Investment Company

An investment company is an organization, trust, or entity that collects capital from various investors to reinvest it in financial securities such as equity, debt, and a wide range of money market instruments. The three investment company types are open-end, closed-end, and Unit Investment Trusts (UIT).

The company shares the profit and losses with the investor in proportion to the investor’s interest. In addition, they employ financial managers who make critical financial decisions on behalf of the investors. Thus, investors can access many investment products without extensive research and preparation.

• An investment company is an entity or trust that collects funds from investors to invest them in different asset classes. It can be publicly or privately owned, and investors receive profits or losses proportionate to their share in the company. 
• The three primary types of investment companies are closed-end, open-end funds (mutual funds), and unit investment trusts. 
• Investment companies are crucial in providing small investors with access to professional financial management, helping them minimize risk and diversify their portfolios.
• These companies employ experienced finance managers who make informed investment decisions, particularly during economic uncertainty or market turbulence.

An investment company pools resources from many investors and invests substantially in various asset classes and security instruments. The company collects funds from multiple investors. It then invests its entirety in various types of assets, including debt, equity, shares, and properties.

The company will earn returns on its portfolio in interest, dividends, etc. These returns are then forwarded to the individual investors, based on their share of the total investment fund. For example, suppose a company invests $2 million, and one has invested $40,000 with this company. They will get 2 percent of whatever returns the company generates.

The type of assets chosen to invest will depend on the overarching management objective of that particular company. For instance, suppose the aim is the quick growth of investments. Then a large portion of funds will be invested in shares and equity, as these assets yield the highest returns.

Suppose the objective is to generate stable, long-term returns while minimizing risk. Then debt securities and commercial real-estate investments will be preferred, as they are less volatile than equity.

The regulated investment company in the US comes under the Securities and exchanges commission (SEC). They must also be registered under the Investment company act of 1940 and the Securities Act of 1933.

The three major categories of registered investment company are as follows:

1. Open-end : They are commonly known as mutual funds, these companies sell shares constantly. They are always ready to purchase their shares from investors at net asset value Therefore the shares of an open-end mutual fund investment company are redeemable.
2. Closed-end : These investment companies list a fixed number of shares traded in the stock market. They do not generally buy back their shares from investors.
3. Unit investment trusts: This is an investment company that holds a static portfolio containing a fixed set of not actively traded securities. The UNIT will dissolve on a particular date when its portfolio gets liquidated and the proceeds handed over to investors. The shares of a UIT can therefore be called redeemable.

Let us take a look at some investment company examples. Imagine a person who has lived frugally for a few years and has managed to save a substantial portion of income. They would now like to invest their savings to earn a profit, either in interest, dividends, or asset appreciation.

They could invest money directly in real estate or the stock market, but this would require a substantial amount of time-consuming research. This is where investment companies come in. Investing indirectly through a company can take some emotional weight out of a person's financial decisions. One will have experienced financial experts guiding them and managing their portfolio, ensuring that they stick to the long-term goals and ignore the daily market fluctuations, scary though they might be.

With countries and states still struggling to recover from the impacts of the pandemic, the importance of regulated investment companies has never been more evident. Unfortunately, when the economy slows down or shows signs of going into recession, individual investors tend to panic, withdrawing their investments from the market. They may also make counterproductive investment decisions driven by fear rather than sound market analysis.

An individual investor will get several benefits from the pooling of funds. The benefits are explain in details below:

• A registered investment company employs experienced and qualified finance managers. As a result, they can provide professional investment management services that allow investors to reach their investment goals quickly and with minimal risk.
• Investment companies also provide ample opportunities for diversification. For example, an individual investor might research a single asset class like the stock market or real estate and then invest all the money there. It is extremely difficult for one person to have in-depth knowledge about different investment vehicles or assets. This can also be risky as one would lose all their money if the stock market crashes or if the housing market collapses, like in the crisis concerning subprime mortgages in 2008.
• An investment company can help investors diversify their investments with the help of multiple financial managers and experts who have great knowledge about various asset classes. As a result, they can take the accumulated savings of many different investors and invest the money wisely in real estate, stock market, option, and commodities.

Even though the system has a lot of benefits, the limitation should also be considered. Let us try to understand them in detail.

• Market risk – The funds that these registered investment company hold in their portfolio belong to investors and invested in various financial instruments that are exposed to market risk. If the market return fluctuates, the investors may face losses.
• Less control of investors – These companies manage the funds that belong to investors, but they hardly have any control over them, because they are managed and invested by these companies due to which the control is in their hands.  
• Fees – These companies manage the corpus in return for a large fee which include management fee, administrative cost and other charges that are borne by the investors. Thus, the service is expensive.
• Conflict of Interest – The companies may become profit driven and thus they may put their own interest above the interest of the investors, which proves harmful in the long run.
• Subject to rules – The investment company structure are subject to laws and regulations that they need to comply with. If not done, they need to pay fines and penalties which affect their brand image and services.
• Transparency issues – Sometimes the companies may not be totally transparent in their approach and do not provide a clear and complete picture about their performance. If investors are not careful, it might lead to loss of the invested funds.

Thus, any investors should analyse both the benefits and limitations before approaching a financial institution for investment related advice.  

It is rarely a good idea to exit the market when you have recently suffered a major loss. This instinctive reaction to losing a large amount of money often causes people to sell at low prices and buy at higher rates later after the market has once again stabilized.

An investment company will help a person define clear, achievable, and measurable goals, determine how much risk they can take on, and diversify their portfolio so that they don’t face financial ruin if one asset class is in jeopardy. This will help an investor stay on course and come out of these economically turbulent times relatively unscathed.

However, when one chooses an investment company, they must ensure that the company does not charge any hidden fees or other associated costs. If one chooses a company without doing some research into their fee structure, they could end up paying nine times more money in the form of seemingly small costs.

Both the above types of companies operate in the financial market. But there are some distinct differences between them as follows:

• The main purpose of the former is to manage the funds on investors and generate maximum return on them whereas the purpose of the latter is to control the operations and decision-making process of the subsidiary companies by owning a significant part of the share capital.
• The mutual fund investment company is only responsible for managing the funds whereas the latter has ownership interest in the capital of the subsidiary company.
• The former achieve diversification through investment in different financial instruments and sectors whereas the latter achieves diversification through acquiring subsidiaries in different industries.
• In case of the investment company structure, management is totally in the hands of the company itself whereas the holding company may give advice but delegate the operation to the subsidiary’s management team.
• Investment firms are regulated by Securities And Exchange Commission (SEC), but in case of the holding company there is no such regulatory body. They follow the company laws.

Thus, the above are some important differences between them.

This has been a guide to what is an investment company. We explain its types along with examples, differences with holding company & benefits. You may also learn more about financing from the following articles –

• Investment Manager
• Investment Property
• Investment Analysis