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