Do you know what is an Investment company? Investment companies are financial institutions obtaining money from individual investors and using it to purchase financial assets like stocks, bonds etc. from the financial markets.
In turn, investors receive certain rights regarding the financial assets that the investment company has bought and the earnings that the company may generate. Investment companies act like financial intermediaries.
Key Notes
An investment company is a corporation or trust engaged in the business of investing pooled capital into financial securities.
Investment companies can be privately or publicly owned, and they engage in the management, sale, and marketing of investment products to the public.
Investment companies make profits by buying and selling shares, property, bonds, cash, other funds and other assets.
Unlike any company, an investment company issues shares of stock to the investors who are stockholders. The stockholders own the investment companies directly and thus own the financial assets indirectly that the company itself owns.
Stockholders are the only investors of the investment companies. They own the investment company, directly and indirectly, and the financial assets the company owns.
There are two reasons for the investment in the shares of investment companies viz., economies of scale and professional management.
Economies of scale help investment companies to provide diversification at a lower cost of investment than that in direct investment by individual investors.
To get the benefits of both diversification and reduction in the brokerage commission, investors invest in the shares of investment companies.
In addition, an investor can turn over all the market activities to a professional money manager known as a portfolio manager.
Types of Investment company
Investment companies are classified as
- Unit investment trusts
- Managed investment companies
Managed investment companies can further be categorized as:
- Closed-end investment companies
- Open-end investment companies.
Unit investment trusts
A unit investment trust is an investment company that owns a fixed set of securities for the life of the company meaning that it rarely alters the composition of the portfolio during the life of the company.
Unit investment trust (UIT) has no board of directors or portfolio manager.
Formation and Functions of UIT:
A sponsor (known as a trust) often a brokerage firm that purchases a specific set of securities and deposits with a trustee like a commercial bank.
A number of shares commonly known as redeemable trust certificates representing the ownership rights with professional interests in the securities are sold to the public by the sponsor.
Any income generated from the fund is paid to the certificate holders by the trustee. Changes in the original set of securities are made only under exceptional circumstances otherwise fund remains unchanged.
The sponsor of the unit investment trust is compensated by setting a selling price for the shares that exceeds the costs of underlying assets.
For example, a sponsor may purchase a worth of bond of Tk. 1000,00 and place them in a unit investment trust to issue 10,00 shares of Ik. 100 each. Each share might be offered for Tk. 105 to the public. When all the shares would be sold, the sponsor would receive a total of Tk.
1,050,00 (equal to Tk. 105 × 10,00). A sum amount of Tk. 50,000 is enough to cover the selling expenses and marked-up profit of the sponsor.
Secondary Market:
Once upon a time shares of a unit investment trust are purchased, and an investor generally can not sell them in the secondary market. These shares can be sold back to the trust at the net value of the assets.
The net asset value of the share is calculated as the market value of the fund per share. Having determined the per-share price, the trustee may sell one or more securities to raise the required cash for the repurchase.
Managed investment companies
Managed investment companies are companies having both board of directors and a portfolio manager.
It may be an independent firm, an investment adviser, a firm associated with a brokerage, or an insurance company.
Closed-end investment company:
A closed-end investment company issues a fixed number of shares which may be listed with a stock exchange and bought and sold like any company’s shares.
It does not stand ready to purchase its own shares whenever one of its owners decides to sell them. Shares of a closed-end investment company are traded on an organized stock exchange.
Therefore, an investor can buy or sell shares of a closed-end investment company by placing an order with the brokerage firms.
Dividend income and another form of fixed income generated by the funds are paid to the shareholders.
Eventually, most of the funds allow the reinvestment of the income and issue additional shares to the investors based on the lower of net asset value or the market price per share.
Open-end investment companies:
Commonly known as mutual funds an open-end investment company stands ready to purchase its own shares at or near net asset value. It can also offer new shares to the public for a price at or near their net asset value.
Since the capitalization of the open-end investment company is open, the number of shares outstanding changes on a daily basis.
The mutual fund’s shares can be sold to the public by either of two methods viz., direct marketing and the use of a sales force.
Under the direct marketing method, an open-end investment company can sell shares directly to investors without the involvement of a financial intermediary. Commonly known as no-load funds, the funds sell their shares at a price equal to their net asset value.
On the other hand, under the sales force method, the funds sell shares on a commission basis.
The Salesforce method involves financial intermediaries like brokerage firms, specialists, investment bankers, merchant bankers, commercial banks, insurance companies, etc.
