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Knowledge Requirements for Investment Funds - Post #07 - FPSC Level 1 Examination - December 2017

Posted by John Gobeil on

The FPSC Level 1 Examination is the first of two exams that must be passed to obtain CFP® certification. We have posted this entry to assist you in your preparation for the FPSC Level 1 Examination (FPE1) on Friday December 1, 2017.

In our last Post, we considered the Refinements to FPSC® Financial Planning Practice Standards.

In this Post, we will provide our summary of the knowledge requirements for investment funds.                                                               

Knowledge of Investment Products

You can expect 15% to 20% of the questions to involve investment products. The investment products of which you need knowledge include CSBs, GICs, T-bills, bonds and debentures, common and preferred shares, investment funds, trusts and derivatives.

According to Appendix B of the CFP® Professional Competency Profile 2.0, the level of knowledge is Detailed for Mutual Funds, Segregated Funds, Exchange-Traded Funds and Pooled Funds.

The definition of Detailed says that: “A CFP professional must have a strong working knowledge of the topic and most of its ramifications in order to effectively analyze all relevant client information, weigh various options and synthesize information to make specific client recommendations. He will be able to draw inferences and explain the key impacts of strategies and recommendations on other client goals. He will be aware of the limitations of his knowledge and when he needs to consult another professional.”

The following table includes our summary of the requirements for investment funds.

Investment Funds

Knowledge Requirements

 

1. The nature of the investment

    An investment fund is a corporation or a trust that pools the savings of individual investors and invests the savings for their mutual benefit.

    The assets held by a fund can include any security and many physical assets.

    2. Liquidity and marketability of an investment

      Most open-ended investment fund are liquid and marketable.

      All exchange-traded funds are liquid and marketable.

      Some hedge funds and closed-end investment funds are neither liquid nor marketable.

      3. The risks associated with an investment

        An investment in one of these funds has all of the risks that are associated with the underlying investments.

        For example, fixed income investments are particularly subject to interest rate risk and equities are subject to financial risk.

        However, investment funds may also be subject to unique risk, large investor risk, liquidity risk, repurchase risk, securities lending risk, geographic risk, sector risk, tracking risk and currency risk.

        4. Any fees and expenses associated with an investment

          The costs of purchasing and owning a fund are many and include front and back-end loads, service charges, foreign currency spread, management fees, trustee fees, performance fee, portfolio transaction costs and other fund costs.

          5. Any rights of the investor

            Under securities laws in some provinces and territories, you may have the right to withdraw from your agreement to buy units of a fund within two business days of receiving a prospectus or cancel your purchase within 48 hours of receiving confirmation of your order.

            You may also have the right to remedies for rescission or, in some jurisdictions, revisions of the price or damages if the prospectus and any amendment contains a misrepresentation or is not delivered to you, provided that you exercise such remedies for rescission, revisions of the price or damages within the time limit prescribed by the securities legislation of your province. 

            6. Evaluation of the return for each investment

              The historical returns reported by the funds would be the most visible return.

              For a taxable account, the after-tax return of your client from investment in a particular fund would be of great significance as a measure of how the client’s investments have performed.

              The reward-to-risk ratio is the return earned by the fund over a specified period, divided by the standard deviation of the return over that same period.

              The beta coefficient (beta) is a measure of systematic risk, or more specifically, an indicator of the volatility of a mutual fund in relation to the volatility of the market.

              The alpha coefficient (alpha) is a measure of the skill of the fund manager.

              7. The types of income and appreciation

                Your client would be informed each year of the composition of the amounts distributed, including amounts in respect of both cash and reinvested distributions.

                This information will indicate whether distributions are to be treated as ordinary income, eligible dividends, dividends other than eligible dividends, taxable capital gains, non-taxable amounts and foreign source income, and whether foreign tax has been paid for which you might be able to claim a tax credit, where those items are applicable.

                8. The income tax considerations

                  In managing your client’s income taxes, you would need to understand how to consider the implications of taxable dividends, income from foreign sources, capital losses, net taxable capital gains, non-taxable capital gains, adjusted cost base, return of capital, alternative minimum tax, proceeds and costs of disposition.

                  9. Strategies for using investment funds

                    Most funds have the objective of outperforming or at least replicating a market benchmark or index, such as the S&P 500.

                    Hedge funds are characterized by their investment strategies, which could be a relative value strategy, an event driven strategy or a directional strategy.

                    You can find an investment fund to pursue almost any investment strategy.

                    10. How to select investment products

                      The first considerations would be your client’s investment objectives, risk tolerance and time horizon.

                      The next consideration would be determining an appropriate investment strategy.

                      The final considerations would be the characteristics of the funds you are considering, their historical performance, their current composition and strategies, and how well they can be expected to implement your client’s investment strategy.

                       

                      We could have chosen a simpler investment, such as a regular Canada Savings Bond. However, it would not have been nearly as interesting.

                      You must know how to apply the concepts to a client situation. Thankfully, the FPSC does not have the time or space to include 200 page prospectuses in the Exam.

                      The following question is a number cruncher and we hope that you remember the formula.       

                      Oprah would like to earn a minimum return of 10% on her RRSP investments. She has narrowed her choice to units of the Ecstasy, an equity mutual fund and shares of iShares S&P/TSX 60 Index ETF, an equity mutual fund.

                      Over the last ten years, Ecstasy posted a mean return of 18% with a standard deviation of 9 and iShares posted a mean return of 20% with a standard deviation of 5.

                      What would you advise Oprah?

                      (A) Oprah would likely achieve her minimum return by investing in iShares. 
                      (B) Oprah would likely achieve her minimum return by investing in Ecstasy.
                      (C) By investing equal amounts in two ETFs, Oprah would likely achieve her minimum return.
                      (D) Oprah should avoid both investments because they would not likely achieve her minimum return.

                      The following question is probably as complicated as you can get with a multiple-choice question.

                      Jerry is a growth-oriented investor. His strategic asset allocation is 0% to 20% fixed income and 80% to 100% equities. He has implemented his strategy by purchasing units of the iShares S&P/TSX 60 Index ETF, which have a fair market value of $78,000 and units of the iShares Canadian Universe Bond Index ETF, which have a fair market value of $22,000.

                      Jerry is very concerned that the financial institutions, which make up over 30% of the iShares S&P/TSX 60 Index ETF, are overvalued by at least 25%. He will not change his strategic asset allocation.

                      Which of the following tactics would you advise Jerry was the most appropriate?

                      (A) Write a put on units of the iShares S&P/TSX Capped Financials Index ETF
                      (B) Short sell units of the iShares S&P/TSX Capped Financials Index ETF
                      (C) Sell units of the iShares Canadian Universe Bond Index ETF
                      (D) Purchase units of the iShares S&P/TSX 60 Index ETF

                      Next Post

                      In our next Post, we will provide the solutions to the two questions on investment funds.

                      John Gobeil, BSc, CFP®
                      David Gobeil, CPA, CA, CFP®

                      Certified Financial Planner® and CFP® are certification marks owned outside the U.S. by the Financial Planning Standards Board Ltd. The Financial Planners Standards Council is the marks licensing authority for the CFP marks in Canada, through agreement with FPSB.


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