In good company

What is the single biggest difference between an investment company and other types of collective funds such as unit trusts and open-ended investment companies? Well, the clue is in the name: an investment company is exactly that; a stock market listed company with a board of directors and owned by a group of shareholders. Other types of fund, by contrast, are effectively products marketed by investment management firms. Both categories of fund have the same objective – to deliver good returns to investors by investing their money well – but investment companies are independent companies.

That difference is much more fundamental than many people realise. Investment company boards must, under the principles of company law, act in the interests of shareholders. They have a legal responsibility to protect and promote those shareholders at every turn.

So, for example, if the fund’s performance disappoints, the board must think about how the company might do better for its shareholders. That might mean changing investment manager, for example, or restructuring in some way. Or it might mean more subtle changes. But the directors’ motivation must always be to safeguard the interests of shareholders.

With other types of fund, the role of those in charge is not always so clear. A fund manager that spends money launching and promoting a fund to investors knows it has to perform well in order to retain its customers. But the manager doesn’t operate under the same strictures and will naturally want to act in its own interests too – it is unlikely to sack itself, for example.

In such situations, investors in most funds have little power. They can take their money elsewhere if they’re unhappy with their investment, but that’s more or less their only sanction. By contrast, investment company shareholders, as the ultimate owners of the company, have a say in how the fund is run. If enough of them feel strongly that a change of direction of some sort would be preferable for the company, they can push for that.

In fact, cases of shareholder activism are relatively common. They may be led by institutional shareholders with deep pockets, but they rely on enough shareholders exercising their democratic rights in a way that will achieve a particular goal. Such episodes can be uncomfortable for all concerned, but that’s not the point; rather, they provide working examples of how investment companies are run for shareholders, not fund managers.

Investment companies are very different to other types of fund. Shareholders and directors can – and do – hold the fund to account, and have the power to effect change if they so desire. This is something investors should welcome – in the end, it is their interests that are paramount.