QUESTION 18 Illustration 8: Investment manager’s share in a mutual fund Mutual Fund X has an Investment Manager Y. At the inception of the fund, Y had invested a nominal or token amount in units of X. Such units rank last for repayment in the event of liquidation. Accordingly, they constitute the most subordinate class of instruments. Examine the nature of the financial instrument.

SOLUTION

The financial instrument in this case is the investment made by the Investment Manager Y in Mutual Fund X. The investment has the following features:

  1. The Investment Manager has invested a nominal or token amount in units of the Mutual Fund.
  2. These units rank last for repayment in the event of liquidation, making them the most subordinate class of instruments.

Based on these features, the investment made by the Investment Manager can be classified as an equity instrument. This is because the investment represents a residual interest in the assets of the Mutual Fund after deducting liabilities. The fact that the units rank last for repayment in the event of liquidation means that they are subordinate to other classes of instruments, but this does not change the nature of the instrument as an equity instrument.

Furthermore, the nominal or token amount of the investment indicates that it is not a significant investment by the Investment Manager. It is possible that the investment was made for the purpose of aligning the interests of the Investment Manager with those of the investors in the Mutual Fund. This aligns with the common practice in the investment management industry of requiring managers to invest a portion of their own capital alongside that of their clients.

Therefore, the investment made by the Investment Manager Y in Mutual Fund X can be classified as an equity instrument.

Complete and Continue