Investment Funds Flashcards

What is a key advantage of an investment trust over an open-ended fund such as a unit trust?

Answer: Investment trusts can borrow money (gear) to enhance returns

Investment trusts, as closed-ended companies, can borrow money (use gearing/leverage) to invest more than the amount of shareholder capital. This can enhance returns when markets rise but also amplifies losses when markets fall. Open-ended funds face strict limits on borrowing.

A fund manager who follows a 'passive' investment strategy will typically:

Answer: Aim to replicate the performance of a specific market index at low cost

Passive (index-tracking) management aims to replicate the returns of a specific benchmark index (e.g., FTSE 100) by holding the same securities in similar proportions. This approach has lower costs than active management because it requires minimal research and trading.

What is a fund of funds?

Answer: A fund that invests in other investment funds rather than directly in securities

A fund of funds invests in a portfolio of other investment funds rather than investing directly in shares, bonds, or other securities. This provides additional diversification across different fund managers and strategies but may result in a double layer of charges.

Under FCA rules, what is the maximum initial charge that can be applied to a UCITS-qualifying fund?

Answer: There is no regulatory maximum — charges are set by the fund manager and disclosed to investors

The FCA does not set a maximum initial charge for UCITS funds. Fund managers set their own charges which must be clearly disclosed to investors in the Key Investor Information Document (KIID) or Key Information Document (KID). Competitive pressures and the move to clean share classes have significantly reduced initial charges across the industry.

What does UCITS stand for, and what is its significance for UK investors?

Answer: Undertakings for Collective Investment in Transferable Securities — an EU-originated framework providing a standard for regulated funds

UCITS (Undertakings for Collective Investment in Transferable Securities) is a regulatory framework that originated in the EU, setting standards for fund management, diversification, liquidity, and investor protection. UCITS-compliant funds can be marketed across jurisdictions and are widely recognised as well-regulated investment vehicles.

Which of the following risks is specific to closed-ended investment funds such as investment trusts?

Answer: Discount risk — the fund may trade at a discount to its NAV

Discount risk is specific to closed-ended funds like investment trusts. Because their shares trade on the stock exchange, the share price can differ from the underlying NAV. An investor may buy at NAV but find the trust moves to a discount, resulting in a loss even if the underlying assets have not fallen in value.