Collective Investments Flashcards
How can a retail investor invest in commercial property through collectives and what are the benefits
By combining their money
with that of other people, it is possible to build a diversified portfolio between them. They can also benefit
from the expertise of top fund managers in this way - expertise that would otherwise cost a significant amount if
they were to deal directly
How similar are unit trusts & OEICS?
Unit Trusts and OEICS are often thought of together. Although the structure and rules applicable to each differ, the basis of each is largely the same. Historically, Unit Trusts were the most popular form of collective investment in the UK, but this structure had important differences from the SICAV
structure favoured in Europe. To bring the UK more into line with Europe and allow for easier trade, OEICs were developed – adopting a similar structure to SICAVs. OEICs are now the most common.
Both Unit Trusts and OEICs are open-ended investments.
What is an open ended & closed fund?
This means that when new investors want to buy into the fund, new units or shares can be created to allow this. For this reason, the price of the unit or share will be closely linked to the value of the underlying investments associated to it.
With a closed ended investment, like an investment trust the number of shares is limited and so supply and demand will control the price.
How will an increase in demand effect the prices of shares/ units in an unit trust or OEIC?
When supply is fixed, an increase in demand will lead to an increase price. With Unit Trusts and OEICs, however, an increase in demand can be met with an increase in supply through the creation of new units. This being the case, the price will be determined by the value of the assets held within the fund rather than by how much demand there is for the unit
UK Collective schemes regulated?
The FCA regulates authorised UK Collective Investment Schemes.
FCA Authorised Funds are structured either as:
· OEICS
· Authorised Unit trusts
· Authorised Contractual Schemes
· Recognised Schemes.
Are Qualified Investor schemes allowed to be marketed to retail investors?
not allowed to be marketed to anyone other than professional investors or sophisticated investors (a form of retail investor). These are also classed as Alternative Investment Funds and as such are managed by an Alternative Investment Fund Manager.
How can UCITS be marketed across europe?
Following BREXIT, Funds from outside the UK that were being marketed to UK retail investors prior to BREXIT can continue to do so under UCITS for 3 years from January
2021 as long as they are a recognised collective investment scheme (otherwise known as an overseas scheme).
The FCA has kept the UCITS rules in place for UK domiciled funds and as such this now splits the category into UK UCITS and UK non-UCITS as above.
How much of a FCA authorised fund must be in approved securities?
For an FCA authorised fund, at least 90% of the fund must be in approved securities. In addition, markets must meet specific criteria to become an eligible market for a particular
fund. An annual review of the markets that a firm considers eligible for each fund must also take place. The FCA also imposes strict duties on unit trust managers, and ACD’s of
OEICS to make sure the market they are investing in is liquid, regulated, operating regularly, recognised by a government agency or statutory body and is open to the public.
What are the differences in diversification rules for UK UCITS and UK non-UCITS
In order for a collective investment scheme (e.g. a Unit Trust or OEIC) to be authorised by the FCA it must be reasonably well diversified.
A retail UK UCITS fund (that’s not an index tracker) is not allowed to hold more than 10% of its value in any one company and all holdings of more than 5% cannot represent
more than 40% of the portfolio. This means that it is possible to have up to 4 different holdings at the 10% limit and thereafter no more than 5% can be held in any other
holding. Therefore, a fund must have at least 16 holdings (4 x 10% and 12 x 5%) – most will have over 50. If it is an index tracker fund, then the 10% minimum in any one company increases to 20% and in rare occasions may increase to 35%.
Name some of the diversification rules for UK UCITS & UK non UCITS
► UK UCITS are not allowed to hold more than 20% in any one group of companies.
► Funds holding more than 35% in government fixed interest securities, from one government (issuer) must have at least 6 different issues of that stock, with no individual one worth more than 30% of the fund.
► 10% can be held in unlisted/unapproved securities for UK UCITS and for UK Non-UCITS this increases to 20% for unlisted/unapproved and in unregulated schemes.
► 20% can be held in another collective scheme for UK UCITS and for UK Non-UCITS this increases to 35%
► There is no limit on the exposure to warrants for both UK UCITS and UK Non-UCITS
Do UK UCITS have gearing facility?
Retail UK UCITs funds are not permitted to borrow for the purposes of gearing up. They can borrow short term up to 10% of the value of the fund to meet short term requirements on the fund such as the payment of a dividend or to meet a
payment out in the short term when capital inflows are expected in the near future. This would prevent them from having to sell investments. Non-Retail UK UCITs Funds can
borrow up to 10% but on a permanent basis.
This means that compared to a similar fund which is allowed to gear, a Unit Trust or OEIC will generally represent a lower
level of risk. Investment trust companies are an example of a fund which IS allowed to gear and we will look at these shortly.
What are UCIS
Funds which are not FCA authorised are collectively known as UCIS (unregulated collective investment schemes). These are
legal structures but are subject to strict marketing conditions along with the standard communication principles of being
clear, fair and not misleading. Since Jan 1st 2014, marketing of UCIS is restricted to ‘sophisticated investors’ and ‘high-net
worth individuals’ with the definitions of these being laid down in the FCA rules. They cannot be marketed to retail investors
in the UK and may not be covered by the Financial Services Compensation Scheme (FSCS). In addition, they are not subject to the same strict rules around management and how should operate. As a result of this there may be a greater risk of loss to the investor, making them typically higher risk.
The FCA consider UCIS as a type of non-Mainstream pooled investment (NMPI).
What is the structure of a Unit Trust and who is the legal owner?
Unit Trusts are structured as, oddly enough, trusts! This means that they have a trustee and the trustee is responsible for looking after the best interests of the investors, just as they would be with any other trust. The trustee is the legal owner of the assets and that the assets are held by a competent custodian (which is usually the trustees), all of which to ensure investor protection. If a unit trust is going to be marketed to the public in the UK then they must be authorised by the FCA.
The trustee is typically a large company (e.g a bank or insurance company) and must be regulated by the FCA and not connected to the unit trust manager (i.e. they must be
independent).
What are the trustees of a Unit Trust responsible for?
► Monitoring the manager – making sure that the manager is acting in accordance with the best interests of the investors and following regulation, the law, scheme rules,
and the trust deed.
► Setting up and holding a register of unit holders (though this can be delegated)
► Making sure that the assets are invested properly and as per the trust’s overall objectives. To do this, they can hire or
replace a fund manager either because of their decision or by majority vote from investors (unit holders).
► Auditing the trust, monitoring unit price calculation (sale and repurchase price to and from investors respectively), setting up meeting with unit holders.
► Creating the unit holder register and certificates along with paying out income to the unit holders and if necessary, making sure that the trust can be recognised as a scheme for a pension or charity.
What must be included in the trust deed of an unit trust
► Made between the unit trust manager and the trustee, it is legally binding and only when signed can the unit trust be created.
► Must contain the investment strategy and aims and objectives of the trust. This should be available for the investors to see.
► Must also contain the limitations of the investment strategy but in reality for authorised funds, nothing other than the statement that the fund can invest in eligible
markets regulated by the FCA needs to be included
► N.B. There is usually an accompanying document to the trust deed that covers dates for valuations and other
provisions known as the ‘scheme particulars’
What are the responsibilities of the unit trust manager
►Being authorised by the FCA
►Managing the assets in accordance with regulation, the law, scheme rules, and the trust deed.
►Investing the funds. This can either be done by the manager themselves but quite often this is outsourced to a specialist. However, the unit trust manager is still ultimately responsible for the actions of any third party they outsource to.
►Having sufficient resources to operate (e.g., financial)
►Keeping a register of the units issued for the trustee to reconcile against their unit holder register.
►Informing both the trustee and FCA of any regulatory breaches
►Providing information if requested by the trustees.
►Promoting and advertising the fund.
How often must authorised unit trusts publish their report?
Authorised Unit Trusts must publish reports at least twice a year including certain content, the details of which are set
out in the Statement of Recommended Practice for Unit Trusts.
How often muct authorised unit trust publish reports?
Authorised Unit Trusts must publish reports at least twice a year including certain content, the details of which are set
out in the Statement of Recommended Practice for Unit Trusts.
What type of funds do non authorised unit trust operate in
Whilst most Unit Trusts will be authorised Unit Trusts, it is also possible to operate a non-authorised Unit Trust. These generally operate for Pension funds and for Charities.
How is the fund taxed within an OEIC/Unit trust?
► Unit Trusts will not pay any corporation tax on gains within the fund nor on income or gains from futures and options,
► UK dividends will be treated as franked income and will be passed straight through to the investor for tax purposes. Whether there is further tax will depend on their tax position
► Interest and rental income are subject to corporation tax of 20%. If the fund pays out interest instead of dividends then the interest can be considered an expense for the fund to offset against corporation tax. This prevents double taxation.
► Foreign dividends may have already been taxed in that country, this is known as withholding tax and may not be reclaimable.
How often is income paid out from Unit Trust?
Income that is paid to the unit trust from the investments held within, is typically paid out to investors half yearly.
How does a equalisation payment work?
Now where
it gets a little complicated is the fact that the unit price paid by an investor when they want to invest will include this income
that has built up between the date it was last paid (distribution date) and the date investor buys the units (purchase date).
This essentially means that the investor has paid an inflated price for the unit and as such to compensate for this, when they receive their first distribution of income, they will also receive an extra amount equal to the amount of income that was included in the purchase price (the equalisation
payment).
There is no income tax on the equalisation payment as it is a return of capital. However, for capital gains tax calculations it needs to be deducted from the purchase price to calculate the base cost
How is income paid from a UT/OEIC taxed on the investor?
► For funds with less than 60% of assets in fixed interest or
cash, the income will be paid as a dividend. . A non-taxpayer will have no tax to pay and neither will anyone whose total dividends do not exceed the annual allowance for dividend income - £1,000 in 2023/24. Above this, a basic rate taxpayer will pay 8.75%, a higher rate taxpayer 33.75% and an
additional rate taxpayer 39.35%.
► For funds with greater than 60% of assets in fixed interest or cash, the income paid out will be treated as a distribution of interest. This will be paid gross but will be taxable and the Personal Savings Allowance can be used (£1,000 for basic rate
taxpayers, £500 for higher rate taxpayers, nothing for additional rate taxpayers!)
What is the CGT position to investors on gains arising from a UT/OEIC
The investor will pay Capital Gains Tax on disposal of the Units, 10% for basic rate taxpayers and 20% for higher rates
and is calculated in the normal way for CGT i.e. Sale price minus purchase price (units held before 31/03/82 have a purchase cost equal to their value as at 31/03/82). Then
deducting losses, then deducting the £6,000 annual exempt amount (2023/24).
What is the tax position on income reinvested within a UT/OEIC
The tax levied on income applies on an ‘arising basis’ - this means it is taxable whether it is reinvested or received by the
investor. The investor cannot escape tax simply by asking for distributions to be reinvested. This is REALLY important to
note. Sometimes the examiners will tell you that ‘Jon receives a £900 dividend under Unit Trust X and under Unit Trust Y
has a £600 dividend reinvested to buy extra units’. Both of these will be taxed in the year of entitlement whether invested or not.
What can increase the price of a UT
Unit Trusts are open ended investments. Where there is demand for more units, the manager will create more units.
As we saw earlier, this means that the value of units will be influenced by the underlying assets and not by supply and demand. For this reason, the total value of assets divided by the total number of units should give the broad unit price
UT - What is the maximum offer price
► Maximum offer price is broadly: the value of the underlying assets at published valuation point, plus uninvested cash, plus costs, less tax, fees and expenses, divided
by the number of units and then plus initial charge (4 significant figures)
UT - What is the mid bid price?
► Min bid price is broadly value of assets at best market prices, less costs of dealing to sell them, plus un-invested cash, plus accrued income (after charges and expenses), divided by number of units (4 significant figures)
What is the offer price?
► The offer price is the price at which the manager ‘offers’ units for sale to investors
