A benefit of a collective investment scheme (CIS)

There are benefits to investing in a collective investment scheme (CIS) (also called a unit trust or mutual fund) relative to an individual share of a listed business in a post-tax discretionary investment account. The benefits hold even if this individual share is held as part of a larger portfolio of shares. 

One of these benefits can be illustrated in the following scenario

If an investor is fully invested in a CIS or individual share portfolio, it may mean he rarely has spare capital to invest in addition to the capital he already has invested. During market downturns he therefore cannot add to his existing investments. 

The benefit of adding during market downturns is that the investor could average down his entry price in an investment. In effect, he could buy himself a cheaper entry point, which would be an implicit or unrealised gain to the investor by increasing his potential upside. 

In general terms, the investor that is fully invested in individual shares, does not have this advantage in this form available to him (more on this later). However, the investor in the CIS is effectively ‘‘piggybacking’’ off of outside capital. This capital can be in the form of new investors or other investors who make cash additions to their existing investments in the CIS.

These investors add new capital to the overall pot which is used to buy individual shares that have declined in price. In this way, the unit trust manager can actually partially correct prior ‘‘too high’’ entry points in individual securities.

We see this often, where Collective Investment Schemes that were previously closed for new investment, all of a sudden open to new investors or to additional subscriptions into the CIS where performance was weak. It is not always the case that the investment manager can attract new capital given recent weak performance, but if long-term performance is good he may be able to attract new capital.

Averaging down can be illustrated by the following simple scenario:

 Pool of capitalOriginal # of Shares OwnedWeighted average entry pricePrice 1 year laterNew Investors Capital AdditionNew # of Shares OwnedAverage cost per shareImplicit relative gain/(loss)Total Return
Individual share $             1 000                       10 $              100 $             80 $                    –                    10 $        100.0-1.8%-21.8%
CIS $             1 000                       10 $              100 $             80 $                   80                  11 $          98.21.8%-18.2%
Relatively better-off

Of course, there are options available to the investor in the individual share portfolio.

  1. He could realise some of his other ‘‘in-profit’’ holdings in his portfolio to be able to invest those proceeds in one of the other individual shares that has declined in value. This is in order to average down his cost on the ”cheaper” share. However, by realising these gains he also realises capital gains tax which is a negative return to the investor.
  2. He could leverage his position by borrowing some capital and investing it in the downtrodden individual share. This presents the disadvantage of interest payments on the debt which may lead to liquidity problems elsewhere in his portfolio when having to settle the periodic interest payments. Another negative return to the investor.

In essence, the CIS investor has a benefit that the individual share investor does not. He can piggyback off of the collective.

Fintax has been an authorised financial services provider (FSP642) since 1983 and is suitably regulated by the FSCA.