WEEK 8

Unit Trusts, Investment Trusts, and OEICs (Collective Investment Schemes)

Learning Objectives

• Understanding different categories of Unit Trusts and OEICs and their uses.

• Explaining pricing and charging systems.

• Describing functions of key personnel (managers, trustees, directors, depositories).

• Discussing taxation effects on funds and investors.

• Distinguishing between various multi-manager products available.

• Explaining the workings of Investment Trusts.

• Differentiating main types of Investment Trusts and share classes.

• Understanding tax positions of Investment Trusts.

Collective Investments

• Definition: Investments pooled together from multiple individuals.

• Advantages:

  • Pooling resources leads to reduced costs.

  • Investment decisions are managed by professionals.

  • Ability to invest in specialized areas and achieve specific objectives.

  • Lower transaction costs compared to individual investments.

• Disadvantages:

  • Limited selection of investments.

  • Potential loss of direct ownership rights for investors.

Funds Sectors & Categories

• Divided into five broad categories by the IMA:

  1. Capital protection funds: Focus on preserving capital.

  2. Income-targeting funds: Aimed at generating steady income.

  3. Growth-targeting funds: Focused on capital appreciation.

  4. Specialist funds: Invest in specific sectors or strategies.

  5. Unclassified funds: Do not fit into the above categories.

Investment Powers and Restrictions

• Importance of rules: Protect investors and ensure sound management.

• Key elements:

  • The Trust Deed: Governing document outlining fund policies.

  • Investment limits: Regulations to restrict risky investments.

  • UCITS and Non-UCITS Schemes: Standardized regulatory frameworks across Europe.

  • Qualifying Investor Schemes (QIS): Special provisions for professional investors.

  • Approved securities: Clear guidelines on eligible investment products.

  • Diversification: Rules to spread risk across various investments.

Unit Trust Managers & Trustees

• Key roles:

  • Trustees: Control assets, audit accounts, distribute income.

  • Managers: Responsible for asset management and regulatory compliance.

• Registration and reporting: Regular obligations to stakeholders and regulatory authorities.

Taxation of Collective Investments

• General Tax Treatment: Understand the distinction between various groups of investors:

  • Group 1: Investors before ex-dividend date.

  • Group 2: Investors after ex-dividend date.

• Income Distribution: Tax considerations for investors receiving income from investments.

• Capital Gains Tax: Implications for investors on selling units.

• Tax Link with ISAs: Utilizing ISAs for tax-efficient investing.

Open-Ended Investment Companies (OEICs)

• Definition: OEICs are self-contained investment structures not classified as investment trusts.

• Key differences from Unit Trusts:

  • Structure: Standalone or umbrella companies.

  • Share classes: Offer various classes, currencies, and fee structures.

  • Regulation: Must maintain annual audited accounts.

  • Borrowing limits: Similar restrictions to Unit Trusts.

Investment Trusts Overview

• Definition: Investment trusts are public limited companies offering shares to investors.

• Classification:

  • Based on sectors (22 main, 5 property, 12 specialist structures).

• Common types:

  • Global Growth, UK Growth, Asia Pacific, Emerging Markets.

Working of Investment Trust Companies

• Independent Board of Directors: Oversees fund management.

• Responsibilities of Managers: Handle day-to-day operations and adherence to regulations.

• Share Price Management: Interaction between share price, net asset value (NAV), and investment performance.

Capital Structure of Investment Trusts

• Types:

  1. Conventional: Limited-life investment trusts.

  2. Split capital: Structure includes redemption yields and specific hurdle rates.

Share Classes in Investment Trusts

• Categories:

  • Ordinary shares: Common equity.

  • Preference shares: Fixed dividends with priority over ordinary shares.

  • Zero Dividend Preference Shares: No dividends until redemption.

  • Income and Capital Shares: Divided based on income or growth objectives.

Gearing, Charges, Dividends, and Taxation

• Gearing and Associated Risks: Leveraging assets to enhance returns.

• Charges: Management and other fees impacting net returns.

• Dividend taxation: Understanding implications for personal investors.

Key Differences: Investment Trusts vs. Unit Trusts & OEICs

• Cost Efficiency: Generally lower share purchase costs in Investment Trusts.

• Management Charges: Older Investment Trusts may have lower annual management charges compared to Unit Trusts and OEICs.

• Risk-Reward Profile: Investment Trusts often carry higher risk but offer higher potential returns.

• Structure: Investment Trusts are closed-ended, while Unit Trusts and OEICs are open-ended funds.

Conclusion

• Collective investments present many advantages, including professional management and cost efficiencies, but they can limit investor choices and ownership rights.

• Understanding the variety of collective investments is crucial for aligning with investor goals and preferences.

• Recommended to review additional materials for deeper understanding of collective investments: video clips and reading materials available on educational platforms.

Understanding Collective Investments: An In-Depth Look

Collective investments are a popular financial tool where funds from multiple investors—whether individuals or institutions—are pooled together into a single investment vehicle. This collective approach allows investors to diversify their portfolios more efficiently than they might be able to individually, especially if they lack the necessary capital or expertise to access diverse markets and sectors. By joining forces, investors can share the risks and rewards of investing, making it easier to navigate the complexities of financial markets.

Advantages of Collective Investments

One of the primary advantages of collective investments is the pooling of resources, which leads to reduced costs. When funds are aggregated, investors can benefit from economies of scale. This results in lower transaction fees, fund management fees, and other administrative expenses that would otherwise be higher if individuals were making investments independently. This pooling power ensures that the cost per investor is minimized, making collective investments an appealing option for those looking to reduce their expenses while investing.

Another significant advantage is that investment decisions are managed by professionals. Fund managers, who are experts in their field, make the decisions on behalf of the investors. This professional oversight allows individuals who may not have the time, knowledge, or inclination to manage their investments to still benefit from expert management. This access to professional expertise opens doors to more sophisticated strategies and broader investment opportunities.

Collective investments also offer the ability to invest in specialized areas that would otherwise be inaccessible to individual investors. For instance, investors can gain exposure to emerging markets, high-risk ventures, or niche sectors like technology or healthcare without needing to directly invest in these areas themselves. This diversification into specialized markets helps investors achieve specific financial objectives and strategies that might not be possible through personal investments alone.

Furthermore, collective investments generally have lower transaction costs compared to individual investments. The bulk buying and selling of securities allow funds to negotiate lower commissions and fees with brokers. This results in cost savings that can enhance overall returns for investors.

Disadvantages of Collective Investments

Despite the many benefits, collective investments come with certain disadvantages. One of the drawbacks is the limited selection of investments. When investing in a collective fund, investors must accept the fund’s investment strategy and the specific assets it holds. While this can provide professional management and diversification, the range of investments may not align with every individual’s preferences. Some investors might prefer more control over their investment choices and may feel restricted by the fund’s focus.

Additionally, investors in collective funds lose direct ownership rights over the individual securities within the fund. Unlike owning individual stocks where shareholders have voting rights and the ability to influence corporate governance, collective investment investors do not have these rights. All decisions regarding governance and other matters are made by the fund managers, meaning that investors relinquish some control over their investments.

Funds Sectors & Categories

Collective investments can be broadly classified into five categories by the Investment Management Association (IMA), each designed to meet different investor needs:

• Capital protection funds are aimed at minimizing risk and preserving the initial investment. These funds often invest in low-risk assets such as bonds or cash equivalents.

• Income-targeting funds focus on generating a steady stream of income, typically through dividend-paying stocks or bonds. These funds are designed for investors seeking regular payouts rather than capital appreciation.

• Growth-targeting funds invest in higher-risk assets with the goal of achieving long-term capital appreciation. These funds typically focus on stocks and other growth-oriented securities that reinvest earnings to fuel further growth.

• Specialist funds invest in specific sectors, industries, or strategies, allowing investors to gain exposure to niche markets that may be difficult to access on their own.

• Unclassified funds do not fit neatly into the other categories, offering flexibility to invest across a broad range of assets or strategies.

Investment Powers and Restrictions

The proper functioning of collective investments relies heavily on rules and regulations. These rules protect investors and ensure that funds are managed responsibly. One of the key components of this regulatory framework is the Trust Deed, a legal document that outlines the operation, investment strategy, and restrictions of the fund.

Regulatory bodies also impose investment limits to prevent funds from making overly risky investments, thus ensuring a balanced approach to risk and return. Additionally, some funds are governed by frameworks like UCITS (Undertakings for Collective Investment in Transferable Securities), which offer high levels of investor protection across Europe. Others may operate under Non-UCITS Schemes, which provide more flexibility but with different regulatory requirements.

For professional or more sophisticated investors, there are Qualifying Investor Schemes (QIS), which allow for broader investment strategies and higher risk exposure. All funds are also bound by rules regarding approved securities, ensuring that only compliant and suitable assets are included in the portfolio.

One of the most important rules for collective investments is diversification, which requires funds to spread their investments across various assets. This helps reduce the risk of a single poorly performing asset significantly impacting the entire portfolio.

Unit Trust Managers & Trustees

Within the realm of collective investments, the roles of trustees and managers are essential. Trustees are responsible for overseeing the assets within the fund, ensuring that they are managed according to the terms outlined in the trust deed. They are also tasked with auditing the fund’s accounts and distributing income to investors. Meanwhile, fund managers are responsible for the day-to-day management of the fund, including making investment decisions, ensuring compliance with regulations, and reporting on the fund’s performance to investors and regulators.

Both trustees and managers are bound by a duty of transparency, providing regular updates to investors and ensuring that the fund is operated in a responsible and accountable manner.

Taxation of Collective Investments

The taxation of collective investments can be complex, as it varies depending on the type of investor and the specific event. For instance, investors who buy units before the ex-dividend date typically receive dividends and may be taxed on the income received. Those who purchase units after the ex-dividend date will not receive the upcoming dividend but could be subject to capital gains tax upon selling their units at a profit.

Tax treatment also depends on the type of income generated by the fund. Dividends and interest income are generally taxable as income. However, for individuals investing through an Individual Savings Account (ISA), there are tax benefits, as income and capital gains within the ISA are tax-free.

Open-Ended Investment Companies (OEICs)

OEICs are another type of collective investment vehicle, distinct from investment trusts in their structure. OEICs are self-contained entities that pool investor funds to invest in a diversified portfolio. They are regulated by the Financial Conduct Authority (FCA), ensuring they maintain transparency and adhere to high standards of investor protection.

OEICs differ from Unit Trusts in several key ways, including the structure (OEICs can be standalone entities or part of an umbrella structure offering multiple sub-funds), the availability of various share classes (which differ in terms of fees, currencies, and investor type), and the imposition of borrowing limits similar to Unit Trusts.

Investment Trusts Overview

Investment trusts are closed-ended companies that trade shares on stock exchanges. These trusts invest in a diversified portfolio of assets, but unlike open-ended funds, the number of shares in an investment trust is fixed. As a result, shares trade on the market based on supply and demand, often at a price higher or lower than the net asset value (NAV) of the trust.

Investment trusts are categorized based on sector, with common types including Global Growth, UK Growth, Asia Pacific, and Emerging Markets trusts. Each of these focuses on a specific geographic region or investment strategy.

Working of Investment Trust Companies

The management of an investment trust is overseen by an independent board of directors, who ensure that the trust is being managed in line with the interests of shareholders. The fund managers are responsible for selecting investments and making buy/sell decisions, while share price management is influenced by the market’s supply and demand, often creating opportunities to buy shares at a discount or premium to the NAV.

Capital Structure of Investment Trusts

Investment trusts come in different structures, such as conventional and split capital. Conventional investment trusts have a fixed lifespan and aim to maximize returns during that period. Split capital trusts, on the other hand, have multiple classes of shares, each with different priorities for income and capital repayment, and often include specific redemption yields and hurdle rates for different share classes.

Key Differences: Investment Trusts vs. Unit Trusts & OEICs

When comparing investment trusts with unit trusts and OEICs, several key differences emerge. Investment trusts often offer lower transaction costs due to their closed-ended structure, which can be more cost-efficient. They may also have lower management charges than unit trusts and OEICs, especially older investment trusts. However, investment trusts carry higher risk due to fluctuations in market prices, while offering the potential for higher returns. Lastly, investment trusts are closed-ended, meaning the number of shares is fixed, whereas unit trusts and OEICs are open-ended and can issue new shares to accommodate new investors.

In conclusion, collective investments offer an array of advantages and drawbacks depending on the investor's goals, risk tolerance, and preferred level of involvement. From reduced costs and professional management to the complexities of taxation and regulations, understanding these investment vehicles is crucial for making informed investment decisions.

FOLLOWING ESSAY IN EASY WORDS TO UNDERSTAND BETTER

Understanding Collective Investments: A Simple Overview

Collective investments are a way for many people, or organizations, to pool their money into a single investment fund. This shared investment helps people diversify their portfolios—meaning they can spread their investments across different assets—without needing a lot of money or expertise. By working together, investors can share both the risks and rewards of their investments.

Advantages of Collective Investments

1. Lower Costs: When people invest together, the costs for things like buying and selling assets or managing the fund are spread out. This means the cost per person is often lower than if someone were investing alone.

2. Professional Management: Experts, called fund managers, make investment decisions for the fund. This is helpful for people who may not have the time or knowledge to manage their own investments but still want to benefit from professional advice.

3. Access to Specialized Investments: Collective investments allow people to invest in areas that may be too complicated or expensive for individual investors, like international markets or high-risk projects. This makes it easier to achieve specific financial goals.

4. Lower Transaction Costs: Since collective investments often involve buying and selling larger amounts of assets, they can negotiate lower fees. This helps reduce the overall cost for investors.

Disadvantages of Collective Investments

1. Limited Investment Choices: Investors in a collective fund must follow the fund's strategy and choose from the assets it holds. This may not suit every investor, especially those who prefer more control over their choices.

2. No Ownership Rights: When you invest in a collective fund, you don’t have the same voting rights as you would if you owned individual stocks. The fund manager makes decisions on behalf of all investors.

Types of Collective Funds

There are five main types of collective investments:

1. Capital Protection Funds: These focus on keeping the initial investment safe by investing in low-risk assets, such as bonds or cash.

2. Income-Targeting Funds: These aim to provide steady income by investing in things like dividend-paying stocks or bonds.

3. Growth-Targeting Funds: These focus on long-term growth by investing in higher-risk assets, like stocks, to increase the value over time.

4. Specialist Funds: These invest in specific industries, like technology or healthcare, allowing people to invest in niche markets.

5. Unclassified Funds: These have more flexible investment strategies and can invest in a wide range of assets.

Investment Rules and Limits

Investment funds have rules to keep investors safe. These rules help make sure that funds don’t take on too much risk. Some funds, like UCITS (a type of European fund), are heavily regulated to protect investors. Others may allow for riskier investments but are designed for more experienced investors.

Funds are also required to diversify their investments. This means spreading the money across different types of assets to reduce the risk that one bad investment will hurt the whole portfolio.

Fund Managers and Trustees

Fund managers are responsible for running the fund and making investment decisions. Trustees oversee the fund to ensure everything is running according to plan. Both are required to provide regular reports to investors, so everyone knows how the fund is doing.

Taxes on Collective Investments

Investors in collective funds are taxed based on the income they receive. If they buy shares before a dividend is paid, they will be taxed on the income they receive. If they buy shares after the dividend, they won’t receive the dividend but may still pay tax on capital gains when they sell their shares. Funds held in an Individual Savings Account (ISA) are usually tax-free.

Open-Ended Investment Companies (OEICs)

OEICs are similar to collective funds but have a different structure. They pool money from investors to create a diversified portfolio. Unlike unit trusts, OEICs are regulated by the Financial Conduct Authority (FCA) to ensure transparency and investor protection. OEICs have different share classes that may have different fees or terms for investors.

Investment Trusts

Investment trusts are a different type of investment fund. They are listed on stock exchanges, and their shares are traded based on supply and demand. The number of shares is fixed, meaning that unlike open-ended funds (which can issue new shares), the shares in an investment trust don’t change. Investors may buy shares at a price higher or lower than the actual value of the assets in the trust.

Investment trusts are often categorized by the type of investments they focus on, such as global growth or specific regions. They can also offer different types of shares, such as preference shares, which give investors fixed dividends.

Key Differences Between Investment Trusts, Unit Trusts, and OEICs

• Cost Efficiency: Investment trusts can be cheaper because of their fixed number of shares, whereas unit trusts and OEICs are more flexible and can issue new shares to accommodate more investors.

• Risk-Reward: Investment trusts are more sensitive to market price changes, meaning they carry higher risks but offer the potential for higher rewards.

• Structure: Investment trusts have a fixed number of shares, while unit trusts and OEICs are open-ended and can issue new shares as more investors join.

Conclusion

Collective investments provide an easy way for people to invest in a range of assets with lower costs and professional management. However, they come with certain limitations, such as less control over investment choices and no ownership rights. Understanding the different types of collective investments, their rules, and how they are taxed is important for making informed decisions. Whether looking for growth, income, or protection of capital, collective investments can offer a range of options to suit different investor needs.