Topic 6 - Managed Funds

Question 1

Why would you want to invest in managed funds?

Answer 1

Question 2

What are the main advantages of investing in a managed fund?

What is an MIS?

Question 3

What are the main characteristics of managed funds?

Answer 3

Question 4

As a pooled investment structure a managed fund provides investors with the potential to benefit from:

Answer 4

Question 5

What is ASICs role in the regulation of financial services?

Answer 5

Question 6

How does the Australian Prudential Regulation Authority (APRA) and the Reserve Bank of Australia (RBA) regulate the financial services sector?

Answer 6

Question 7

Explain this diagram.

Answer 7

PDS:

• rights
• responsibilities
• risks
• expected returns

Question 8

What is the definition of a single responsible entity (RE)?

Answer 8

Question 9

What must a managed investment scheme (MIS) include?

Answer 9

Question 10

When is a PDS required?

Answer 10

Question 11

Define unitholders.

Answer 11

Question 12

What are the diversification advantages of investing in managed funds?

Answer 12

Question 13

What are the main downsides of investing in a managed fund?

Answer 13

Question 14

Comment on the market and security risk of investing in managed funds.

Answer 14

Question 15

Comment on the currency and liquidity risk of investing in managed funds.

Answer 15

Question 16

Comment on the gearing and taxation risk of investing in managed funds.

Answer 16

Question 17

What types of fees may be charged under a MIS?

Answer 17

Question 18

What is the indirect cost ratio (ICR)?

Answer 18

Question 19

What is the management expense ratio (MER)?

Answer 19

Question 20

What are some criteria for selecting a managed fund?

Answer 20

Question 21

Name some characteristics of unlisted managed funds.

Answer 21

Question 22

Describe this formula:

Answer 22

Question 23

Differentiate between a listed investment company and a listed investment trust.

Answer 23

Question 24

Differentiate between real estate investment trusts and exchange-traded funds.

Question 25

List some multi-sector funds.

Answer 25

Question 26

Describe master funds and wrap accounts.

Answer 26

Question 27

Differentiate between active and passive investment styles.

Answer 27

Question 28

Differentiate between value fund and growth fund managers.

Answer 28

Question 29

What is the taxation office position on managed funds?

Answer 29

Question 30

What are the similarities and differences between the performance of a managed fund and other direct investments?

Answer 30

Question 31

Differentiate between standard deviation and tracking error.

Answer 31

Question 32

What is an information error (excess return/tracking error)?

Answer 32

Question 33

What is the Sharpe ratio?

Answer 33

Question 34

What are the main summary points of managed funds?

Answer 34

Question 35

What are the advantages and disadvantages of investing in managed funds?

See pages 242-245 of the textbook

Answer 35

Advantages of investing in managed funds include:

• The ability to invest with relatively small amounts of funds
• The ability to achieve effective diversification – across different managers, management styles and asset classes
• The ability to generally withdraw funds if needed within a short period of time
• Funds are managed by a professional manager
• Franking credits attached to dividends received by the managed funds are passed onto the investor

The drawbacks associated with investing in managed funds include:

• The costs charged by the fund (ICR - indirect cost ratio)
• The possibility of funds being frozen within the fund
• The investor has no control over what specific investments are acquired and sold by the fund manager and of its timing

Question 36

What factors should an investor consider before deciding to invest in a particular managed fund?

Learning objective 7.5., pages 248 – 256 of textbook

Answer 36

An investor would consider the following factors when deciding to invest in a particular managed fund:

• The investment objective of the fund which encompasses a wide range of issues such as its time horizon; income and capital growth mix; the level of volatility and the type of investments targeted.
• The historical returns of the fund
• The types of investments undertaken by the fund. For example the proportion of bonds, shares and listed property that the fund typically holds. Knowing the types will provide a rough guide on the expected returns, level of diversification and level of risk that the fund undertakes.
• Whether the fund actively picks assets or is a passive investor. An active fund will use research to find perceived under-priced assets while a passive fund will track a certain benchmark (e.g. the ASX/S&P 200).
• The fees and charges of the fund as higher fees will reduce the total return of the fund if it is not commensurate with higher risk-adjusted returns. These may include management fees and the bid-offer spread when getting into and out of the fund.
• Whether the fund is listed on the stock exchange or unlisted. The main difference is that listed funds are predominantly bought and sold through the stock exchange while unlisted must be invested through the fund provider.

Question 37

Why have some unlisted property and mortgage managed funds suffered from liquidity problems in the past?

Pages 246 and 249

Answer 37

There may have been a run on the funds (e.g. during GFC) where investors seek to withdraw all funds and the fund does not hold onto sufficient liquidity. During the GFC a number of property and mortgage funds faced a run of withdrawals due to lack of confidence and were forced to suspend redemptions due to lack of cash holdings.

Assets of the fund are tied up in long-term investments (property and long-term mortgages) that can’t be quickly liquidated.

Equity funds, in particular, are liquid and can be easily disposed of, albeit at a loss, to provide liquidity to investors

Question 38

Are there reasons why an investor would not simply invest all their funds into the managed fund that has delivered the highest return to investors over the past year?

Page 262 and 263

Answer 38

Like for any investment, past performance is not an indicator of future performance.

A fund with the highest performance in the past year may have achieved this through luck or high risk and these are not sound investment criteria.

Rather,

• a careful analysis of the fund’s investment objective;
• their level of diversification and risk;
• and the consistency of their performance to their investment benchmarks are better criteria for picking a fund.

Question 39

What is the difference in management style between an active fund manager and a passive (index) fund manager? Why would an investor want to invest in an actively managed fund if its management expense ratio (MER) was higher than that of an index fund?

Pages 258- 260

Answer 39

The difference in management style between an active and passive fund is the belief of being able to outperform its target investment benchmark (e.g. the S&P/ASX 200 or the NASDAQ 100).

An active fund will use research in hopes of building a portfolio of under-priced assets that will outperform the target benchmark.

A passive fund will simply build a portfolio to track a benchmark in order to achieve benchmark returns.

An investor may want to invest in an active fund with an indirect cost ratio (ICR)/management expense ratio (MER) higher than an index fund if it is able to consistently achieve a net return that exceeds the net return of a passive fund with the same target benchmark.

Question 40

Why have wrap accounts and master funds become such popular investment vehicles with clients and especially financial planners?

Page 256

Answer 40

Some of the reasons include:

• They provide a simple administrative structure for managing investments
• They provide a consolidated statement of funds held and tax situation
• They provide an easy means of achieving effective diversification
• They allow an investor to change investments and funds without withdrawing funds from the structure
• These structures can provide investors with the opportunity of investing in a wide range of different types of investments – e.g. term deposits, direct shares, managed funds and cash
• They allow a financial planner to easily and quickly monitor a client’s investment portfolio including a listing of each investment, overall asset allocation, the performance of each investment, unrealised capital gains indicating gains payable if the asset was sold.

Question 41

What are the advantages of investing in one managed fund that invests across all asset classes compared with investing in a number of different managed funds that each invest in a separate asset class?

Page 254 and 256

Answer 41

Some of the advantages of investing in a diversified fund include:

Ease of administration and management for the investor- managing only one fund rather than a number of funds

Automatic rebalancing and re-weighting of funds between asset classes - this is done by the fund rather than the investor being required to monitor the weighting of their separate investments

Management costs of a diversified fund may be lower

Question 42

Would you recommend that an investor allocate their entire international share exposure to an emerging markets fund, such as China or India? Provide reasons.

Answer 42

Allocating the entire international share exposure to emerging market funds for an investor is unusual. It would depend on the level of risk that the investor is willing to bear and his/her preferences to emerging markets.

Emerging markets are riskier than other international shares as they are more sensitive to the upturns and downturns of the global economy. They also have greater country-specific risk such as to their government policies and global trade ties. It would, therefore, take a very aggressive investor to seek such an exposure.

Rather, an investor should seek to diversify their international share exposure across markets and/or allocate a larger percentage of their portfolio to international shares. That way they would reduce country-specific risk while keeping exposure to the global economy.

Question 43

Calculate the unit price of this fund using the following information:

Page 250

Answer 43

Net assets / number of units issued:

Total assets – Total Liabilities / number of units issued = 295m – 110m /11,109,657

= $185m/11,109,657 units = $16.65 per unit

Question 44

Analysing performance **

(a) Calculate the Sharpe index for the following funds:
(b) Explain the difference between the two results to a potential investor.
(c) Which fund would you invest in? Explain.
* Page 266 and 267*

Answer 44

Return for Fund A

RA = (7.18-6.54)/6.54 = 9.78%

Sharpe Index for Fund A

SI = (0.098- 0.035)/0.76 = 0.0829 = 8.3%

Return for Fund B

RB = (2.75-2.25)/2.25 = 22.2%

Sharpe Index for Fund B

SI = (0.222- 0.035)/0.98 = 0.191 = 19.1%

(b) The standard deviation is a measure of the systematic risk of the portfolio, and the second portfolio includes stocks with higher risk. Even so, after allowing for this higher risk, the second portfolio manager achieved a higher risk-adjusted return.
(c) Given only the returns and standard deviations of the funds, an investor choice would depend on his/her attitude to risk. In general, fund B is preferred as it has a higher Sharpe Index (i.e. higher return per unit of risk). However, an investor who has a lower tolerance to risk may prefer fund A as they may be willing to give up a higher risk-adjusted return in fund B for reduced risk.

Question 45

Cash management funds would be unlikely to invest in which of the following assets?

Select one:

a. Overnight deposits.
b. Mix of short and medium-term government securities.
c. Mix of international short-term government securities.
d. Mortgage loans.

Answer 45

d. Mortgage loans.

Question 46

A diversified managed fund adopting a conservative investor risk profile:

Select one:

a. is designed for investors seeking short-term growth returns.
b. would include mainly longer-term growth-type investments.
c. would likely seek out investment in small companies, private equity funds and emerging markets.
d. none of the above.

Answer 46

d. none of the above.

Question 47

The calculation of an absolute return arising from the recent sale of a managed fund requires which of the following information?

Select one:

a. Purchase price, inflation rate and risk-adjusted sale price.
b. Purchase price and inflation rate.
c. Purchase price and risk-adjusted sale price.
d. Purchase price and actual sale price.

Answer 47

d. Purchase price and actual sale price.

Question 48

Beta risk is particularly relevant for fund managers adopting which investment approach?

Select one:

a. Passive investing
b. Active investing.
c. Contrarian investing.
d. None of the above.

Answer 48

a. Passive investing

Question 49

The relationship that exists between unsystematic risk and the number of securities held in an investment portfolio is:

Select one:

a. non-applicable as no relationship exists.
b. inverse until unsystematic risk is removed.
c. positive until unsystematic risk is removed.
d. inverse up to a maximum of 10 securities and then positive.

Answer 49

b. inverse until unsystematic risk is removed.

Question 50

Unlisted managed funds that have a bid-offer spread to allow for transaction costs:

Select one:

a. provide a selling price higher than the buying price.
b. provide a buying price higher than the selling price.
c. provide a buying price equal to the selling
d. none of the above.

Answer 50

b. provide a buying price higher than the selling price.

Question 51

The constitution of a managed investment scheme (MIS) includes matters such as:

Select one:

a. the cost of buying interests in the scheme.
b. the name of the auditor of the MIS.
c. both a and b.
d. none of the above.

Answer 51

c. both a and b.

Question 52

Investing in asset classes directly or indirectly via managed funds results in:

Select one:

a. different risk outcomes but the same return relationships.
b. the same risk outcomes but different return relationships.
c. the same risk and return relationships.
d. all of the above.

Answer 52

c. the same risk and return relationships.

Question 53

The management expense ratio (MER) is a ratio of fees charged to the:

Select one:

a. book value of assets under management.
b. market value of assets under management.
c. unit price of the fund.
d. none of the above.

Answer 53

b. market value of assets under management.

Question 54

According to the Australian Securities and Investments Commission (ASIC), a managed investment scheme (MIS), commonly known as a managed fund, exists where:

Select one:

a. people are brought together to contribute money to obtain an interest in the scheme.
b. money is pooled together with other investors or used in a common enterprise.
c. a responsible entity operates the scheme and hence investors do not have day-to-day control over the operation of the scheme.
d. all of the above.

Answer 54

d. all of the above.

Question 55

With managed funds it is NOT possible to diversify across:

Select one:

a. asset classes.
b. management styles
c. investment sectors.
d. none of the above

Answer 55

d. none of the above

Question 56

The underlying value of units in an unlisted managed fund is based on the

Select one:

a. net prevailing market value of the fund’s investment portfolio divided by the number of units issued.
b. supply and demand for those units.
c. inflation-adjusted value of the fund’s net assets.
d. none of the above.

Answer 56

a. net prevailing market value of the fund’s investment portfolio divided by the number of units issued.

Question 57

The main contributors to the overall growth in funds under management has/have been the:

Select one:

a. deregulation of financial markets in the 1980s.
b. increase in superannuation contributions made by employers since 1990.
c. both a and b.
d. an increase in the savings ratio in the domestic economy.

Answer 57

c. both a and b.

Question 58

Unlisted managed funds:

Select one:

a. are closed-ended structures.
b. are structured so that a prospective unitholder will purchase units from other unitholders.
c. operate as a trust structure and issues units to investors.
d. all of the above.

Answer 58

c. operate as a trust structure and issues units to investors.

Question 59

Managed funds are popular because they allow investors to gain:

Select one:

a. access to a wide range of different asset classes.
b. exposure to different industry segments.
c. diversification across a range of different investment types.
d. all of the above.

Answer 59

d. all of the above.

Question 60

The information ratio:

Select one:

a. ignores market movements from returns but instead adjusts for the risk undertaken.
b. is used as a risk-adjusted measure of the relative performance of a portfolio.
c. helps to answer the question, ‘Was the manager sufficiently rewarded for the risk incurred by deviating from the benchmark?’.
d. all of the above.

Answer 60

d. all of the above.

Question 61

Nominate the incorrect statement in relation to the standard deviation:

Select one:

a. Standard deviation is the statistical measurement of the dispersion of outcomes around a mean.
b. A higher measure of standard deviation infers higher risk
c. In approximately 99% of the time, the returns will vary plus or minus two standard deviations from the average.
d. All of the above.

Answer 61

c. In approximately 99% of the time, the returns will vary plus or minus two standard deviations from the average.

Question 62

The indirect cost ratio (ICR):

Select one:

a. measures management costs not deducted directly from investors’ account balances to the average net assets of the fund.
b. measures the average net assets of the fund divided by the management costs deducted directly from investors’ account balances.
c. approximates current performance bonuses.
d. all of the above.

Answer 62

a. measures management costs not deducted directly from investors’ account balances to the average net assets of the fund.

Question 63

The four main types of listed managed fund structures operating through the ASX

Select one:

a. LICs, LITs, REITs and ETFs.
b. LIRs, LITs, RDITs and ETFs.
c. LICs, LITs, RDITs and ETAs.
d. none of the above.

Answer 63

a. LICs, LITs, REITs and ETFs.

LICs - listed investment companies

LITs - listed investment trusts

REITs - real estate investment trusts

ETFs - exchange-traded funds

Question 64

Passive fund managers attempt to:

Select one:

a. outperform the market.
b. time the market.
c. replicate the performance of the index.
d. all of the above.

Answer 64

c. replicate the performance of the index.