Understanding Investment Funds

Investment Funds Overview

• Investment funds facilitate a better understanding of fund structures, regulations, classifications, and risks within a real-world context

Learning Objectives

• Aim to give an understanding of the characteristics of an investment fund, and its operations
• Aims to clarify the legal standing of different investors, specifically in Switzerland
• Gives a clear definition of Net Asset Value (NAV)
• Teaches how the fund sector operates globally
• Gives a comprehensive overview of potential risk variables for consideration, when deciding in investing in particular funds

Key Features

• Investment funds pull money together from multiple investors, to invest it collectively
• Investors have gains and losses proportional to each other
• Funds are managed on behalf of the investors
• A minimum of two independent investors are needed, this excludes exceptions for pension or insurance funds
• Funds are Professionally managed investments where investors own a fraction of the investments and get instant diversification, and someone actively makes the trade decisions

Legal Structures by Country

• Swiss funds can be Investment fund contracts, or SICAV
• French funds are often SICAV (Société d’Investissement à Capital Variable)
• American funds are usually Mutual funds
• UK funds consist of Unit trusts

Regulation & Investor Safeguards

• Funds are heavily regulated
• Funds need approval from financial authorities like FINMA in Switzerland
• Assets are segregated meaning, in the event of bank or managers failure, funds are secure from their bankruptcy estate

Exchange Traded Funds

• Exchange-Traded Funds (ETFs) are investment funds listed on exchanges such as the stock exchange
• ETFs can be exchanged like stocks
• Track an index like the S&P 500 or MSCI World

EFC

• The European Fund Classification (EFC) exists as a way to compare the thousands of investment Funds, by classifying them and making them comparable "apples to apples"
• Equity funds are mandated to have a minimum of 85% allocation in equities
• Bond funds need to have a 90% allocation to bonds
• Bond funds cannot hold equities but can hold up to 20% in convertible bonds

Fund Classification

• Bond funds are classified by country of issue, currency exposure, and credit and interest rate exposure
• Equity Funds are classified by sector, market capitalization and country
• Multi-asset funds have Broader classification criteria
• Money market funds are classified for their credit, interest rate exposure, liquidity and safety

Summary

• An Investment Fund is a pool of money managed for collective benefit
• Investment funds are regulated and require authorization
• Asset segregation protects investors funds from manager / bank bankruptcy
• Fund types are Equity, Bond, Multi-Asset, or Money Market funds
• Classifications help compare similar funds
• ETFs are funds traded on exchanges

Swiss Regulation

• Investment funds in Switzerland are regulated starting from the core law down to the operational guidelines and self regulation
• Primary law comes from the Collective Investment Schemes Act (CISA) and guarantees investor protection goals
• The Collective Investment Schemes Ordinance (CISO) adds details to CISA
• CISO-FINMA offers FINMA's rules for effective supervision
• Self-regulation comes from the Asset Management Association Switzerland (AMAS) and guarantees model documents and codes of conduct

Understanding CISA

• Seeks to Protect investors, transparency and proper function of investment fund market
• CISA aims for open ended and close ended funds
• Framework law outlines but defers to ordinances and regulatory bodies with principles & responsibilities

Understanding CISO

• Fills the high level details with technical, operational, and procedural elements
• Specifies how CISA can be implemented

Understanding CISO-FINMA

• FINMA's own regulatory ordinance
• Includes detailed operational rules for daily regulation of fund providers
• Applies to management companies, custodians and distributors

Understanding AMAS

• Formerly SFAMA, it is the self-regulatory body of the investment fund industry
• Publishes model documents for practitioners and a code of conduct, plus guidelines which interpret regulatory obligations
• These guidelines provide market standards for members

FINMA Roles

• FINMA is the Swiss Financial Market Supervisory Authority
• Is the regulator of the Swiss Investment fund industry
• Monitors authorization and licensing of funds
• Monitors fund management companies and custodian banks
• And monitors compliance with regulations

Regulations Analogy

• Consider the architectural blueprint of a house to be CISA
• Consider the construction manual for the parts of the house to be the CISO
• Then CISO-FINMA is the contractor instructions for the workers on the building site
• AMAS Guidelines is best practices and maintenance advise from experienced architects

Regulations Summary

• CISA is the core law protecting investors & market function
• CISO details how to implement CISA
• CISO-FINMA holds FINMA's rules for market participants
• AMAS holds self-regulation with guidance, best practices and model documents
• FINMA itself is the supervisor, acting as the enforcement authority

Swiss Funds

• Switzerland classifies collective investment schemes into two categories, Open-Ended Funds or Closed-Ended Funds
• Open Ended funds can be contractual investment funds or SICAV
• Closed-Ended funds can be LPs or SICAF

Open Ended Funds

Contractual Funds

• The legal structure of a Contractual Investment Fund (Fondsvertrag) is a tripartite contract between investor, fund management company, and custodian bank
• Investor rights are proportional to the fund units, but not of the underlying securities
• Funds are not legal persons, but contractual
• The custodian bank oversees the fund manager to protect investor

The SICAV Structure

• SICAVs (Société d’Investissement à Capital Variable) are companies with variable capital and shareholders
• Investors get membership rights on voting and property rights on financial return
• Capital adjusts dynamically with shares being issued and redeemed

SICAV Analogy

• Its a fund as a company where you co-own it

Closed Funds

• Closed-Ended Funds are non redeemable on demand, trading on a secondary market or held to maturity

Limited Partnerships Structure (LP)

• Are limited partnerships exclusively used for investment purposes
• They have General and Limited partners
• At least one General Partner is required, needs to be a Swiss stock company
• Multiple Limited Partners are required, and contribute capital with limited Liability
• Available to Qualified investors for venture capital investments
• Also used for real estate and infrastructure
• And alternative assets such as private equity

LP Distinction

• LPs are private capital pools and are not offered to the public

The SICAF Structure

• SICAF (Société d’Investissement à Capital Fixe) is a closed-ended cousin of the SICAV
• Their fixed capital does not fluctuate like SICAVs
• Has a corporate structure like a public company, and still subject to CISA
• Used as an alternative to listed Investment companies

SICAF Analogy

• Suited when capital does not need changing over time, or for the long term

Fund structure summary

• Contractual Funds are open-ended and have no legal entity, claims via units, often retail or qualified investors
• SICAV’s are open-ended companies with variable capital and shareholder rights; often retail or qualified investors
• LPs are closed-ended funds with limited partnership interests, suited for qualified investors
• SICAF are closed-end companies with fixed capital and shareholder rights, suited for qualified or retail investors

Closing takeaways

• Open funds are flexible for investors to enter or exit easily
• Closed funds lock capital and are good for illiquid investments
• The legal form determines your investment rights
• Claim units with with contractual funds, or share with SICAV/SICAF.
• LPs are available only to professional investors and can invest in alternative vehicles

Structure of Swiss Funds

• Switzerland has Securities Funds (UCITS-Compatible), Real Estate Funds, and Other Funds, for open-ended investment fund types
• Securities Funds are geared toward retail investors through listed securities
• Real Estate Funds are geared toward retail investors through property investments
• Other Funds are for qualified investors through alternatives

Securities Funds

• Tightly regulated and widely distributed and inteded for retail investors
• They have Money market instruments, Bonds, Equities, Regulated derivatives (listed) as eligible investments
• They are prohibited from investing in precious metals, short sales, derivatives for non-portfolio management reasons
• Borrowing allocated up to 10% of net assets, and collateralized assets up to 25%
• No more than 10% of a security can be from one issuer
• No more than 40% of the fund can be in issuers that constitute >5% of the funds weight
• Max of 20% is the single bank exposure on cash, deposits, or OTCs
• Max of 35% can be in bonds from public bodies, but 30% in a single issue

Real Estate Funds

• Specialized funds with underlying assets as physical property and related claims
• Invests in Residential, commercial, development land, Mortgages, and shares in real estate companies
• They must own at least 10 properties with no single property going over 25%
• No leverage is permitted, with derivatives only for hedging
• Real estate experts are required by governance for asset valuations and buy/sell decisions

REITS Analogy

• The structure prevents over-concentration and misvaluation in illiquid real estate

Other Funds

• These are non-UCITS and geared for qualified investors, and have higher risk and flexibility
• They offer precious metals, commodity derivatives, and structured products
• They may short sell
• The borrowing maximum allocation is 25%, pleading 60%, and commitment stands at 225%.
• Alternative investment funds have higher borrowing exposure at 50%, pleading at 100% and commitments totaling 600%
• Alternative investment funds may also include commodities, but needs FINMA approval
• Alternative Investment Funds are often used by Institutional or qualified investors

Fund Types Summary

• Securities provide Bonds, stocks,money market with low leverage to retail investors
• Real Estate Funds include Property, mortgage notes and has no leverage to retail investors
• Traditional include commodities but are 25% leveraged for qualified investors
• Alternative Funds are liquid and can have broad strategies, and +50% leverage, for qualified investors

Last Words on Classification

• Securities Funds offer transparent and safe diversification
• Real estate funds offer tangible asset exposure, but carry liquidity constraints
• Other Funds give skilled investors more tools with an increased risk profile

Investment Operator Overview

• In Swiss regulation, not only the structure but key institutions of the fund must be regulated by law, licensed, and continuously supervised
• Licensed Operators in a fund can be the Fund Management Company, Manager of Collective Assets, or the Custodian Bank

Fund Management

• Is the operational brain of the entire fund, and is the central and legal manager of a fund
• They issue & redeem fund units with unit prices based on NAV after decision making in investments and rights
• The management company cannot delegate administrative functions, but can delegate investment decisions to portfolio managers

Accountability

• Irregardless of delegations, The Management fund has full liability to the investors

Collective Assets Manager

• Known as the Portfolio Manager and the entity is legally responsible for the portfolio allocations
• Also manages all operational and financial risks, with the ability to perform extra administrative duties
• These managers can also be external firms or in house in the fund management
• To be licensed for Swiss Funds, Swiss-based managers must be licensed by FINMA, unless exempt (AUM max is CHF 100 million for AUM, or CHF 500 million for closed-end funds with limitations)

Banks

• Custodian banks can be a custodian in investment schemes and must be authorized
• The custodian acts as the watchdog & vault of the fund, safekeeping and over seeing assets
• Regulatory oversight occurs through auditing for legal limits and NAV calculation
• Is done through spot & test based checks and balances that verify work already done

Banks Licensing

• Only banks fully licensed with FINMA can be custodians for collective investment schemes in Switzerland

Responsibilities

• Fund Management Company performs all operational tasks, issues but cannot outsource admin functions
• Manager of Collective Assets managers portfolio & risk and must be managed under supervision
• Custodian Bank acts as asset custody, and cannot perform fund management duties

Supervised archiecture

• Ensures regulatory compliance by focusing on Investor protection
• Ensures segregation of duties through independent control mechanisms
• Ensures operational resilience in case one party defaults

Qualified Investors

In Swiss law

• Qualified investors need to understand investment risks
• Investors should have financial strength, and be suitable to access previously unavailable funds

Significance

• Key because certain schemes are only available to qualified investors

Rationale

• Certain funds are not FINMA authorized
• Only qualified investors can invest in them

How to qualify

Institutional entities

• Banks, managers and brokers
• Pension funds, listed companies, and public agencies
• Family offices

Retail investors

• Knowledge+ CHF 500 investments
• Over CHF 2 million in assets
• Under an advisory contract

Obligations for intermediaries

• Must know of investor classification
• Investors must know about high risk alternative funds
• Investors can opt in or out.

Investor ratings

• Supervised Financial institutions are all automatic
• Clients with CHF 500 receive an opt in
• Advisory clients all receive automatic approval

Protections vs Access

• Retail Investors (Non-professional clients) get More Protection
• Professional Clients get More access

Offering vs. Distribution

Then

• Distribution
• Required finMA for distribution

Now

• Offering
• Does not require FINMA
• New classification of distributors as advisors

Distribution vs Offering

Retail investor

• Requires financial authorization from distributors
• Needs client advisors
• Advisors must advise
• Fulfill code of conduct obligations

Investment Funds

• Legal foundation document for the fund through Prospectus + Fund Regulation
• Freely offered
• Outlining strategy and fees

The Kid

• Short summary
• Tailored for retail investords
• Outlining profile
• Historic Performance
• Must be concise in plain language
• In Swiss and English
• Is free for investors
• Does not replace advisors

Regular Reporting

• Annual report in four months
• Contains all holdings
• Financial records.

Marketing Material

• Brochures, factsheets, websites
• Needs legal grounds from documentation

Overseeing Guidelines

• Allignments with FINMA

Takeaways

• Understand kid
• Explore prospectus
• Use TER
• Understand obligations

Understanding UCITS

• It is an EU regulatory framework that allows investment funds to
• Operate under a single license,
• Markets all countries

Two Pillars

• product strategy for Swiss Funds
• Guiding rules on management

Details

• Similar to Swiss
• Genral investors
• Stable
• Simiar concentrations

Allowed

• Strict limits
• Alt are allowed though

UCITS Companies

• Athoruhized supervisory authority
• Nav caluclation
• Able to delegate

Ucits Benefits

• Operate EU wide
• Many Swiss adopt

AIFMD

• Post 2008 EU
• Regulates alternative investments

AIFMS detail

• Hudge funds
• Equity funds
• Real eatate
• Capital risks
• Focus on controls

AIFMS VS UCIT

• GENRAL VS PROFFESIONAL
• PRODUCT MANEGEMENT VS MANAGEMETNS
• HIGH VS LOW RISK'
• YES FOR BOTH

Fund structure

• Either can be offered and tailored to classes/units
• These either exist as simple, sub or multi class investments

Overview funds.

• Legal
• One investment policy

Classes

• Factors
• fees
• currency
• investors

Fund Structure

• Can have various layers of fees, sub funds and multi funds structures
• Some feeder funds invest smaller funds into a single master

Why is it benefeical

• Manage
• Tax
• Expand

Why is it benificial-2

• Tax and jurisdiction
• Scalae bal

Fund is a cell.

• Receives funds

Requirements

• All regulations

Important

• Not confused with other funds

NAV

• The Net Asset Value (NAV) at date t represents: • The per-unit value of the fund at that point in time.

• It is used to set: o Subscription price: price at which new investors enter o Repurchase/redemption price: price at which investors exit

Cash flow in a FUND

Formula.

• Know per unit.

Break Down

Net and Liabilities

•Market value of all portfolio positions (e.g., stocks, bonds) •Accrued income (e.g., bond coupons, interest) •Receivables (e.g., reclaimable withholding tax) •Cash holdings:

• Commitments (e.g., unsettled transactions)
• Accrued expenses (e.g., management fees, performance fees)
• Taxes payable, interest payable
• Dividends payable

Gives.

We provide accounting post

•Valuation rules (e.g., mark-to-market vs. amortised cost) •Timing of NAV calculation •Consistency in accounting policies Therefore NAV is fair

• Valuation rules (e.g., mark-to-market vs. amortised cost) •Timing of NAV calculation •Consistency in accounting policies

NAV detail

• The accounting
• Snapshot

Levels

• Micro Macro

Details macro

• Diversity to exposure
• Skilled management

Nav Level 2

• Liquidity
• Able to access

Economic Benefits

• Channels savings
• Efficient market
• Economical
• Retirment

Funds Details

Fund rules Aum depends on goal depends on structure

Primary Market.

The primary market refers to the direct interaction between the investor and the fund.

• Created (issued) when an investor subscribes
• Destroyed (cancelled) when an investor redeems

This only applies to open-ended funds (equity, bond, real estate, etc.), which can increase or decrease the number of units based on investor demand. Issuance and Redemption

More Details

Unit created at request

—Cancelled at request Real Estate