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Collective investment schemes (Reasons for using (Professionally managed…
Collective investment schemes
May be referred to as pooled investments or mutual funds are schemes or arrangements where many investors collectively invest their monies into a single fund rather than make any single investment by themselves
Provide investors as a collective the opportunity to invest easily and at relatively low cost, pooling their money into a professionally managed and diversified portfolio
Investor should aim to find a scheme that reflects their investment aims and objectives
Such funds hold a variety of diversified underlying assets including equities, property and bonds
It is likely that any single fund will have a very diversified portfolio which may hold many hundreds of different stocks in order to mitigate the investment risk of the underlying portfolios
Remove the burden form an investor of having to monitor the underlying portfolio assets, this exercise will be performed by the fund manager who will also make any decisions concerning investments in the underling assets but within the scope of the agreed mandate
Objective to provide returns for the funds investors, in the form of either capital growth or income as dividends paid to the unit holders or shareholders in direct proportion to the number of units they own
Considered to be far less risk involved in holding a basket of shares when compared to the risks associated with investing in a single company share or a handful of assets or indeed a single asset class as the likelihood of failure is reduced
May be used to gain exposure to specialised markets where direct investment would be too risky or expensive to undertake as a single investor
Holding investments in more than one geographical region can also form part of a diversified investment strategy
Managers benefit from the support of multiple teams including both researchers and analysts who help in making investment decisions. This expertise would then be used to achieve returns for the investors
May or may not be regulated
In the UK the creation of a CIS is deemed to be a regulated activity and must be authorised by the FCA
An arrangement that enables a number of investors to 'pool' their assets and have these professionally managed by an independent manager
Reasons for using
Professionally managed diversified funds
This element of diversification helps to reduce the level of risk rather than investing in just a handful of securities
Some funds have a range of diversified assets including bonds, equities, property and near cash assets which others will be more specialised funds in terms f geographical area, sector or equities
Provide investors who may only have a relatively small amount of capital with the opportunity to obtain exposure to areas in which they would not ordinarily be able to do by themselves
Afford exposure to a diversified portfolio which they would not be able to do by themselves
Offer a spread of risk because they diversify and thus naturally spread the risks
Reduce the administrative burden for investors
Allow losses in some areas to be counterbalances with profit in others - provided that there is sound management
Allow access to professional expertise in dealing with the specified asset classes
Offer portfolio administration at a relatively low cost
Are suitable for investors without financial acumen or limited time to invest
Reduce the cost of having to employ an investment manager directly
Eliminate day to day monitoring which is the case for some derivative instruments such as CFDs
The scheme manager will use the fund to invest in various asset classes through a variety of securities with not all having the same level of risk
Investors should be mindful of the underlying assets comprising a particular fund and ensure that they are happy with the level of associated risk. Profits will be made by selling units or shares at a higher price than the price paid
Types
Open ended
Always open to new investors and have a variable asset pool
Could issue an unlimited amount of units to investors
The managers will make the market for the units and will always sell or buy units at or very near to their Net Asset Value (NAV
Scheme managers are obliged to buy units back from unit holders should the unit holder wish to cash in their investment
Whenever a new investor chooses to investment money or an existing investor chooses to withdraw money in the open ended fund, this net asset value is equal to the price and weight of the securities in the fund
Bought and sold on demand at their NAV, which is based on the value of the fund's underlying assets less all liabilities
NAV is calculated as the total value of the underlying assets divided by the number of units in issue and is usually calculated each trading day at a specific time (and shown on a per unit basis)
Units/shares are always directly purchased from and sold to the fund manager and never on the secondary market
The fund management company is always prepared to sell units to new investors thus increasing the overall pool of assets
The funs received from investors are added to the existing portfolio and will be used to buy more assets and thus create more units
The number of units in existence will change daily and the size of the fund will expand or contract as new investments into the fund are made and thus new units created
The total value of the fund changes not only as a result of incoming or outgoing funds but also due to any appreciation of depreciation in the value of the individuals underlying assets which comprise the portfolio as these will change on a daily basis
Forward pricing
All open ended schemes are subject to forward pricing
When investors either buy or sell units they will not know at the time when they place their order the actual price they will have to pay or the amount they will receive for their units
The cost or the proceeds will not actually be known until the deal is completed
he fund is revalued each business day – for example, at 12:00 noon. Therefore, if an order had been placed at perhaps 9:00 a.m. the same day, investors will not know the execution price until after 12:00 noon. If an order is placed after 4:30 p.m., the price will not be known until after noon on the next business day
The rationale underpinning this is to act as a deterrent to short-term trading which would adversely affect the fund managers investment strategies
Closed ended
A fixed amount of share capital usually raised by an IPO
The asset pool and number of shares will not increase
Issued shares will be traded on the secondary market and subject to the usual forces of supply and demand
Additional funds may be raised by those methods employed by companies eg a rights issue
Not open to new investors and their share capital is limited - neither expanding nor contracting in response to investor demand
Total expense ratio
The measure of the total cost of managing and operating an investment fund to the investor. It is calculated by dividing the fund's total annual costs by the fund's total asset value for the year and is expressed as a percentage
Total expenses include management fees, auditors fees, custodian fees and dealing charges
The larger the TER the more impact it will have on a fund's performance especially if the investment is held for a long period
The TER does not include costs such as bid/offer spreads, commissions or market impact costs
Since the RDR, the cost of investing in collective funds has reduced, which means TERs will fall to the benefit of investors. It should be noted that with increased transparency of costs under MiFID II, charges will become lower
Funds of funds with an absolute return objective can be worth the higher charges levied if the fund is successful. Such funds invest in equities, bonds and alternative asset classes, moving the level of exposure between these asset classes depending on market conditions to obtain a positive return
The performance of a fund often depends on the manager. There are four important characteristics that a fund manager should possess
integrity: they do what they say they will do;
technical competence;
ability to communicate competence and integrity through numbers: that is, good performance compared to the market conditions
permanence: the length of time a manager has run a fund is important as frequent changes of manager may result in a fund underperforming
ITAP