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Other Investment Companies


An investment company is a company that is registered with the SEC under the Investment Company Act of 1940. It can be structured as either a corporation or a trust, and engages in the business of investing the pooled funds of investors in securities appropriate for stated investment objectives. Investment companies provide investors with more diversification, liquidity, and professional management services than would normally be available to them as individuals.

There are three main types: open-end funds (commonly known as mutual funds), closed-end funds (CEFs), and unit investment trusts (UITs). Exchange traded funds (ETFs) are investment companies that can be organized as either a mutual fund or a UIT. Shares of CEFs, UITs and ETFs that are organized as UITs are publicly traded on an exchange or in the over-the-counter (OTC) market. Shares of ETFs that are organized as mutual funds, on the other hand, are sold directly to investors.

This discussion is concerned only with CEFs, UITs and ETFs.

Technical Note: A fourth type of investment company, known as face amount certificates, is rarely used anymore.

What are closed-end funds?

A CEF typically issues shares during the initial public offering. Once the money has been raised, the fund trades on an exchange or in the OTC market. CEF shares generally are not redeemable. Open-end funds, on the other hand, stand ready to issue and redeem shares on an ongoing basis. There are two main types of CEFs: stock funds and bond funds.

Because CEFs trade on market exchanges, the market price of a CEF share can fluctuate with the supply and demand of the market. When demand exceeds supply, the market price at which the shares of a CEF trade may be at a premium to its net asset value (NAV) (the intrinsic worth of a share of the CEF). Conversely, when supply exceeds demand, the shares of the CEF may trade at a discount to its NAV. Though some funds trade at a premium, most shares of CEFs trade at a discount. Shares of CEFs, when purchased at a discount, offer a form of leverage. This leverage can improve the returns of the investment.

A CEF is professionally managed and can be either diversified or nondiversified. If the fund does well, an investor can enjoy share price appreciation, dividend income, and, if the fund sells shares for a profit during the year, capital gains distributions.

Some of the potential pitfalls include

  • Share price depreciation: The CEF's share price may decrease if market demand diminishes. Demand can diminish if the market has a poor perception of the fund or fund manager, or if the fund performs poorly.
  • Liquidity: CEFs have more flexibility to invest less liquid securities than mutual funds. An illiquid security generally is considered to be a security that can't be sold within seven days at the approximate price used by the fund in determining NAV.
  • Volatility: Depending on their investment objective and underlying portfolio, CEFs can be very volatile or fairly stable.

What are unit investment trusts?

A UIT (sometimes called a focused portfolio or a defined portfolio) buys and holds a relatively fixed portfolio of stocks, bonds or other securities. By fixing the portfolio at the date of deposit, the investor knows exactly what securities are in the portfolio, when the trust is scheduled to mature, and the income stream the trust is expected to generate.

Redeemable units in the trust, which generally cost at least $1,000, are sold to investors, who receive an undivided interest in both the principal and the income generated by the portfolio in proportion to the amount of capital they invest. The UIT will buy back an investor's units, at the investor's request, at their approximate NAV.

Unlike mutual funds, UITs end on a date established when the UIT is created (if the UIT consists entirely of bonds, that date is usually the date the portfolio matures). The investor can then take his or her proceeds in cash or, in some cases, roll the proceeds over to another UIT.

There are two basic categories of UITs: equity and fixed-income. Equity UITs offer a fixed portfolio of stocks and often seek to capture capital appreciation over a period of a year or a few years. Fixed-income UITs offer fixed portfolios of bonds. Interest payments for fixed-income UITs are distributed on a predetermined date--either monthly or semi-annually.

There are several advantages to UITs:

  • Diversification: Investing in a variety of bonds or stocks allows a UIT to diversify its holdings. This means that an investor can offset possible losses from one set of securities with possible gains in another set of securities within his or her portfolio, thus reducing risk.
  • Liquidity: Investors can sell their units at any time at their current NAV. Caution: A sales charge may be imposed.
  • Reinvestment/exchange: If you choose not to receive distributions from a bond UIT, you are generally permitted to reinvest them in a mutual fund or in another UIT. If you choose not to receive distributions from an equity UIT, you may be able to reinvest in additional units of the same UIT.

But there are risks as well. A UIT is considered a passively managed investment vehicle, as opposed to a mutual fund, which is actively managed. A mutual fund manager can react to market conditions by buying and selling. A UIT cannot.

What are exchange traded funds?

ETFs represent shares of ownership in mutual funds, UITs, or depositary receipts. Generally, ETFs are index-linked funds--they are passively managed funds that track the trends of an underlying index. However, unlike index mutual funds, which can generally be purchased or redeemed only at an end-of-day closing price, ETFs are priced and can be bought and sold throughout the trading day. Furthermore, ETFs can be sold short, bought on margin and optioned. Stop loss and limit orders may also be placed.

There is an ever-growing number of ETFs available. They can be categorized into three types: broad-based, sector and international. Examples of ETFs include Spiders, Cubes (or Qubes), Diamonds, WEBS and iShares.

ETFs do not sell individual shares directly to investors and only issue their shares in large blocks known as creation units. Generally, a financial institution will purchase a creation unit and then split it up and sell the individual shares on a secondary market. The institutional investor may redeem its creation units only by exchanging them for the same number of other ETF shares. Individual investors can only buy and sell ETF shares via a broker once they are listed on an exchange--he or she cannot redeem shares directly from the ETF, as with a mutual fund or UIT. The forces of supply and demand that exist in the marketplace determine the market price of an ETF. Thus, ETFs do not always trade at the NAV of their underlying holdings.

ETFs offer a number of advantages:

  • Cost efficient: Because there is no active management to pay for and no expensive equity research required, ETFs typically have lower expense ratios. Caution: If an investor buys and sells a little bit at a time, commissions can offset the savings on other costs.
  • Easy trading: ETFs can be bought and sold throughout the day on the stock exchange, purchased on margin and sold short. Stop loss and limit orders may also be placed.

The risks associated with ETFs include:

  • Volatility: Because ETFs are based on an underlying index, they are subject to the same market fluctuations as the securities that make up the index during market swings.
  • Market price: An ETF can trade at a premium or discount from its NAV. Therefore, the ETF's price might not reflect its true value.
  • Commissions: Investors purchasing ETFs in the secondary market are subject to regular stock commissions.

2 West Dry Creek Circle, Suite 100
Littleton, Colorado 80120
Phone: 303 734 7142

© 2016 Archer Private Financial Group.


Securities offered through: AOS, Inc. doing business as MoneyBlock, Member FINRA/SIPC. A Registered Investment Advisor. Corporate Office: 311 S. Wacker Dr. Ste. 650 Chicago, Illinois 60606 800.591.8243 Mark D. Bowman Registered Representative FINRA BrokerCheck