FAQs - Collective investment schemes (“funds”) and pooled investments

There are many different types of investment (funds and pooled investments are just some of them). Each has its own level of risk but, basically, you take a risk with your money by investing in things (assets) that could rise or fall in value. There is normally no guarantee you will make money or even that you will get back the same amount you invested in the first place. Investments are different from savings – they are typically designed for the longer term (ten years or more) and involve different types of risk. Before investing, it’s usually a good idea to have sorted out your debts, made sure you’ve looked at protecting yourself against unforeseen events (for example through insurance), built up some savings and arranged your pension. And, once you start investing, it’s highly advisable to spread your risk across different investments in case one or more go wrong (diversification).

A pooled investment is where lots of people’s money is put together and invested in one or more types of asset by an investment or fund manager. Typically the pooled investments will be in a fund (or collective investment scheme) although they could be in other pooled investment products including investment management accounts. Some reasons why people pool investments include:

• Professional expertise – an investment expert picks investments for you, watches the performance of those investments and judges when to sell them.
• Spreading your risk – even if you have a small amount to invest, you can spread your money across a wide range of underlying investments. This reduces the impact on your investment if, say, one investment performs badly. Pooled investments will invest in one or more types of asset.
• Reduced dealing costs – if you want to buy a range of different investments directly, you might only be able to invest a small sum in each. This means dealing costs could eat into any profits. By pooling your money, you make savings because of bulk buying.
• Less administration – the manager handles the buying, selling and collecting of any dividends and income for you. They also deal with foreign stock exchanges and brokers, which can be tricky and time consuming.
• Choice – there is a very wide choice of funds and pooled investments so that you can pick one, or many, that suit your precise needs.

Funds (also known as collective investment schemes) are pooled investments run by fund management companies, designed to produce medium to long-term capital growth, income or a combination of the two. There are many different types of fund available to you.

You buy units or shares in the fund, which then invests that money on your behalf according to the fund’s rules, either:

• in the hope that the value goes up over time as the prices of the underlying investments rise; and/ or
• to get income from the assets in which the fund has invested.

You can invest a lump sum or save regularly each month. You can buy funds directly from the fund manager or through a financial adviser, a stockbroker, an investment manager, fund supermarket or other type of platform.

If you invest through an adviser they will ask you about your situation, needs and aims and give you advice on which investments may be best suited to you. If you use a fund supermarket or other type of platform, you can choose from the funds of several fund management groups. This can make it easier for you to keep track of your investments and can make switching between funds in the future easier.

Your money will be invested in accordance with the investment and borrowing objectives of the fund. This may include equities (company shares), bonds, gilts, property, cash etc. Funds may use derivatives (a more complex financial instrument), which may make the return they are likely to provide different to the returns generated by funds that don’t use derivatives. Derivatives can help offset the risk involved in owning assets or in holding assets valued in other currencies, but can bring more risk to a fund.

Many funds employ gearing/leverage (borrowing). A geared/leveraged fund borrows money to increase the amount of assets held. As an example, if the borrowed money is used to buy shares that then grow in value, then you could get more than you may have expected. On the other hand, if the borrowed money is invested in shares that later fall in value you can lose more than the drop in value of those shares as the loan must still be repaid.

Think carefully about how you want to invest your money and consider taking professional advice. It is often the case that one fund cannot meet all of your investment needs. Whatever funds you choose, it is sensible to review them regularly to make sure they continue to meet your changing needs in the future. If you have a financial adviser, ask whether this is part of the service they provide.

Most funds are actively managed. The manager researches the market and buys and sells assets to try and provide a good return for investors. There is no guarantee that an actively-managed fund that performs well at any time will continue to do so. Past performance is no guarantee of future returns.

Tracker funds are passively managed – they simply aim to track the market in which they are invested. For example, a FTSE100 tracker would aim to copy the movement of the FTSE100 (the index of the largest 100 UK listed companies). They might do this by buying the equivalent proportion of all the shares in the index. (For technical reasons the return is similar to but not identical to the index, in particular because charges need to be deducted.) Trackers tend to have lower charges than actively-managed funds. Trackers do not beat or under-perform the market and they are not necessarily less risky than actively-managed funds invested in the same asset class.

Investment risk can never be eliminated but it is possible to reduce the ups and downs of the stock market by choosing a range of funds and/or other investment products to help you avoid putting all your eggs in one basket. Different types of asset tend to behave in different ways and are subject to different risks. Putting your money in a range of different assets (diversification) will help reduce the loss should one or more of them fall.

Generally speaking funds that are highly geared or leveraged are considered to be more risky. This is because a fund with high gearing (high leverage) is more vulnerable to market downturns because the fund must continue to pay interest and repay capital on its borrowings.

Under a geared / leveraged fund, if the assets outperform the cost of borrowing, the fund value will go up more than if the fund was not geared/ leveraged. If the borrowing costs are more than the increase in value on the additional assets then a geared/leveraged fund will perform worse than a fund which is not geared or leveraged. If the asset value goes down a geared fund’s value will be affected more than a fund that is not geared because it will still need to meet the borrowing costs and repay the amount borrowed.

There are a huge number of funds and investment products on the market, and firms are coming up with increasingly more sophisticated investment products and strategies. Charges are often higher for these more complex or innovative funds, and the risks will be different from more standard funds. Make sure you read the information you get from the firm so that you understand the impact of charges, the risks involved and how the fund is expected to perform in different market conditions. If you do not feel that you understand these points, ask questions until you do. If you still do not understand everything, do not invest your money.

If you want to move from one fund to another, this may incur a tax liability on any investment growth at that time. You may also be charged a new initial charge for switching to new funds. Funds generally have four types of charge –

• Initial charges – when you invest in a fund, you usually pay an initial charge at the beginning which is shown as a percentage by which your investment is reduced. The initial charge is often around 5% (so, effectively, the amount you invest is reduced by 5% at the outset). Fund supermarkets or other types of platform are often able to reduce initial charges, sometimes quite substantially. Some funds have no initial charge, but there may be exit charges or a deferred sales charge applied instead.
• Annual charges – each year you will pay annual charges (via charges levied on the fund in which you have invested) to cover ongoing costs (such as the costs of fund management, administration and other services provided to the fund). The amount you pay will vary from one fund to another. You can compare these ongoing charges between funds, by looking for the Total Expense Ratio (TER) that firms quote in their literature. This ratio gives an estimate of the ongoing costs of the fund.
• Performance fees – some funds may have a performance fee, which is a percentage of the fund's profits. If a fund levies a performance fee the amount will vary depending upon the performance of the fund.
• Cash-in charges – when you decide to withdraw some, or all, of your money, you may be charged to do so (particularly if you withdraw money in the early years).

You should also have regard to other fees which will be specified in the fund’s literature and will typically include:

• Directors fees
• Trading costs associated with buying and selling of assets in the fund
• Switching charges - If you want to change investment funds, you may have to pay initial charges on the new fund. If you choose a new fund offered by your existing fund manager or fund supermarket or other type of platform, the charge may be lower than if you move to a fund offered by a new provider. If you move funds often, this may mean that it is more economic to invest via a fund supermarket or other type of platform than to go directly to a fund manager.
• Market value adjustment (MVA) – an MVA is an adjustment which is sometimes applied where the value of the assets underpinning a fund increase or decrease – it applies mostly in cases where the asset value decreases and so is usually a downwards adjustment. This is typically seen in a guaranteed fixed term fund where investment performance is guaranteed to be a certain value at a future date (for example where it is linked to traded endowment policies). If an investor wishes to come out of the fund before that date a downwards MVA will often be applied to take account of the current (usually lower) value of assets to which the fund is linked. You should consider whether a fund has the ability to apply an MVA and the often adverse impact that could have to your investment.

Funds are long term investments. Whilst you may be able to take out some or all of your money, with some funds there may be a charge (particularly in the early years). In addition, from time to time, it may be difficult to take your money out of certain funds, depending on the type of assets in which they invest (for example assets that cannot always be quickly bought or sold such as property). You should make sure that you understand whether delays to withdrawal of your money (redemption risk) is relevant to a fund in which you are considering an investment and, if so, whether or not you are happy to take this risk. If your fund has grown in value you may want to check whether there are any capital taxes applied in your country of residence or domicile.

Taking an income – As well as taking out a lump sum from the investment, some funds will allow you to take an income (for example interest on cash or dividends on shares). You can usually choose whether you take this income out of the fund or reinvest it within the fund to provide additional capital growth.

Income-producing funds typically pay you income twice each year, but some pay it more regularly. As the income you receive is based on the underlying assets, it will often vary over time. Some funds prioritise paying income over ensuring capital growth. If a fund provides you with a high level of income, any increase in the capital value will be less over time than if the fund reinvested the dividends it receives and paid no income to you. Other funds aim to provide an increasing level of income and capital value, but the income from these is likely to start at a lower level.

Some firms have an option where you can specify the amount of money (subject to a minimum amount) that you would like to withdraw. You can often choose how often you want these withdrawals. The money withdrawn will come from the capital held in your investment and, if the fund is not growing fast enough to cover the withdrawals, the investment value will go down over time.

You should make sure that you understand how your holding in a fund or a pooled investment will be treated by your relevant tax authorities.

The types of fund you may come across include:

• Unit trusts
• Open-Ended Investment Companies (OEICs) (sometimes called Investment Companies with Variable Capital (ICVCs))
• Exchange Traded Funds (ETFs)
• Hedge funds/ alternative investment funds.

There are some important differences between unit trusts and OEICs, investment trusts and ETFs.

Unit trusts and OEICs - The price of units in unit trusts and shares in OEICs reflects the value of the underlying assets. So, if the fund invests in equities and they increase in value, your fund will go up in value to the same degree.

Investment trusts - Investment trusts tend to be listed on the stock market, like companies. The price of shares in investment trusts depends on the value of the underlying investments but also on the popularity of the investment trust on the market. This means that the price of an investment trust does not always reflect the value of the investments it holds. So, for example, if the investment trust invests in equities and they increase in value, the value of the investment trust is not guaranteed to go up in value to the same degree.

Exchange Traded Funds (ETFs) - These are listed on an exchange such as the London Stock Exchange. Most ETFs will attempt to replicate an index (such as the FTSE 100) by investing in the same assets in the same proportions as that index.

The theory behind ETFs is that by buying one ETF share you get the equivalent performance of the index that it replicates, less any fees or charges the ETF has to pay. So, if you buy an ETF that replicates the FTSE 100 and the FTSE 100 goes up 10% in a year, you will have made a 10% gain on your ETF share (less those fees and charges). However, if the FTSE 100 goes down then so will the value of your share and by a greater amount (because of fees and charges).

Hedge funds or alternative investment funds - are sophisticated funds typically aimed at professional investors and cannot be marketed directly to the public. They often use advanced investment techniques, such as complex derivatives, or invest in asset types that are considered too specialist for inclusion in the kind of funds discussed above. As a result, they may expose their investors to significantly higher levels of risk than other types of fund.

Before you invest in a fund you should read its literature which will include an offering document which explains the main advantages and disadvantages of the fund. A financial adviser can help you understand the fund and the risks and implications of investing. You should consider whether a fund is suitable for your circumstances or if a different investment would be better. Think about the following when considering whether a fund is right for you.

• Fund choice – think about which fund or funds to invest in and whether you should spread the risk by investing in different funds.
• Risk – make sure that you are happy with the different types and level of risk associated with the investment and that you can afford a loss in value.
• Gearing/leverage - If you are investing in a fund remember to consider whether it can be geared/leveraged (where the fund borrows money to buy more assets – but has to pay back the loan with interest. If the assets outperform the cost of borrowing, the fund value will go up more than if the fund was not geared/leveraged. If the assets do not outperform the cost of borrowing losses will be greater).
• Charges – make sure you understand all of the charges that you will pay on the fund, or that will be paid by the fund and their effect (the reduction in value) on your investment.
• Inflation – this means that your money will buy less each year. Think about whether the funds you choose are likely to grow sufficiently to cover both the charges and inflation. If not, the investment may not be good value for money.
• Tax – make sure you understand the tax implications of the fund and whether a different product would be better for you.
• Commission – if you are getting advice, ask how much commission your adviser will get. Make sure you are happy with the answer. Ask if the commission pays for advice for the lifetime of the investment.
• Fund supermarkets or other types of platform – if you are thinking of using a fund
• Past performance – when looking at a fund’s literature you will often see statistics on the fund’s past performance. Whilst this information is useful you should always note that the past performance of any investment is not a guarantee of future performance.
• How regulated is the fund (see later)

If you already have an investment fund, you should regularly check to see how it is doing. You can check your latest statement or ask the provider for some current information about it. Some product providers will publish the price of buying or selling units or shares in each fund in the newspaper or on the internet every day. You may also have an adviser who you could ask for help. If so, you should check if this will cost you any money. It may be that they have already promised to provide ongoing reviews paid for from commission they receive from your investments.

• Consider your tax position – when reviewing and managing your investments you should consider your personal tax situation in your country of residence/domicile.
• Consider how often you switch funds - You are likely to pay new initial charges when you move from one fund to another (and you may have to pay a cash-in charge on some existing funds). If you reinvest with the same fund manager, fund supermarket or other type of platform, the charges might be lower than if you move to a new provider. If you move funds often, it may be more economic to invest via a fund supermarket or other type of platform than to go directly to a fund manager.
• Regularly check whether the fund choice remains suitable for your current needs - For example the risks that you are prepared to accept (your appetite for risk) might have changed, you may feel that one investment fund is likely to do better than another in the future, or you might want to rebalance your choice of investment funds.
• If you are thinking of cashing in your fund in order to buy another type of investment or have been advised to do so, make sure that this is in your best interests - Find out how much the new investment costs compared with your existing funds and what else you are giving up when cashing in a fund, and decide if what you are getting makes up for that loss.

Some funds are highly regulated, subject to detailed requirements and protections and are the only types of fund that can be sold directly to the general public in the Isle of Man (IOM). These funds are Authorised Schemes (a type of IOM fund) or Recognised Schemes (non-IOM fund subject to equivalent requirements to Authorised Schemes in their country). Authorised Schemes benefit from an investor compensation scheme. Many Recognised Schemes benefit from compensation schemes in their own country.

Other funds are not authorised but are subject to fairly detailed requirements and are reviewed by, but not approved by, the regulator. For example, in the Isle of Man there are Regulated Funds and Full International Schemes. Other countries offer similar types of funds.

Other funds will not be subject to a detailed review but will be registered with the regulator and must be operated in accordance with a specific set of regulations. Because they are less regulated and may offer higher risks, these schemes cannot be sold direct to the general public and can only be sold to certain specialised investors. Investors in such schemes must certify that they meet the entry criteria for investing in the fund and that they understand and accept the risks associated with the investment.

• Specialist Funds which can only be sold to specialist investors
• Qualifying Funds which can only be sold to qualifying investors
• Professional Investor Funds which can only be sold to professional investors
• Experienced Investor Funds which can only be sold to qualifying type investors/ experienced investors (depending upon their structure).

Other countries offer similar types of funds.

You can check whether a fund is subject to Isle of Man regulations by clicking the relevant funds lists on the FSC website.

Finally some fund types are private arrangements with a restricted number of investors that cannot be marketed to the public anywhere in the world. These types of funds are not subject to regulation (although persons providing services to them may be regulated). On the Isle of Man such funds are known as exempt schemes. Other jurisdictions offer similar types of funds.

As with most investments, you could lose some or all of your money. However this risk can be much greater for less regulated/ unregulated funds which frequently invest in assets that are not available to regulated funds, and may have a more complex structure. Less regulated/ unregulated funds are not subject to regulatory investment and borrowing/gearing restrictions. As a result they are generally considered to be a higher risk investment, and you should always ensure that you understand the risks before investing.

Less regulated and unregulated funds can be complicated. Before you agree to invest in these funds, take your time and consider the investment carefully.

If your adviser recommends a particular fund to you, they must make sure that it is suitable for you, having established your knowledge and experience of less regulated/ unregulated funds, your financial situation and your investment objectives including whether you want capital, income or combination of capital and income. Less regulated/ unregulated funds cannot be promoted to the general public, only to certain limited categories of investor. Make sure you:

• read and understand all the documentation, including the risk factors stated in any offering document or prospectus and the latest financial statements and auditor’s report and ask questions if anything is not clear
• fully understand and accept the risk that you may lose some or all of your money
• do your own research and check the information being provided about the fund
• understand any rates of return your adviser quotes and all charges and how these will affect the fund
• are comfortable that you fully meet the investor criteria to invest in the fund.

Ask your adviser:

• how easy it will be for you to take your money out of the fund, if at all, as some funds require investment far longer than you might expect, for example -
  - some funds invest in illiquid assets (ones that are hard to sell)
  - some funds apply initial lock-in periods meaning no withdrawal is possible for a set period of time or penalties are applied to early withdrawal
• why the fund is suitable for your particular circumstances, for example
  - how much of your money is invested in unregulated schemes
  - what other types of funds have not been selected in making the recommendation and why
• if the fund is described as low risk, guaranteed, capital protected or some similar description, what does that mean in the context of that fund
• how much they will be paid for arranging the sale
• whether you may have access to the Financial Services Ombudsman Scheme if things go wrong.

You should seek professional advice if you are in any doubt about the potential risk and returns involved.

The value of your investments can be linked to the performance of funds by you investing directly in the fund or investing into something whose performance is linked to the performance of a number of funds. Many life assurance policies and personal portfolio bonds can link their performance to funds that are not operated by the life assurance company. If the value of your investment is linked to funds you should ensure:

• that you are aware of the details of the fund (or funds), including the fund’s
  - risk profile (including the matters set out in the answer to Q12 “What should you consider before investing in a fund?”)
  - investment strategy (please also refer to the answer to Q5 “Where is your money invested by the fund” and Q6 “How can you minimise investment risk?”)
  - degree of gearing or leverage (please also refer to the answer to Q7 “What is gearing and leveraging?”)
  - charges and fees (including the matters set out in the answer to Q8 “What types of charges are levied on an investment in a fund?”)
• that you meet the entry criteria for investing directly in the fund (please also refer to the answers to Q14 When is a fund regulated/ less regulated/ unregulated? Q15 “What are the risks associated with investing in less regulated/ unregulated funds?” and Q16 “What should you think about before investing in a less regulated/ unregulated fund?”)
• that you understand how you will get up to date information about the performance of the fund and events affecting it, including suspension of a fund. These information flows will not normally come to you directly from the fund. This is because in relation to life policies and personal portfolio bonds it is the Insurance Company that owns the actual investment in the fund; the performance of the policyholder’s policy or bond is simply linked to the performance of the fund and.
• that you understand that when investing into a fund via a life policy or personal portfolio bond any ability that you may have to access the Financial Services Ombudsman Scheme could be limited to the life policy or personal portfolio bond and may not extend to the Insurance Company’s investment in the fund to which your policy is linked.

By law, most financial services firms must be regulated by the Authority before they can do business in or from the Isle of Man. The Authority publishes a Register of licenceholders currently doing business in or from the Isle of Man and classes of persons exempt from the licensing requirements.

It is recommended that investors seek professional advice from a financial adviser, investment manager or stockbroker about the suitability of proposed investments to their personal circumstances.