What makes investment companies different?
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Investment companies have a fixed pool of assets which is not affected by the buying and selling of their shares. Open-ended funds such as unit trusts, OEICs and UCITS expand and contract when investors buy and sell their units.
Independent board
Each investment company has a board of directors whose job is to look after your interests. Almost all of these boards are independent from the fund manager and so they can exert pressure to keep running costs down and keep the manager on the right path, or even replace the manager.
You have a vote
As a shareholder, you have a say in how your company is run. You get to vote on important issues. You can attend shareholder meetings such as Annual General Meetings (AGMs) and ask questions.
Liquidity
Managers of open-ended funds must be able to turn investments into cash in a hurry if investors decide they want their money back. Closed-ended funds such as investment companies have a more stable base because the number of shares in issue is usually fixed. With the freedom not to worry about short-term cash flows, investment companies have more freedom to invest in assets that cannot be sold in a hurry like property and private equity. The board of directors of an investment company can choose to issue new shares or buy them back but, because this is optional, they can also take a genuinely long-term view about the merits of an investment. Investment companies can also operate with low levels of cash and can even borrow money to invest – improving performance when returns exceed borrowing costs.
Net Asset Values
Investment companies publish net asset values. The frequency usually depends on the ease with which a valuation exercise can take place. The net asset value (NAV) is the value of all the company’s investments, including cash, less the value of all the money it owes, and is usually expressed as a number per share. This is the same calculation used to work out the price of an open-ended fund.
Discounts and premiums
The value of shares in an investment company is largely determined by supply and demand. If there are more shares than people want to buy, the price normally falls. If there is demand for more shares than are available, the price tends to rise. In each case the share price is likely to settle at a level where demand and supply are matched. This means that the share price can be lower than the net asset value – a discount – or higher than the net asset value – a premium.
Gearing
Investment companies can borrow money. This is often referred to as gearing or leverage because, just like gears on a bicycle, it multiplies effort. For investment companies, gearing exaggerates performance. It is a two-way street, however, as gearing can magnify losses as well as enhance returns. Generally gearing adds risk. Most investment companies use gearing sparingly and many don’t use it at all.
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