What are investment companies?
Investment companies, sometimes referred to as investment trusts, closed end funds or closed ended, only exist to invest. They make a profit by buying and selling shares, property and other assets. An investment manager decides what assets to buy in order to build a diverse, managed portfolio.
When you buy shares of an investment company you make an investment that includes a share of all those assets. It’s a simple way of expanding your portfolio and spreading your risk.
You’re not investing alone. Different people contribute money to the company. When you invest you become one of its shareholders. This means investment companies are a type of collective investment fund, like unit trusts.
With an investment company:
- you gain access to a wider range of investments than you could normally buy yourself
- your investment is managed by an expert fund manager
- depending on the company you choose, you can invest in specific markets, industries or even small unlisted businesses which are at an early stage in their development
There are over 400 investment companies, many of which have existed for more than 50 years. They include:
The benefits of investing in investment companies
Investment companies are a type of collective investment fund. All collective investment funds have some benefits in common. In the next section we look at the special features of investment companies.
All types of collective investment funds, including investment companies, give you:
- economies of scale
When you buy shares you have to pay dealing costs and admin fees, which can eat away at the value of your investment. In an investment company, all the investors pool their money and split the admin costs. You can end up paying much less.
- a way to spread your risk
Each investment company owns shares in a range of investments, so buying shares in only one investment company effectively gives you a diversified portfolio. As you are not dependent on the success of just one or two investments, this spreads your risk.
- a professional manager’s expertise
Each investment company uses professional management expertise.
- a chance to invest small amounts
You can invest small lump sum amounts or even invest monthly. Most companies are available through savings schemes run by their managers, some of which start from as little as £20 a month.
Put all these benefits together and you find that collective investments are an effective and efficient way to invest in a diverse range of assets.
How investment companies work
|The Association of Investment Companies (AIC) was founded in 1932 to represent the interests of the investment trust industry – the oldest form of collective investment. Today, the AIC represents a broad range of closed-end investment companies, incorporating investment trusts and other closed-ended funds and VCTs.|
- Closed-ended structure
- Listed on a stock exchange
- Boards of directors
- Shareholder democracy
- Different share classes
- Specialisation in particular sectors
Investment companies are known as closed-ended, rather than unit trusts which are open-ended.
In an open-ended fund, the fund is constantly expanding and contracting as investors move their money in and out of the fund.
This means that managers have to plan and manage the fund to be able to meet the demands for investors who may want their money back at any time. Open-ended funds are often restricted to investing in liquid assets, in other words investments that can be sold at short notice.
Investment companies, however, have no such issues, as they have a fixed number of shares in issue at any one time, which are traded backwards and forwards on the stock market, which has no impact on the portfolio.
In addition to allowing managers to take a longer-term view, this enables investment companies to invest in less liquid assets classes such as private equity, venture capital and commercial property, with the potential to deliver better long-term returns or higher levels of income.
Shares of investment companies are traded on a stock exchange, just like the shares of ordinary companies. They can be listed on one of several stock exchanges, for example:
- the Official List of the London Stock Exchange (LSE)
- the International Stock Exchange (TISE)
- the LSE Alternative Investment Market (AIM)
In the UK, investment companies are most often listed on the LSE's Main Market.
Investment companies have independent boards of directors. The directors’ duty is to look after your interests as an investor, by ensuring the company is as successful as possible.
The directors meet several times a year and monitor the company’s performance. They answer to the shareholders, which means you have some say in how the company is run.
When you buy a share in an investment company you become a shareholder. Shareholders in investment companies have the same rights as other shareholders in other companies.
- vote on issues at the company's annual general meeting (AGM)
- table motions to be discussed
- call for extraordinary general meetings (EGMs)
- vote in a new board of directors if they are not happy with the current one
In other collective investments, you don’t have as much of a say in how the fund is run.
Investment companies, being companies, can borrow money to make additional investments. This is called 'gearing'. It lets the company take advantage of a long-term plan or a particularly attractive stock without having to sell existing investments.
The idea is that the additional investment makes enough money to pay off the loan and make a profit on top of that. If it works, the more the company borrows, the more profit it makes. If the investment fails, the more the company borrows, the more it loses.
Investment companies can usually borrow at lower rates of interest than you’d get as an individual. They also have flexible ways to borrow – for example they might get an ordinary bank loan, or issue preference shares.
Not all investment companies use gearing. Many of those that do use modest levels. It’s a decision taken by the fund manager and the board of directors. The gearing policy of the company may change from time to time. It’s regularly reviewed by the board and manager.
Other kinds of collective investments can’t use gearing to the same extent as investment companies.
Investment companies which issue only one class of ordinary share are commonly known as 'conventional' investment companies. The shares usually give shareholders a right to dividends and the opportunity to increase the capital value of their investment.
Some investment companies, called ‘split capital investment companies’ (splits) issue more than one class of share. These are designed to suit different types of investor and different attitudes to risk. Some split shares aim to pay high levels of dividends for investors who want an income. Others aim to pay out only a capital amount at the end of the company’s life.
Investment companies can invest in a much wider range of investments than other types of fund. In fact, they can invest in almost anything. The investment company will set out its particular approach in its investment policy.
Investment companies can specialise in things like:
- a particular region or type of company
- mainstream global companies
- companies from different parts of the world
- particular business sectors
There are various specialist investment companies including:
- Venture Capital Trusts (VCTs), which invest in young, high-risk companies
- property investment companies
- private equity investment companies
- hedge funds
Some investment companies are what are called a 'fund of funds' – they only invest in other investment companies, which means they take advantage of another layer of investing expertise (the fund managers in those investment companies). This can give good results, but the disadvantage is that you may be exposed to additional layers of operating costs and gearing.
The different investment companies suit different investment purposes. For example, you might put some core money in a large globally invested company, and add spice by investing a little extra with a smaller specialist company.
Each company has a fund manager who makes the day to day decisions about what stocks and other investments to buy and sell.
Most investment companies are managed by an external management group which may manage a number of companies. The board of directors select the fund manager (or managers).
Companies that have no management group involvement are called 'self-managed'. This means the board of directors selects and employs a salaried fund manager (or managers) directly.