Investment Companies Overview

Management company structures may be:

"open-end" or "closed-end":

Investment Company

An investment company collects funds from individuals and purchases securities with those funds that are consistent with the investment company's objective. For example, an older customer who desires income may purchase an income fund; a younger customer who desires capital gains may purchase a growth fund.

Diversification / Professional Selection

Because the investment company has a large amount of money to invest, it can diversify its portfolio, reducing risk to the investor. The investment company also offers professional selection of investments, and, in most cases, ongoing management of the portfolio.

Closed-End "Publicly Traded" Fund / Not Redeemable

Closed-End Management Company: Under this structure, the fund has a one-time issuance of stock. The stock is then listed on an exchange and trades like any other negotiable security. Thus, they are called "publicly traded funds." The fund usually invests in bonds, with the shareholders receiving income distributions from interest earned as well as capital gains. Under this structure, the shares are not redeemable. The shares are negotiable, and can be sold on the exchange where they are listed at the prevailing market price.

Face-Amount Certificate Company

Face-Amount Certificate Company: This type of company is virtually obsolete. Investors in a "face-amount certificate" pay a fixed monthly amount to the investment company, which invests the funds in the highest quality obligations such as U.S. Government debt and AAA municipal and corporate debt. The certificate promises the investor a guaranteed rate of return so that at a fixed date, let us say 10 years off, the certificate matures and the investor receives the stated "face" amount. The total payments are less than the face amount, with the difference being the compound interest earned on the investments. In years past, these certificates were used in conjunction with bank mortgage loans. Back in the 1930s, mortgages as we know them today did not exist. A customer could get a bank loan, paying interest only, with the full principal amount due at maturity. To ensure that the funds would be available to pay off the loan at maturity, the bank would require the customer to buy a face amount certificate in the principal amount of the loan with the same maturity. Because current mortgages provide for both interest and principal repayment, the need for face-amount certificates no longer exists.

The Investment Company Act of 1940 regulates the functions of investment companies. The "Act" defines 3 types of companies:

Face-amount certificate company Management company Unit investment trust

Fixed UIT

Fixed Unit Investment Trust: The trust selects a portfolio of securities (usually bonds), which are placed in trust. Once the portfolio is selected, it is not changed - no buying or selling takes place in the trust. There is no "management." The trust then sells "units" of the fixed portfolio to investors. As interest payments are made on the bonds, they are passed to the unit holders. As bonds mature, the principal is repaid to the unit holders. When all the bonds have matured, the trust self-liquidates.

Management Company

Management Company: A management company is an investment company organized as a corporation, issuing shares of stock. The investment company uses an "investment adviser," or manager, to decide which securities to place in the portfolio. The manager is free to "manage" the portfolio, buying and selling, consistent with the fund's investment objective.

Open-End "Mutual Fund" / Redeemable

Open-End Management Company: This investment company type is commonly known as a "mutual fund" and is the most popular investment company structure. The company issues only common shares. The number of common shares issued is "open-ended"; as investors place new money in the fund, they are issued additional shares. The shares are non-negotiable. They cannot be traded. Instead, the shares are redeemable with the fund.

Participating UIT

Participating Unit Investment Trust: Instead of the trust selecting individual securities, the trust invests in the shares of a management company - specifically mutual fund shares. In this way, purchasers of participating trusts are indirectly buying mutual fund shares. Participating trust structures are used when investors buy mutual funds within an insurance company "wrapper" to fund variable annuity contracts.

Unit Investment Trust

Unit Investment Trust: A unit trust is a type of investment company organized under a "trust indenture" rather than being set up as a corporation. Corporations can issue shares; whereas trusts issue "shares of beneficial interest" representing an undivided interest in a "unit" of specified securities. There are two types of "Unit Investment Trusts" ("UITs") - Fixed Trusts and Participating Trusts.

Variable Annuity

Variable annuities are generally used as retirement planning vehicles. The purchase of "units" is made until retirement age. At retirement, the investor can "cash out" of the investment either as a lump sum payment, in periodic payments, or in the form of an annuity. Because the amount of the annuity or payment(s) varies, depending on the performance of the mutual fund shares purchased, these are called "variable annuities." Variable annuities are covered in the Retirement Plans Chapter.