Methodology

Investing Basics

Module 2

What is a portfolio?

Investment Companies

Investment companies are companies that are involved in the business of investing, on behalf of clients. An investment company invests the money that it receives from investors, on a collective basis (it invests all of the money it receives as one pot of money). Each investor receives a share in the profits or losses of the fund, in proportion to the amount of money that they invested. 

 

The performance of the investment company will be based on the performance of the investments it holds.  For example, if an investment company decided to invest their funds into 30 American stocks that grew by 10% in 6 months, then the value of the investment company would also have grown by around 10%. It won’t be exactly 10% though, as the fund will have expenses to pay (i.e. the salary of the manager, transaction fees).

 

 

There are two main types of investment companies. The first is called an open-ended investment company (also known as a mutual fund), while the second is called a closed-ended investment company (also known as a closed-ended fund).

Open-ended funds

An open-ended fund (also known as a mutual fund), such as a unit trust, is one where a company creates new shares when new investors subscribe, only to cancel them when the investor sells their stake in the fund.  

 

Open-ended funds are much more common than closed-ended funds. Some mutual funds, hedge funds and exchange-traded funds are examples of open-ended funds. Open-ended funds are not traded on a stock market, instead, the value of the fund is based on the net asset value of the fund (it basically means the assets held by the fund, i.e. value of investments, minus the liabilities, i.e. expenses).

 

The objectives of the fund can vary a lot. Some open-ended funds will invest in very risky investments, while other open-ended funds may take a more conservative approach. Investing in an open-ended fund is usually very affordable, with transaction fees usually standing at around $2 per investment. Investors pay an on-going fee to the fund, which also varies depending on the provider. With that said, it usually ranges between 0.06% and 1% per year.

Closed-ended funds

In contrast to an open-ended fund, a closed-ended fund, such as an investment trust, is one where there is a fixed number of shares that investors buy and sell to one another. Closed-ended funds follow the same structure as a public company and are usually listed on a stock market.

 

Instead of being valued based on the value of the investments that it holds, closed-ended funds are valued based on their stock price. So, if a closed-ended fund is very popular, then the value of the fund will increase based on that demand.

 

A disadvantage of a closed-ended fund is that the value of the fund is based on its value on the stock market. Therefore, the price of the fund may experience huge swings that are irrelevant to the value of the investments that it holds. At the same time, this is also an advantage as closed-ended funds may become very popular, resulting in larger gains for investors.

 

Like open-ended funds, closed-ended funds can have a variety of different objectives. Some may invest in stable companies, while others may be willing to take huge risks. If you are interested in investing in a closed-ended fund, they are available through a stockbroker. Open-ended funds can either be invested into via a stockbroker or invested into directly. 

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