Collective investment schemes

Purpose

Diversification and lower portfolio risk

Access to expertise

access to large/ unusual investments

economies of scale (reducing investment expenses)

possible tax advantages

Closed and open ended

Closed-ended

Open-ended

e.g. ITC

once initial tranche of money invested the fund is closed to new money

After launch, only way of investing is to buy units from a willing seller

e.g. unit trust

managers can create or cancel units in the fund as new money is invested or disinvested

NAV

value of underlying assets divided by number of ordinary shares.

if gearing allowed, underlying assets would be net of debt liabilities

Characteristics of ITCs/ UTs

Stated investment objective

Closed/open-ended

written into prospectus/ offer for sale document (ITC)

Public company/ trust. Governed by company/trust law

Often quoted on the stock exchange (ITC)

Can raise both debt and equity capital (ITC)/ Limited ability to gear (UT)

Operated by

company directors and investment managers (ITC)

e.g. merchant banks or specialist ITC managers

trustees (UT)

e.g. insurance companies, large banks

investment managers (UT)

e.g. merchant banks

Buy shares/units

receive fees

price

often discount to NAV (ITC)

Based on NAV (UT)

Advantages vs direct investment

Access to larger/ more unusual investments

Discount to NAV (cheap) - ITC only

Diversification

Divisibility

Economies of scale

Expected return higher due to extra volatility (ITC only)

Due to gearing and changes to discount to NAV

Expertise of investment managers

index-tracking of a quoted investment index possible

marketability

quoted prices make valuation easier

suitable for small investors

tax advantages (possibly)

Disadvantages vs direct investment

loss of control

lack of diversification away from equities

additional layer of charges

Need to hold some cash for liquidity reducing expected exposure/ return (UT only)

extra volatility caused by gearing/ discount to NAV (ITC only)

tax disadvantages (possibly)

Differences between UTs and ITCs

Marketability

Shares in ITC less marketable than underlying assets

Guaranteed by managers (UT)

Liquidity

hold cash to maintain liquidity (UT)

lower expected returns

greater price stability

Gearing

ITCs can

UT limited

extra volatility

Discount to NAV

ITC shares more volatiltile

Size of discount can change

Similar to underlying assets (UT)

higher expected return

Uncertainty as to true level of NAV especially if unquoted

ITCs can invest in wider range of assets

differing tax treatment