CHP 18

Question 1

Collective investment schemes (CIS) provide structures for management of investments on a grouped basis.

Answer 1

They provide the opportunity for investors to achieve wide spread investments and thus lower portfolio risk.
Managers of these are likely to be specialists in their area.
Closed-ended, cannot take in new money after the tranche is closed. Can only purchase units from a willing seller, thus works the same as ordinary shares of a company.

Question 2

Regulations for CIS vary in different countries, typically regulation will cover aspects such as:

Answer 2

•	Categories of assets that can be held
•	Whether unquoted assets can be held 
•	The maximum level of gearing
•	Any tax reliefs available
Some schemes may only be available to certain classes of institutional investors, such as pension funds.

Question 3

1. Investment trusts

Answer 3

These are closed-ended funds.
They are public companies whose function it is to manage shares and other investments.
They have a capital structure exactly the same as other public companies and can raise debt or capital.
Mot investment trusts are quoted on the stock exchange and can be bought and sold similar to other quoted shares.

Question 4

The main parties in an investment trust are:

Answer 4

• Board of directors – responsible for the direction of the company.
• Investment managers – day-to-day investment decisions, the same group of managers may manage more than one investment trust but with different directors.
• Shareholders
Investment trusts usually have a stated investment objective, and new investment trusts usually have this written into their prospectus or offer for sale documents.

Question 5

2. Unit trusts
   Open-ended, they are trusts and thus not subject to company law.
   Main parties:

Answer 5

• Management company
• Trustees – often an insurance company or a large bank. The role of the trustees is – as with any trust – to ensure that the managers obey the trust deed. They oversee the calculation of bid and offer prices and see that the unit trust is run in a legal manner with the admin being properly conducted. The fees of the trustees are paid by the managers.
• Investors
Investors buy units in a unit trust that will have a stated investment objective.
Units can be created or cancelled, depending on the demand for them.
Unit trusts have limited power to borrow against their portfolio. They can generally only invest the funds entrusted to them by unit holders.

Question 6

3. Open-ended investment companies (OEICS)

Answer 6

This is a cross between unit trusts and investment trusts.
They are open-ended, units are priced at Net Asset Value.
They are governed by company law and entry and exit prices are explicit.

Question 7

4. Difference between open-ended and closed-ended funds

Answer 7

• Marketability of closed-ended funds are often less than that of the underlying assets. The marketability of open-ended funds is guaranteed by the managers.
• Gearing for closed-ended funds can make the price more volatile than the underlying equity. Most open-ended funds can only be geared to a limited extent.
• Shares in closed-ended funds are more volatile than the underlying because the size of the discount can change. Volatility of open-ended price should be the same as the underlying assets.
• The increased volatility in closed-ended means that they should provide a higher expected return.
• Closed-ended may have uncertainty about the true level of net asset value per share, especially if the investments are unquoted.
• Management charges are usually higher for open-ended funds
• Closed-ended funds may be able to invest in a wider range of assets than unit trusts.
• It may be possible to buy assets at less than net asset value in a closed ended fund.
• They may be subject to tax at different rates.

Question 8

5. Indirect versus direct investment

Answer 8

• Control
• Diversification
• Expertise and specialization
• Expenses
• Marketability
• Taxation
• Expected returns and risk
• Gearing
• Discount to net asset value
• Volatility
• Individual investment products

Question 9

5.1. Advantages of collective investment vehicles/schemes

Answer 9

• Useful for obtaining specialist expertise
• Easy way of obtaining diversification
• Avoid some costs of direct investment management
• Holdings are divisible
• Tax advantages
• Marketability advantages (could also be less marketable than the underlying share)
• Can be used to track the return on a specific index.

Question 10

5.1. Disadvantages of collective investment vehicles/schemes

Answer 10

• Loss of control
• Management charges are incurred
• There may be tax disadvantages such as withholding tax that cannot be reclaimed.