Topic 8 Flashcards
Collective investment schemes
1
Q
What are the main legal forms of collective investment vehicles?
A
Unit trusts, investment trusts, investment bonds, and OEICs (Open-Ended Investment Companies).
2
Q
What is the role of an investment manager in collective investments?
A
They manage the fund, research companies, make investment decisions, and handle administrative tasks.
3
Q
How do collective investments reduce investment risk?
A
Through diversification, where funds are spread across many different companies to minimise losses from any single failure.
4
Q
Why do collective investment funds benefit from lower dealing costs?
A
Fund managers handle large investments and can negotiate reduced trading fees.
5
Q
What are the key advantages of collective investments?
A
Diversification, investment manager expertise, reduced dealing costs, and a wide choice of funds.
6
Q
How do collective investments provide access to certain assets?
A
They allow investors to access assets like corporate bonds, which may have high minimum investment requirements.
7
Q
What is diversification in investing?
A
Spreading investments across different areas, asset classes, and sectors to reduce risk.
8
Q
Why is diversification important for investors?
A
It helps balance losses from poorly performing investments with gains from better-performing ones.
9
Q
How can investment funds be categorised?
A
By location (e.g., UK, Europe, America, Far East), industry (e.g., technology, energy), type of investment (e.g., shares, gilts, fixed interest, property), or other specialisations (e.g., recovery stocks, ethical investments).
10
Q
Can funds have multiple categorisations?
A
Yes, for example, a UK equity fund is categorised by both location (UK) and type of investment (equity).
11
Q
What are the three main investment objectives of funds?
A
- High income with modest capital growth.
- Capital growth at the expense of income.
- A balance between income and growth.
12
Q
What are the two main management styles for investment funds?
A
Actively managed funds and passively managed (tracker) funds.
13
Q
What is an actively managed fund?
A
A fund where a fund manager makes decisions on which assets to buy or sell.
14
Q
What is a passively managed (tracker) fund?
A
A fund that aims to replicate the performance of a stock market index (e.g., FTSE All-Share), often using a computerised selection process.
15
Q
What is the alternative meaning of ‘managed fund’ as a marketing term?
A
A fund that allocates investments across multiple funds offered by the same company, such as a ‘managed growth’ or ‘managed income’ fund.
16
Q
What is the manager’s role in a company’s ‘managed fund’?
A
Deciding how investments should be allocated between the company’s other funds.
17
Q
What is a unit trust?
A
A pooled investment created under a trust deed, where investors buy units that represent a share of the trust’s total assets.
18
Q
What are the two main types of unit trusts?
A
Equity trusts, which invest mainly in shares and pay dividends, and fixed-interest trusts, which invest mainly in interest-yielding assets and pay interest.
19
Q
What does it mean for a unit trust to be “open-ended”?
A
The trust manager can create more units if demand increases, unlike closed-ended investments like investment trusts.
20
Q
What are the two types of unit trust units?
A
Accumulation units: Reinvest income for capital growth.
Distribution (income) units: Pay income to investors and may increase in value.
21
Q
How is the price of a unit calculated?
A
The total value of the trust’s assets is divided by the number of units issued, allowing for costs.
22
Q
What are the four key unit prices?
A
Creation price: The cost of creating units.
Offer price: The price investors pay to buy units.
Bid price: The price at which investors can sell units back to the manager.
Cancellation price: The minimum bid price after accounting for costs.
23
Q
What is the bid-offer spread?
A
The difference between the offer price (buying) and bid price (selling), typically 3%-5%.
24
Q
What is single pricing in unit trusts?
A
A pricing system where a single price is determined based on net fund flows, avoiding bid-offer spreads.
25
What is the difference between forward and historic pricing?
Forward pricing: The unit price is determined at the end of the dealing period.
Historic pricing: The unit price is based on the previous period's closing price (now rarely used).
26
Why is there no secondary market for unit trust units?
Unit trust managers are obliged to buy back units, so they are not traded on the Stock Exchange, making buying and selling simple for investors.
27
How can investors buy units in a unit trust?
They can buy units directly from managers or through intermediaries, using writing, telephone, or online methods.
28
What two documents may a unit trust investor receive?
Contract note: Confirms the fund, number of units, unit price, and amount paid.
Unit certificate: Proves ownership of the units.
29
How are units sold in a unit trust?
Investors sign the renunciation form on the unit certificate and return it to the managers. Non-certificated holdings require a separate renunciation form.
30
Who regulates unit trusts in the UK?
The Financial Conduct Authority (FCA) under the Financial Services and Markets Act 2000.
31
What are the borrowing limits for unit trusts?
A unit trust cannot borrow more than 10% of its net asset value, and only for a temporary period.
32
What are the key responsibilities of a unit trust manager?
Managing the trust fund in line with the trust deed.
Valuing fund assets and fixing unit prices.
Offering units for sale and buying back units.
33
What are the key responsibilities of unit trust trustees?
Setting investment directives and controlling assets.
Ensuring investor protection and approving marketing.
Supervising the unit holder register and issuing unit certificates.
34
How are unit trusts classified for tax purposes?
Fixed-interest (non-equity) funds: More than 60% in cash/fixed-interest securities → Income taxed as interest payments.
Equity funds: Less than 60% in cash/fixed-interest securities → Income taxed as dividends.
35
How is dividend income from an equity-based unit trust taxed?
Tax-free if within the dividend allowance (DA). If exceeded, it is taxed at rates based on the investor’s tax band.
36
What are the two main charges applied to unit trusts?
Initial charge: Covers purchase costs (usually in the bid-offer spread).
Annual management charge: Paid for professional management (typically 0.5% to 1.5% of fund value).
37
How is income from a fixed-interest unit trust taxed?
It is classed as savings income and paid gross (without tax deducted). Tax depends on whether it falls within the Personal Savings Allowance (PSA).
38
How does the legal structure of a unit trust help mitigate fraud risk?
The trustees ensure proper management, reducing the risk of fraud.
39
Why is investing in a unit trust generally lower risk than investing in individual equities?
Because unit trusts are pooled investments, typically spread across 30 to 150 different shares.
40
How does the risk level of a unit trust depend on the type of fund?
Different unit trusts cater to different risk profiles:
Cash funds: Low risk, similar to a deposit account.
Specialist funds (e.g., emerging markets): High risk.
Overseas funds: Additional currency fluctuation risk.
41
Are unit trusts guaranteed to return the initial capital or a specific income level?
No, there is no guarantee that the initial investment will be fully returned or that a specific level of income will be paid.
42
What is an investment trust?
A public limited company (plc) listed on the stock exchange and established under company law, unlike unit trusts which are not companies.
43
How is an investment trust different from a unit trust and an OEIC?
An investment trust is closed-ended, meaning the number of shares available remains constant, while unit trusts and OEICs are open-ended and can create more units as needed.
44
How can investors purchase and sell shares in an investment trust?
Shares in an investment trust can be purchased through a stockbroker, financial adviser, or directly from the manager, and sold via the same methods.
45
What factors affect the share price of an investment trust?
The share price is influenced by the underlying investments and supply and demand, and can trade at a premium (above net asset value, NAV) or discount (below NAV).
46
What is gearing in the context of investment trusts?
Gearing refers to the ability of investment trusts to borrow money to enhance potential returns. While this can boost growth in a rising market, it can exacerbate losses in a falling market, making investment trusts riskier.
47
How are investment trusts taxed?
Investment trusts pay income in the form of dividends, with at least 85% of income distributed to shareholders. They are exempt from corporation tax on capital gains, but investors may be subject to capital gains tax (CGT) on gains from the sale of shares.
48
What is a split-capital investment trust?
A split-capital investment trust offers different types of shares, such as income shares (receiving income but no capital growth) and capital shares (receiving no income but sharing in the capital growth when the trust ends). It is typically a fixed-term investment.
49
What is a real estate investment trust (REIT)?
A REIT is a tax-efficient property investment vehicle that allows private investors to invest in property without many of the disadvantages of direct property investment.
50
What are the advantages of investing in a REIT compared to direct property investment?
One key advantage is that REITs are subject to stamp duty reserve tax at 0.5%, while the rates for direct property purchases are much higher. Additionally, REITs are tax-efficient and avoid many direct property investment drawbacks.
51
What are the qualifying features that a REIT must meet?
A REIT must meet the following criteria:
At least 75% of gross income from property rent
At least 90% of profits distributed to shareholders
No shareholder can hold more than 10% of shares
Single-property REITs are allowed in special cases (e.g., a shopping centre with multiple tenants).
52
How are the profits of a REIT taxed?
REITs pay no corporation tax on income or growth from property rental income, but income and gains from other activities (e.g., development) are taxed. Dividends paid to shareholders are subject to tax at the dividend rates.
53
Can REITs be held in tax-advantaged accounts?
Yes, REITs can be held in ISAs, Junior ISAs, Child Trust Funds, and self-invested personal pensions (SIPPs).
54
What is an OEIC (Open‑Ended Investment Company)?
A limited liability company (LLC) that pools investors' funds to buy and sell shares of other companies and deal with other investments. It is called "open-ended" because the number of shares can increase or decrease based on demand.
55
How does the structure of an OEIC differ from that of an investment trust or unit trust?
Unlike an investment trust, which is a closed-ended company, an OEIC is open-ended, meaning it can issue or redeem shares based on investor demand. Additionally, OEICs can only borrow short-term for operational needs, unlike investment trusts.
56
How is the share price of an OEIC determined?
The share price of an OEIC is calculated by dividing the total value of assets by the number of shares in issue, similar to how the unit price of a unit trust is determined. Some OEICs use swing pricing, adjusting the price to reflect transaction costs from inflows or outflows.
57
How are OEICs regulated and managed?
OEICs are regulated under the Open‑Ended Investment Companies Regulation 2001 and associated FCA rules. They must be authorised by the FCA. The operations are overseen by a depositary and managed by an authorised corporate director who handles investments and share transactions.
58
What charges are associated with investing in an OEIC?
Investors in an OEIC may incur:
An initial charge (3%–5% of the investment value)
Annual management charges (typically 0.5% for index funds and 1.5% for actively managed funds)
A dilution levy, which adjusts the share price in response to large inflows or outflows
Other administration costs deducted from generated income.
59
How are UK-based OEICs taxed?
The tax treatment for UK-based OEICs is the same as for unit trusts. Income from fixed-income OEICs is subject to income tax as savings. Equity-based OEICs pay dividends without tax deduction, with income tax liability if the dividend income exceeds the investor’s dividend allowance. Fund managers are not subject to corporation tax on capital gains, but individual investors may be liable for capital gains tax (CGT) when selling their shares.
60
How are offshore OEICs taxed for UK residents?
For offshore OEICs, UK residents are liable for tax on income and gains. If the fund is a ‘reporting fund’, all income attributable to the investor is reported, and the investor will pay income tax on income and CGT on gains. If the fund is a ‘non-reporting fund’, the investor will pay income tax, not CGT, on any gains from the fund's disposal.
61
What are the risks of investing in an OEIC?
The risks of investing in an OEIC are similar to those of a unit trust. These include:
Compliance with FCA rules on diversification and borrowing, reducing risk.
Being a pooled investment, which generally lowers risk compared to investing in individual equities.
The ability to spread investment risk for relatively small amounts. However, there is no guarantee that the original capital investment will be maintained or that a specific level of income will be generated.
62
What are endowments?
Endowments are a type of investment based on life assurance, combining life assurance and regular savings. A lump sum is paid either if the life assured dies during the term or, if they survive, at maturity. Types of endowments include with-profits (low-risk with guaranteed minimum value) and unit-linked (value depends on underlying investments). Endowments are often used as repayment vehicles for interest-only mortgages.
63
What are friendly society plans?
Friendly society plans are tax-exempt savings plans offered by mutual organisations. These plans, which are effectively endowments with tax benefits, allow individuals to save on behalf of children and grandchildren. They are set up for an initial ten-year term, with no tax on encashment. There are limits to how much can be saved: £270 per year, £25 per month, or £75 per quarter.
64
What are investment bonds?
Investment bonds are collective investment vehicles offered by life assurance companies, structured as single-premium, whole-of-life policies. Investors pay a lump sum, which is converted into units of a chosen fund. The value of the bond depends on the units' value when cashed in. Investment bonds are attractive due to their ease of investment, simplicity, and flexibility in switching funds. With-profits bonds are also available, but the value may be less if cashed in early.
65
How are investment bonds taxed?
Investment bonds attract internal tax at 20% on capital gains, which is not recoverable by investors. Policies can be qualifying or non-qualifying for tax purposes. A qualifying policy has no tax liability on proceeds, whereas a non-qualifying policy may lead to a tax liability for higher- and additional-rate taxpayers. Non-qualifying policies are subject to tax even if the investor does not pay capital gains tax directly.
66
What are non-mainstream pooled investments (NMPIs)?
NMPIs are collective investment schemes that do not meet the criteria for regulated schemes under the FCA Handbook. They include unregulated collective investment schemes (UCIS), qualified investor schemes, securities issued by special vehicles, traded life policies, and certain rights or interests in these investments. NMPIs may invest in non-traditional assets and carry higher risks. They are generally only suitable for high-net-worth individuals, and their marketing to retail customers is restricted by the FCA.
67
What are structured products?
Structured products are investments that offer some protection of capital (up to 100% in some cases) while enabling investment in higher-risk assets like shares. They appeal to cautious investors who want potential growth without full exposure to market downsides. The FCA classifies them as either deposits or investments, depending on their characteristics.
68
What is a structured capital-at-risk product (SCARP)?
A SCARP is a structured product where the return of initial capital is linked to the performance of an index, a combination of indices, or a "basket" of selected stocks. If the performance stays within certain limits, the initial capital is repaid; if not, the customer may lose some or all of the invested capital. SCARPs provide a range of potential outcomes depending on the performance of underlying assets.
69
What is a non-SCARP structured investment product?
A non-SCARP structured investment product promises a minimum return of 100% of the initial capital invested, as long as the issuer(s) of the underlying financial instrument(s) remain solvent. The repayment of the initial capital is not influenced by market risks or performance factors, unlike SCARPs, where the repayment is tied to market performance.
70
What are the risks associated with structured products?
Structured products carry several risks, including:
Counterparty risk: The risk that the issuer may default.
Market risk: The risk of losing money due to market fluctuations.
Inflation risk: The risk that returns may not keep pace with inflation. Additionally, these products are complex, and investors must fully understand the terms, conditions, and risks before investing.
71
What is a wrap account?
A wrap account is an internet-based platform set up by a provider to hold all an investor’s investments within one framework. This allows the investor to view all relevant information in one place and analyse their holdings based on value, tax treatment, and product type. Wraps are generally offered by independent financial advisers, who charge additional fees on top of the individual fund management charges.
72
What is the difference between a wrap and a fund supermarket?
While both are referred to as 'platforms,' wraps and fund supermarkets differ in the investments they offer. A wrap can hold any class of asset or fund and provides a wider range of investment options, such as investment trusts, offshore investments, and direct equities. In contrast, a fund supermarket provides access to a wide range of funds, such as OEICs, unit trusts, and ISAs, but not investment trusts.
73
What is sustainable finance?
Sustainable finance refers to making investment decisions based on environmental, social, and governance (ESG) factors that are material to a firm’s profitability. This can include considerations like a company's environmental practices (e.g., paper recycling), social factors (e.g., employee treatment), and governance factors (e.g., transparency, tax fairness).
74
What are the potential advantages and disadvantages of sustainable investment?
Advantages:
Ethical funds meet the needs of clients who want to use their investments for the wider good.
Firms that take ESG seriously may be more forward-thinking and successful.
Many socially responsible funds have performed well.
Disadvantages:
Investing solely in ethical funds can limit diversification, reducing portfolio balance.
Companies with strong ESG scores are often smaller and more volatile, which can increase investment risk.
Many socially responsible funds are actively managed, leading to higher charges.
There is the risk of ‘greenwashing’, where firms make unsubstantiated sustainability claims.
75
What are cryptoassets?
Cryptoassets are a digital representation of value, whose ownership is cryptographically proven using computer code. They do not have equivalent physical manifestations and typically exist only notionally. Bitcoin is the first and most well-known cryptocurrency.
76
How do cryptoassets work?
Cryptoassets work by creating a digital wallet, generating a pair of keys: a public key (account number) and a private key (PIN). These keys are used for sending and receiving transactions, proving ownership. Transactions are validated using distributed ledger technology (DLT) on networks like blockchain. Blockchain records transactions in "blocks," creating an irreversible, auditable, and transparent transaction trail.
77
What are the three categories of cryptoassets identified by the UK Cryptoassets Taskforce (CATF)?
Exchange tokens: Used as a means of exchange, typically decentralised, for buying and selling goods and services.
Utility tokens: Grant holders access to a product or service but do not provide rights similar to specified investments.
Security tokens: Provide rights and obligations similar to specified investments like shares or debt instruments.
78
How were cryptoassets regulated before and after 2023 in the UK?
Before 2023, cryptoasset firms were subject to anti-money laundering (AML) and terrorist financing checks, but cryptoassets were not generally regulated by the FCA. This changed in October 2023 with the FSMA 2000 (Financial Promotion) (Amendment) Order, which brought qualifying cryptoassets under the FCA’s remit for financial promotions. Firms must now be authorised or registered with the FCA to promote cryptoassets, ensuring clear risk warnings and appropriate advertising.
79
What requirements must firms meet when promoting cryptoassets to UK consumers?
Firms must be authorised or registered with the FCA or have marketing approved by an authorised firm. They must include clear risk warnings, ensure advertisements are not misleading, and implement a 24-hour cooling-off period for first-time investors. Additionally, firms must conduct client appropriateness testing and categorise clients into appropriate categories such as restricted, high-net-worth, or certified sophisticated investors.
