Safe Method for Small Investors - Term Paper Example

Contents Introduction Collective Investment 1. Risk 2. Time and Access 3. Charges 4. Performance 2. Direct Investment 2 Risk, Returns and Access 2.2. Performance 3. Comparison 4. Conclusion Collective Investments versus Direct Investments Portfolio Large and small scale investors are on the run to earn additional by investing in shares and securities. To attain the objective of making many do not realize the safe side of investment and returns and the associated risk. Hence first time players in the stock market should analyse various viabilities before making a decision. There are two types of investment options available to the small investor in the UK. They are collective investment and direct investment. The article is aimed to argue that collective investment is a safe method for small investors in terms of access, fees, low risk and steady returns. 1. Collective Investment Collective investment is a facility that permits a number of investors to pool their funds or assets that would be managed by an independent professional manager. Collective investments can comprise of bonds, listed equities and gilts depending on the scheme availed by the investors the number of assets will increase. Investors can also invest in unlisted investments or assets. Hence these investors can limit the risk factor by spreading the investment in a wide range of assets instead of making a direct investment in these assets. Risk is limited in collective investment because risk associated with one investment will have a lesser impact on the profitability of the entire portfolio. Section 235 of the Financial Services and Markets Act 2000 (FSMA) defines collective investment. Collective investments in the UK are divided into different types. The main types are Open Ended Investment Companies (OEIC’s), Authorised Investment Funds (AIF’s) or combined term for authorised Unit Trusts (AUT) and Unauthorised Unit Trusts (UUT’s). The main difference between AUT and UUT is based on the recognition of the Financial Service Authority on these investments. However, Open Ended Investment companies operate only with the recognition of the FSA. The authorisation decides on the eligibility to avail investment in these funds and the type of assets to be invested. (Anon, What is a collective investment scheme?) Unit Trusts, Investment Trusts and OEICs offer professional management of small amounts of money for a fee with the added benefit of capital returns made by the managers being free of tax. OEIC’s and Unit Trusts are identical in nature. In this type of investment shares held by the investor indicate the value of the investment managed by the managers who handle the investment for charges. The difference between these two investments lay in the mode of paying charges. Charges for Unit Trust are acquired through a bid/offer spread where there are chances that a high price will be charged to the investors who wish to purchase units as against the amount paid to an investor while selling their units. (Anon, Talking points) 1.1. Risk Unit Trusts and OEICS extend and shorten depending on the sum of investment invested or revoked by the investors. But the size of investment trust is fixed and does not change with the investment behaviour of investors and Investment trust managers have the right to acquire money from other sources for investment. Due to these two aspects, investment trusts is vulnerable to risks that OEIC’s and Unit Trust and the value of investor’s share is usually less than its actual value held by the Investment trusts. (Anon, Talking points) The value of the invested amount can increase or decrease and the investor may sometimes receive a lesser amount than actually invested. This depends on the performance of invested assets. Hence performance and the amount of returns cannot be assured. This is because the rate of growth of investments may be less than expected, withdrawal of money by the investor, increase in the rate of service charges, effect of inflation on future buying capacity, change in the rules of taxation, etc.(Anon, Collective Investment Plan for Income) 1.2. Time and Access Collective investments perform well in the long run. If the investor withdraws money in the initial stages of investment, the desired amount of returns can be availed for the total amount of investment. Collective investments are subject to fluctuations in the market and an assured amount of returns cannot be guaranteed for the actual amount of investment. Past performance of assets need not necessarily indicate future returns on a specific collective investment. Tax is applicable on returns depending on the nature of individual investors. (Anon, Talking points) Collective investment trusts are managed as separate accounts by comparing the gross performance of funds on a quarterly basis. This enables investors and managers to assess the performance levels especially in retirement schemes and can access the investments on a timely basis with adequate information about the investment. Usually the collective investment industry evaluates the performance of this investment on a gross returns basis rather than on monthly performance since these investments have a direct competition with mutual funds. (Anon, 2006) Collective investment is a dependable form of investment for small investors who yearn to make income. Investment in this kind of funds is usually for a minimum period of five years. This form of investment however gives the flexibility to withdraw money at any point of time and continue with the invested amount for as long as the investor prefers though the minimum duration cannot be altered. . (Anon, Collective Investment Plan for Income) Collective investment plan has the flexibility to hold the account in up to four names with the added advantage of adding amounts to the investment with a minimum of 500 L or more at any point of investment. Returns from the investment can be withdrawn on a quarterly basis and the total amount can be withdrawn at any point of time. The invested amount can be allocated according to the investor’s choice at any point of time. When a part of the investment is withdrawn it will affect the rate of returns. (Anon, Collective Investment Plan for Income) 1.3. Charges Collective investments are managed by fund management companies for a fee for their services. The fee is often levied in the form of a percentage of the amount managed by the company though it is often related to the performance of the funds. Other expenses associated with collective investments are entry or exit costs, commission of brokers, stamp duty and spreads. Single priced collective investments do not attract cost of spreads but the returns are often balanced with the initial and closing fees. (Anon, Collective investment vehicle) However, for Investment Trusts and OEIC’s the charges for purchasing and selling is the same, where the manager fee is paid in addition to the cost for the buying or selling with a lesser cost for the Investment Trusts. (Anon, Talking points) 1.4. Performance of Collective Investments a) Halifax Investment Fund Managers Limited The objective of the company is to earn a fair income for their investors by investing in diversified portfolio of securities. The policy of the company is to invest in euro and sterling securities with returns that exceed the FTSE FTA Government Securities All Stocks index. The company investment in Corporate Bonds has registered a 3.9% growth in the year 2002, with an increase to 9% growth in 20003 and the rate of growth has touched 12.5% in the year 2005 for collective investments. Corporate Bond Fund attracts very low risk but yields above average returns with diversified investment in grade interest bearing securities that comprise gilts and corporate bonds. Minimum duration of investment in these funds is 6.9 year. While the expense ratio for this investment is calculated at 1.03 percent, the rate annual turnover of the portfolio is estimated at 250.9 percent. Halifax’s investment in equities of companies listed in the UK is aimed to earn high amounts of income and growth of capital in the long run. This kind of investment in low risk securities have yielded a steady growth rate beginning with 10 percent in 1996 and exceeding 25 percent in 2005. The cumulative performance of collective investments in both Corporate Bonds and Equities of the company beginning at 0% in 1995, the performance has surpassed 120 percent growth in July 2005. . (Anon, Collective Investment Plan for Income) b) Aberdeen Cash Unit Trusts and OEIC’s of Aberdeen Cash have registered a steady growth of 17% in January 2008 from its beginning in January 2004. The company invests in cash deposits, transferable securities and money market vehicles. (Anon, Aberdeen Cash) c) British Empire Securities & General Trust plc British Empire Securities & General Trust plc has recorded a growth rate of 133.8% in share price, 125.5% in Net Asset Value and 42.1 percent growth in index. The charge for collective investment is based on the performance and is calculated by the increase or decrease in the net asset value of normal shares. The percentage range varies from 0.4 % to 0.8%. (Anon, British Empire Securities & General Trust plc) d) F&C Capital and Income Investment Trust PLC F&C Capital and Income Investment Trust PLC have recorded a growth rate of 62.1% in index, 61.2% in share price and 58.4% in net asset value. The company levies an annual management fee of 0.4% of the total assets of the company plus value added tax. The company has the flexibility of terminating the fund with mutual one year notice period. (Anon, F&C Capital and Income Investment Trust PLC) e) Pacific Horizon Investment Trust PLC Pacific Horizon Investment Trust PLC has registered a growth of 175.2% in net asset value, 170.9% in share price and 109.9% in index. The company levies a quarter fee of 0.25% on the total assets less present liability for the quarter. (Anon, Pacific Horizon Investment Trust PLC) f) BlackRock New Energy Trust plc BlackRock New Energy Trust plc has registered a growth of 331.7 % in share price, 240.2 % growth in Net Asset Value and 47.9% growth in index over the last five years with its Investment Trusts. The company levies a fee of 1%p.a on the assets as management fee and levies performance based charges. (Anon, BlackRock New Energy Trust plc) 2. Direct Investment Direct investment comprises investment in stocks and shares. Most of the investors in UK prefer to invest in shares, bonds and gilts. The spread of buying shares had increased in the UK after the 1980’s and people are aware about share ownership and related rules. Investors determine the significance of a share by calculating the worth of its assets and the nature of the share to increase its value. When the price of the share increases beyond a preconceived rate, investors tend to sell the shares and this would result in the decrease in the price of the share. If the price of a good share falls, investors would rush to buy the share and this would result in the increase in the price of share. Companies that want to issue share but do have enough finance opt the Alternative Investment Market which attracts more risks than the shared listed in the stock market. From the investors perspective AIM is not advisable because it does not have liquidity. Investors in the share market usually chose to buy or sell shares that are listed in the FTSE. Since AIM attracts lesser transactions, trading is conducted through a set up called matched bargain where the buyer or seller communicated with a broker to strike a deal with a third party. In this set up there are chances for marginal difference in the price quoted by the broker and the actual price. Under direct investment small investors can directly invest in bonds and gilts. Bonds are nothing but a collection of debt. By purchasing bonds, the investor is lending money to the issuer of bonds. Here the investor knows the rate of returns is associated with lesser risk than shares. Gilts are bonds issued by the government of UK. By purchasing gilts, the purchaser is providing money to the UK government. Hence, gilts are considered to be a safe type of investment by individual investors because the government assures to pay back the invested amount when the term is over. (Anon, An IFA can broaden your investment horizons. 2008) 2.1. Risk, Returns and Access to Investment Bonds offer interest to the investor on a yearly basis at a certain rate. The rate of interest may vary year after year resulting in a lesser return to the investment. This nature of bond makes it unattractive when compared to cash deposits. When a bond is traded in the market it ensures a better coupon rate and the return of initial investment at the end of a year. Fluctuating rate of interest will affect an increase in coupon rates thus compounding to a reduced return to the investor though the initial amount of investment will be returned at the time of redemption. Besides, governments, corporate bonds are also available for the direct investor. These companies assure a coupon rate and the assurance to return the capital. Investor can trade them in the market if they require their invested amount before the expiry of the term. But companies can abstain from paying the invested amount and so these bonds accompany a greater amount of risk though higher coupon rates are offer to lure investors. (Anon, An IFA can broaden your investment horizons.2008) Off late there has been a good rate of appreciation for investments in the long term however the investor cannot blindly trust the company based on the increase in the price of its share. Unprecedented fluctuation in the prices is one of the major drawbacks of direct investment in shares. Any company can register a high or low value of share at any point of time based on the performance of the industry or section to which the company belongs. This shows that a good company can also register low price due to problems in the sector. It is essential to ascertain the right company before making direct investment in shares. This is a caution towards investing small investor’s total earnings into one share. The direct investor should keep a close watch on the performance of their share for this reason. (Anon, An IFA can broaden your investment horizons. 2008) It is a known fact that when rules are relaxed for trading in shares there will be mis-selling when new investors are lured to invest in high risk shares. Companies take various steps to convince that their shares are the best to attract inexperience investors. However Relaxation of trading rules is of significance to experienced investors. A report by Price Waterhouse Coopers states that the performance of private equity funds stands at 10.2 percent at the close of the year 2003. Experts in the share market expect a wide range of failure because the number of private firms offering shares is on the rise. This leaves room only for adventurous investors to invest in private equity funds who are experienced with a strong portfolio. However the investor should make sure that only 5% of the total investment is allotted to one sector. Further this type of funds is available only for high net worth individuals giving no opportunities for a small investor to invest in these funds to earn good returns. (Anon, 2005) Other than securities commodities also comprise the risk factor. The price of commodity can increase or decrease depending on the market conditions and the investor may lose a part or whole of the initial amount of investment. (Ohingardail, 2008) Direct investments are facilitated by stockbrokers who purchase and sell shares on behalf of the customer. The charges differ for each broker but the commission is usually a permanent fee or a percentage of the investment. If a person intends to trade continuously in stocks, the charges can be recouped over a period of time. (Anon, Investment Portfolio Planning). 2.2. Performance During the last three years shares in the private equity has earned a 79 percent return. According to Trustnet, private equity trusts have earned a return of 84 percent. Hamish Mair, head of private equity investment at F&C explains the importance of a small investor to invest in portfolios rather than individual companies to reduce the amount of risk. Another disadvantage of direct investment in private equity is the high rate of illiquidity. The investor cannot access the investment until the end of the investment period. This is in contrary to the nature of liquidity offered by investment trust where shares can be sold at any point of time at the prevailing market value. (Anon, 2005) The performance of few companies may be observed to check the viability of investing directly in shares. a) Autonomy Corporation The performance of Autonomy Corporation can be reviewed to find out the profit made by the share in the last five years. The company is a software technology provider and the nature of the business has had implications in the rise and fall of its share’s price. The revenue of the company has appreciated to 221% in 2006 from a 20% growth in 2003 and there has been a steep fall in the growth rate in the year 2007 when the negative growth touched 48% from 221 percent in the previous year.(Anon, Autonomy Corporation, 2008.) b) 3i Group (III) The second company under review is 3I. The company is one of the largest investors in the private sector in the beginning stage and had registered a growth rate of 364%in 2005. After 2005, the growth rate has been in a declining trend and reached minus 6% in the year 2008. (Anon, 3i Group (III), 2008.) c) Aviva (AV.) A review on the performance of UK’s largest insurance company Aviva reveals that the company’s shares have noise dived its performance in terms of growth with a dangerous minus 44% growth rate in 2007 as against 19% growth in 2006. (Anon, Aviva (AV.),2008) d) Barclays (BARC) Barclays is a name to reckon with banks and credit card in the UK. The name also has a strong position in the investment banking sector. However, the price of shares has been fluctuating in the last five years. The company registered a 21 % growth in EPS in 2004 and declined to 7% growth in 2005, followed by an increase in the growth rate to 32 % in 2006 and again falling to minus 4% in 2007. (Anon, Barclays (BARC), 2008) e) British Airways (BAY) British Airways is the leading airline in the UK and flies to more than 550 destinations worldwide. The company is facing stiff competition from no frill airlines and it is struggling to maintain its leadership in the industry. Though this is the business scenario, the shares of company has fared well except for a negative growth in the year 2007. The growth rate of the company stands at 59% in the year 2008 however a five year performance comparison shows that the company registered a growth of 191% in 2005.(Anon, British Airways (BAY), 2008). 3. Comparison A comparison between Collective Investment and Direct Investment based on risk, time, access and performance reveals the following; i. The level of risk is high in direct investment when compared to collective investment because small investors do not have the expertise to ascertain the right type of shares, gilts or bonds that will earn them steady returns and return their original amount of investment. In collective investment the risk is spread over a number of investments. ii. The probability of earning returns is high in collective investment where the investor can avail income on a quarterly basis. iii. Investment trusts allow the investor to withdraw the invested amount at any point of time while money invested in direct investment can be withdrawn only after the fixed term of investment. iv. Performance of collective investment fund over the last five years exhibit a high rate of growth while the price of shares have been fluctuating extremely. 4. Conclusion From the above inference, it may be concluded that Collective investments provide small investors with reduced levels of risk and greater potential for steady profits than a direct investment portfolio. 3i Group (III) (online). 2008. Available: http://investing.thisismoney.co.uk/companyresearch/10050/3i_Group/company_research.html (Accessed 9th July 2008) Aberdeen Cash.(online) 2008. Available: http://www.trustnet.com/ut/funds/?fund=9663 (Accessed 8th July 2008) An IFA can broaden your investment horizons.(online). 2008.Available: http://www.unbiased.co.uk/find-an-ifa/guides/savings-and-investments/an-ifa-can-broaden-your-investment-horizons/ (Accessed 8th July 2008) Autonomy Corporation (online). 2008. Available: http://investing.thisismoney.co.uk/companyresearch/24851/Autonomy_Corporation/company_research.html (Accessed 9th July 2008) Aviva (AV.) (online). 2008. Available: http://investing.thisismoney.co.uk/companyresearch/10028/Aviva/company_research.html (Accessed 9th July 2008) Barclays (BARC) (online). 2008. Available: http://investing.thisismoney.co.uk/companyresearch/10012/Barclays/company_research.html (Accessed 9th July 2008) BlackRock New Energy Trust plc (online). 2008. Available: http://www.trustnet.com/it/funds/?fund=67728 (Accessed 8th July 2008) British Airways (BAY) (online). 2008. Available: http://investing.thisismoney.co.uk/companyresearch/10015/British_Airways/company_research.html (Accessed 9th July 2008) British Empire Securities & General Trust plc (online). 2008. Available: http://www.trustnet.com/it/funds/?fund=108. (Accessed 8th July 2008) Bulford, T. (2005). PLUS Markets: The Private Investors Guide (online).Available: http://www.fspinvest.co.uk/investment-services/red-hot-penny-shares/articles/plus-markets-investors-guide-00016.html (Accessed 9th July 2008) Collective investment vehicle (online) Available: http://moneyterms.co.uk/collective-investment-vehicle/ (Accessed 7th July 2008) Collective Investment Plan for Income.(online)Available: http://www.bosinvestment.co.uk/pages/pdfs-cip/$file/cipincomekfd.pdf (Accessed 8th July 2008) F&C Capital and Income Investment Trust PLC (online). 2008. Available: http://www.trustnet.com/it/funds/?fund=252. (Accessed 8th July 2008) Investment Portfolio Planning (online). Available: http://www.stationfinancialservices.co.uk/investment2.htm (Accessed 9th July 2008) Morningstar Enhancing Coverage of Collective Investment Trusts, Offering Timelier, More Transparent Data for Investors (online). 2006. Available: http://corporate.morningstar.com/uk/asp/subject.aspx?xmlfile=501.xml&filter=PR4197 (Accessed 7th July 2008) Ohingardail. 2008. ETF Securities provide private investors a method of investing directly in commodities. (online) Available: http://www.dooyoo.co.uk/funds-investments/etfs-securities/1071926/ (Accessed 9th July 2008) Pacific Horizon Investment Trust PLC (online). 2008. Available: http://www.trustnet.com/it/funds/?fund=144 (Accessed 8th July 2008) Should You Gamble On Private Firms? (online). 2005. Available: http://www.hotbed.uk.com/index.php?id=60&tx_edanews_pi1%5BshowUid%5D=21&cHash=1 (Accessed 9th July 2008) Talking points (online) Available: http://www.marshallsaymumford.co.uk/talking.html (Accessed 7th July 2008) What is a collective investment scheme? HMRC (online) Available: http://www.hmrc.gov.uk/collective/what-is.htm (Accessed 7th July 2008) Read More