs each asset class, who responsible for managing and fund assets and costs

Answer 16

Multi manager products - allows investor to spread money between different manager or fund thus achieving greater diversification. Two types; - fund of funds and manager of managers.

Fund of funds - invests in selection of funds and can be either;

• fettered - only invests in funds by same management group
• unfettered - no obliged to one management group
• in house funds may not levy additional charge but external usually do and taken from funds assets
• can usually get rebate on these costs or lower dealing and management costs and no commission.
• provider selects funds with aim of maintaining balance and maximising returns

Manager of managers funds - appoints several managers with different styles

• overall fund manager decides on appropriate asset allocation for fund
• external investment manager chosen to run each asset class
• overall manager responsible for managing them and has control over funds assets.
• costs are more transparent than fund of funds

Question 17

Offshore funds - classes of recognised schemes - who recognises these for what purpose under what act, UCITS recognition from FCA, funds under designated territories rules and funds not recognised by FCA subject to what?

Taxation;

• if invested in equities, dividends are subject to what
• if invested in FIS, income is what due to being invested in what and pay what gross. Tax efficiency compared to the above.

EU Savings Directive - what is it (exchange of info), HMRC receives info on what and compare it to what, what do some territories do instead of this and what rate is this taxed, how can this be offset (tax, income and CGT) and replaced by what

Answer 17

FCA recognises offshore funds for marketing purposes under FSMA 2000. Funds categorised as UCITS under EU legislation receive automatic recognition from FCA. Funds under designated territory have similar rules to UK funds. Classes of funds not recognised by FCA are subject to marketing restrictions.

Although usually based in tax haven, not usually free of tax;

• if offshore fund invests in equities, dividends received subject to non-reclaimable withholding tax.
• Investments in FIS generally yields tax free income as funds will choose investments such as Euro corp bonds and exempt gifts which pay income gross. These are more tax efficient than offshore equities.

EUSD - EU members exchange information on savings held by non-residents. HMRC receives info on savings income they receive from abroad an d match it to info declared by investor. Some territories operate withholding tax on savings income instead of exchanging info and taxed at source at 35%. Can be offset against other tax paid or reclaimed if exceeds income or CGT liability. Replaced by council directive.

Question 18

Offshore funds - taxation treatment of investors
Reporting funds;
- main advantage (taxation), to get this must be what throughout period of ownership, dividends from what are taxed as foreign dividends and subject to what in same what as divs from what, if funds holds more than what % in what then income is taxed how, distribution of income and reporting to HMRC, physical and deemed dis and taxed even is what

Non-reporting;
- income is what and divs payable, CGT allowance rules and why, taxed at what rates even though usually, roll ups funds good for what and non uk resident and taxation

Answer 18

Reporting funds;

• main advantage is that dividends and interest treated in same way as UK based funds and only capital gain subject to CGT rules.
• to benefit from this, must be reporting throughout period of fund ownership
• dividends from funds constituted as companies are taxed as foreign dividends. Subject to income tax in same way as dividends from equities.
• when offshore fund holds more than 60% of assets in interest bearing securities, income taxed at normal bands.
• reporting fund does not have to distribute all income but must report to HMRC
• allows for physical and deemed distributions
• UK investor taxed on their share of income even is actual dis not received.

Non-reporting funds;

• usually income accumulated and no divs are paid
• CGT allowance cannot be used to mitigate tax liability as taxed as income.
• taxed at income tax rates even though usually largely dividends.
• roll-up funds used to shelter acc income allowing investor to realise gains once tax rate has dropped or non-UK resident.
• non uk resident, offshore income free of UK tax but may be taxable at home

Question 19

Close ended funds/investment trusts - what are they (pool), investment trust can (company, lending, global) and trust are classified into sectors based on what.

How operate (directors etc) and - shares issued are, regulated and LSE, borrowing, long term view on investments and sale of assets, can appoint who to run (2)

Answer 19

Investment trusts are a collective investment that pools money together and spreads across a portfolio of stocks and shares. Investment trust can; - invest in any kind of company

• provide venture capital to firms
• invest in any country in the world
• classified into sectors based on regional and industry focus of portfolio

They have board of directors and shareholders and;

• issue fixed number of shares
• regulated company by law and shares traded of LSE
• can borrow to gear up
• can take long term view with investments and don’t have to sell best assets like unit trust sometimes forced to.
• can appoint fund manger or external management to run

Question 20

Investment trusts - share price - difference between bid and offer price known as what

Discount - difference between what and happens when, when is it trading at discount. Narrowing discount - what is it (straightforward, think demand) and Widening discount - what is it and creates what opportunity, if discount widens too much managers can reduce what and why

Premium - happens when and occurs

Answer 20

Share price - difference between bid and offer price is known as market makers spread or turn.

Discount - is difference between share price and NAV per share and happens as inv purchase under assets at lower price that if bought direct. If share price lower than NAV per share, trading at a discount. Narrowing discount - demand causes share price to increase thus providing better return on share price than underlying assets do. Widening discounts - opposite to narrowing and can be regarded as buying opportunities. If discount is wide, the managers may seek to buy back some shares to reduce oversupply.

Premium - share price higher than NAV per share and is rare but can occur if demand is high.

Question 21

Investment trusts - capital structure - two categories?

Conventional - issue what type of shares, entitles investors to what, limited life ITs - vote on what and extended by and the benefit of these ITs are (discount)

Split Capital - can have different what which provide what (think previous chapter), some can offer what which are what and produce what, life span and liquidity

SC Redemption yield - what is it (simple) and comparing, assumes what (price, redemption and rate)

Answer 21

Split into two categories - conventional and split capital.

Conventional - issue only ordinary shares

• entitles investors to all income and capital gains
• limited life ITs fall under this and vote on whether to extend its life and usually by three years. Benefit of these is that they help reduce the discount as wind up date gets closer.

Split capital - can have different share classes which provide different returns and have different priority of payments (think previous chapter).

• some offer units which are packages of different shares and produce equivalent to ordinary shares.
• limited initial life span (5-10 years)
• can sell at any time and proximity to wind up date will effect price.

SC - redemption yield - measures income and capital return on share until wound up as an annual % so to compare against other instruments.
- assumes shares are bought at current price, held until redemption and that assets and dividends grow at same rate assumed.

Question 22

Investment trusts - Split Capital - hurdle rates - indicate what needed each year in order to repay what at (3 different prices/values), a negative hurdle rate means what and assets can

Wipe out rate - measures annual rate of what that would lead to what (capital)

Asset cover - measures what and e.g.

Redemption - on wind up, generally offer what and transfer without? What must always be offered on wind up

Answer 22

Hurdle rate indicates annual growth rate needed each year in order to;
- repay each share class at wind up date at current purchase price, pre-determined redemption value or repay prior charges. A negative hurdle rate means surplus assets and can decline in value each year.

Variation known as wipe-out rate which measures annual rate of decrease in gross assets that would lead to no capital payment on wind up date.

Asset cover - measures companies ability to cover liability of pre determined redemption price. E.g. 50% means can only cover half.

Redemption - on wind up, generally offer investors a roll over investment vehicle in form of new investment trust which they can transfer to without CGT liability. A cash alternative must always be offered.

Question 23

Investment trusts - warrants - are right to buy what when (think repo)
- produce no what and risk, movements in price effect on share price, LSE, value beyond expiry and taxation

Suitability for investors - offer opportunity to… and who is good for;
- annuity shares, income shares, income and residual capital shares and capital shares

Share buyback;
- buyback why and permission

Answer 23

Warrants are right to buy shares at fixed price at pre determined date.

• produce no income and no tax and are high risk
• movements in price of warrant magnify changes in share price
• can be bought and sold on LSE
• if held beyond expiry, have no further value
• subject to CGT

Suitability for investors;

• offer opportunity for investors to invest in different share classes to fulfil different needs including;
• if high income and prepared to erode capital can get annuity share
• require income with capital protection can purchase income shares
• as above but higher risk = income and residual capital shares
• capital growth at low risk = zero dividend preference shares
• higher capital growth for higher risk = capital shares

Share buybacks;

• can buy back own shares to tackle discount and give greater control of supply and demand.
• must seek permission from shareholders

Question 24

Investment trusts - gearing - what is it, formula and 100 and 120 gearing means? Characteristics;
- implemented how? (4), beneficial when (returns) and if they don’t, higher gearing means

Split capital ITs already geared as a result of and known as and following effects;
- returns and rankings, number of classes and structural gearing and riskier classes

Answer 24

ITs can borrow money to buy shares and assets if good investment opp.
Gearing = total gross assets/net assets*100
E.g. 100 means no gearing whilst 120 means 20% of assets are borrowed funds.

• can be implemented through bank loans in sterling or foreign currencies, issue debentures, unsecured loan stock or preference shares.
• can be beneficial for shareholders if returns achieved with the borrowed money exceed cost of servicing loans
• however, if they do not, trusts performance will suffer and may be forced to sell shares to repay loan.
• higher level of gearing = riskier investment

Split capital ITs will be geared as a result of capital structure (structural gearing) which has following effects;

• returns on each share class affected by rank of payments
• number of share classes determine level of structural gearing
• share classes lower down pecking order are higher risk

Question 25

Investment trusts - gearing - need to provide what when recommending and must be given if - who uses gearing in investment strategy (2) and gearing creates what in company shares compared to what.

Charges;
- older trusts, newer trusts, compared to UTs & OEICs and other expenses

OCF does not include what that is included in TER

Answer 25

Need to provide warnings if recommending highly geared ITs and must be given if;

• IT uses or proposes to use gearing as investment strategy
• invests in other ITs that use or may use gearing
• result of gearing likely to create fluctuations in investment company shares compared to underlying investments.

Charges;

• older trusts tend to have 0.5% or under
• newer more specialists trusts have AMC of 1-1.5%
• some may have performance fees
• usually lower than UT or OEICs
• other expenses include custody and auditor fees, directors renumeration, marketing, promotion and secretarial costs.

OCF does not include performance fees whereas TER does.

Question 26

Investment trusts - shares bought through who (3), execution only (fees + SDRT) and directionally offered for who and charges

ITs & ISAs - appeal most to who and others better off using?

Dividends are paid where or if held where can be what

Taxation of ITs;

• if approved by HMRC, not subject to what
• not subject to what else (franked income)
• unfranked income and how taxed and can be offset by

Answer 26

Investment trust shares can be bought through stockbroker, platform or regular savings scheme. Execution only - investor chooses and minimal fee + SDRT of 0.5%. Discretionary can be offered for larger clients and are charged AMC plus dealing costs.

ISAs - ITs held in ISAs appeal most to higher and add rate taxpayers and those that need CGT shelter. Others better off using straightforward savings scheme.

ITs dividends are paid directly into account or if held in wrapper can be reinvested.

Taxation of ITs - ITs approved by HMRC not subject to tax on gains made from sale of shares or other holdings in their portfolio

• not subject to additional tax from franked income (income from divs)
• do have to pay corp tax of unfranked income (from gilts or deposits) but can reduce liabilities by offsetting expenses.

Question 27

Investment trusts - taxation of investors - dividends taxed how, CGT and held within ISA

Offshore investment companies - taxation in UK and origin

Answer 27

Taxation of investor;

• £2k of divs tax free and above is taxed at normal div rate
• liable for CGT on any profit
• if held within ISA all divs and gains are tax free

Offshore investment companies;
- not subject to UK tax but may be in country of origin

Question 28

Investment Trusts vs OEICs vs Unit Trusts - cost of purchasing lower for what

Risk reward in what greater than what due to;

• trading at discount and effect of narrowing whilst UT or O price cannot do what further than what
• if discount widening, what leads to what changes (2) in ITs whereas UTs?
• borrowing

Which provides higher level of income and why

Specialist unit benefits;
- split capital shares mean can do what with what whilst UT or O have equal entitlement to what

Answer 28

• costs of purchasing shares in ITs are lower

Risk and reward in IT is greater than unit trust due to;

• ITs frequently trade at a discount and if narrows, shares may outperform assets whilst UTs & OEICs price of units cannot rise or fall further than underlying investments.
• if discount widening, shareholder pressure may lead to management being changed or produce better performance whilst investors in UTs have no such powers to bring about this change.
• ITs can borrow to invest whilst the others have tighter borrowing powers.

ITs can provide higher level of income than equivalent UT or O because of discount to NAV. Same amount of money buys exposure to more securities.

ITs can have specialist units;

• split capital shares divide out investment returns and risk levels
• whilst all investors in UT or O have equal entitlement to income and capital gains with same amount of risk.