Indirect Investment | The Investment Companies | International Investment:- Buying & selling of shares of investment companies which in turn keep portfolio of securities is generally referred as indirect investment. Mutual fund is common example of the investment company that is involved in the process of providing indirect investment opportunity to many investors. The investors do not need to make efforts to purchase securities and then manage the portfolio by themselves. They simply put their money into an investment company which performs all the work and all the decisions. This means that investors buy shares of specific portfolio which is being managed by an investment company and this investment in share become indirect investment for them.
Investment Company stands between the portfolio of securities and the investors. The indirect investment is different from direct investment on the basis of certain additional costs (management fee + sales charges) and benefits (additional services obtained from Investment Company like check-writing privilege and record keeping etc)
The Investment Company
A financial service organization that sells shares in it to the investors and utilizes the raised money to make investment in a portfolio of securities, is considered as an investment company. A widely diversified portfolio of financial assets can be purchased from the raised money of thousands of investors. A variety of services are provided by the investment company.
There are no federal taxes payments associated with the payments of interest, dividends & realized gains to the shareholders. These income distributions are paid to the shareholders by the investment company whose role is of conduit, through which these incomes travel. So the shareholders pay marginal tax on the received income by themselves. The indirect investors are treated in a same way as direct investors who directly possess the portfolio of assets in charging of tax element on the income. The shareholders only pay the income tax on their received income. When a investment company or fund receive short term income than that income considered as the ordinary income of the shareholders and when long term capital gains are received the company than that are also considered as the long term income of then shareholders. Investment Company which is exempted from the tax is treated, is resultantly considered as tax exempt income of the shareholders.
The investment companies must registered themselves with the Securities and Exchange Commission (SEC) according to the Investment Company Act of 1940. There are many provisions in this detailed statute which protects the shareholders. It is also important to understand that investment companies are not guaranteed or insured by any financial institution or government agency from which an investor may obtain shares. These indirect investments are risky and there are chances of loss too. The promotional material of the investment companies clearly states this aspect.
Types of Investment Companies
All investment companies offer their own shares to general public for sale. The securities are purchased from the raised money of the shareholders. Most of the investment companies are managed type of companies which provide the services of the professional management of the portfolio. There is another type which relates to the un-managed ones. Following are the main types of investment companies.
- Unit Investment Trusts
Unit Investment Trust is that type of Investment Company which is different from the managed category. Unit Investment Trust unmanaged company which has fixed income security portfolio which is combined together by a sponsor and managed by an independent trustee. The trust offers its redeemable trust certificates to the shareholders that reflect claims on the assets of the trust. These trust certificates are sold to the investors at net asset value along with little additional commission. The holders of the certificate receive all dividends (or interest) and principal amount. Either equities or tax exempted securities are held by most unit investment trusts. The assets remain unchanged forever and the trust discontinue when the bonds mature, however the unit of trusts can be redeemed. The major objective of unit investment trust is the capital preservation.
- Closed End Companies
Closed companies are the managed type of Investment Company which generally never offers additional shares of its own stock after the initial public offering. These companies have fixed capitalization, unless additional public offering is made. The shares of closed ended investment companies are traded on the exchanges (secondary market) similar to ordinary stocks. The investors acquire the services of brokers in order to buy or sell the shares of these closed ended trusts.
- Open Ended Investment Companies
These are most popular kind of managed investment company that continues to sell its shares to the public after the initial public offering. Mutual fund is the most common example of this type of open ended investment company. The mutual fund has changing capital as some new investors purchase additional shares of fund while some existing investors sell back their shares to the company and receive cash. Mutual funds are normally purchased.
- Directly from the investment company by using telephone or mail or at the location of the company’s office
- From sales agent indirectly including banks, securities firms, financial planners and life insurance companies
Mutual funds can be associated with an underwriter which generally has an exclusive right to deliver shares to the investors. Many underwriters deliver shares through dealer/broker firms.
The investment advisory firm typically forms the mutual trust by selecting the board of directors (trustee) of the company. The trustee in turn engage a separate management company, generally investment advisory company, fro management of fund. The management company receives a fee from the investment company against the management of portfolio, conduction of necessary research and handling of administrative work.
Major Types of Mutual Funds
There are many types of mutual funds on the basis of risk return factor. However the major types of mutual funds are as follow
- Money Market Mutual Fund
- Stock Fund and Bonds & Income Funds
These types of funds correspond to their relative market. Money market funds focus on short term investing by keeping assets of money market. On the other hand stock and bond & income fund focus on long term investment by usually keeping the assets of the capital market.
- Money Market Funds
The money market funds (MMFs) are open ended funds which are potential innovation of investment company industry. MMFs contain portfolio of money market instruments. In 1974, these funds are developed when there was very high interest rates. The investors sought to gain the high short term rates which enhanced the growth of these funds. The competition for the short term saving of investors has drastically increased with the deregulation of the thrift institutions. Large amounts of funds are attracted by the Money Market Deposit Accounts (MMDAs) which are insured and offer competitive market rates.
Money market funds are taxable as well as tax-exempted kinds. Taxable type include approximately 85% these assets. The investors should consider the tax-exempted type while making investment analysis of the MMFs.
Assets like negotiable certificates of deposits (CDs), Treasury bills and prime commercial papers are included in the taxable MMFs. Some funds keep only bills whereas others keep different mixtures. 40 to 50% of the total assets kept by these funds are commercial paper with government agency securities, Treasury bills, repurchase agreements and domestic and foreign bank obligations rounding out the portfolio. The money market portfolios have average maturity of approximately one to two months. The maximum average maturity of the money market funds is limited to 90 days by the SEC.
- Stock Funds and Bond & Income Funds
The objective of an investment company must be set by the board of directors (trustee) of that company so that the company can follow that objective in its investment policy. The consistent investment policy should be followed by the company which must correspond to its specified objective. On the basis of objective of the company, the investors purchase its shares.
The investment company industry is represented by a well known organization named Investment Company Institute uses many major kinds of objective. Many of these objectives are for stock, bond & income fund.
- Mutual Fund
Some mutual funds employ certain sales force to capture investors, with shares being available from insurance agents, brokers and financial planners. The company may also use direct marketing in which advertising is made and direct mails are sent for attracting new investors. The stock and bond & income mutual fund makes about 60% of sales by using sales force.
Mutual funds can be categorized into two kinds which are
- Load funds which charge a sales fee
- No-load funds which do not charge a sales fee
International Investment through Investment Companies
Mutual fund industry has turned into global industry. There is rapid growth in the open ended funds around the world, especially the emerging market economies. In the mid of 2002, there are approximately $11.6 trillion worldwide assets. Worldwide mutual future assets have 42% investment in equity funds and additional 26% in the money market funds. The one third of the aggregate mutual fund assets is invested in Europe. About one-half trillion dollars of mutual funds are invested in Japan. The US investor can trade the shares of international mutual funds on exchanges. Many international mutual funds invest in non US stocks. There are also certain risks associated with investing internationally through investment companies.