What Is an Investment Company?
Let me explain what an investment company is: it's a corporation or trust that invests pooled funds from investors into financial securities. You'll see this done through closed-end funds or open-end funds, which you might know as mutual funds. In the US, most of these are registered with the SEC under the Investment Company Act of 1940.
You could also hear them called a 'fund company' or 'fund sponsor.' They often work with third-party distributors to sell mutual funds.
Key Takeaways
Here's what you need to know: an investment company specializes in investing pooled capital into financial securities. These can be privately or publicly owned, and they handle the management, sale, and marketing of investment products to the public. They profit by buying and selling shares, property, bonds, cash, other funds, and various assets.
Understanding an Investment Company
Investment companies are business entities, whether private or public, that manage, sell, and market funds to you and other investors. Their core activity is holding and managing securities for investment, but they also provide services like portfolio management, record-keeping, custodial services, and handling legal, accounting, and tax matters.
These companies can take forms like corporations, partnerships, business trusts, or LLCs, pooling money from investors collectively. The pooled money gets invested, and you share in the profits and losses based on your stake. For instance, if a company pools $10 million and you put in $1 million, you have a 10% interest, which applies to any gains or losses.
You'll find investment companies divided into three categories: closed-end funds, mutual funds (open-end funds), and unit investment trusts (UITs). Each must register under the Securities Act of 1933 and the Investment Company Act of 1940.
Keep in mind that investment companies charge fees on their products, including management fees and other expenses, which reduce your returns. You should review the fund’s prospectus and performance carefully before investing in a closed-end fund.
Closed-end Funds
Closed-end funds issue a fixed number of shares that trade on stock exchanges. As demand for these shares changes, the supply stays constant, so the price is set by market demand and can be at a premium or discount to the fund’s net asset value (NAV). Shares are usually offered initially at a discount to NAV.
If you want to sell your shares, you do so to other investors on the secondary market at a market-determined price; they're not redeemable directly. Since only a fixed number of shares exist, trading them doesn't affect the underlying portfolio.
Mutual Funds (Open-end Funds)
Mutual funds have a variable number of shares, and you can sell or redeem them back to the fund or broker at the current NAV at the end of each trading day. As money flows in or out, the fund grows or shrinks. These funds often stick to liquid assets because managers need to be ready for redemptions anytime.
They charge fees like management fees, 12b-1 fees, and others, which cut into returns—though fees have been trending lower. Mutual funds are popular for their diversification and professional management, but you should check the prospectus and performance before investing.
Unit Investment Trusts (UITs)
A UIT issues a fixed number of units representing interests in a specific, fixed portfolio of securities. They have a set termination date, and at that point, you get a pro rata share of the net assets. UITs are passive; they invest in a fixed set of stocks or bonds without active trading or rebalancing like mutual or closed-end funds. Fees include creation and development, trustee fees, and others, reducing returns.
Additional Facts
Each fund type can invest in stocks, bonds, commodities, and some use leverage to boost returns, which also raises risk.
Hedge funds aren't investment companies if they only take money from accredited investors with substantial assets; they're exempt from the 1940 Act but follow other securities laws. Private funds like hedge, private equity, and venture capital fall into this.
The first investment company dates back to the 1800s, but the Massachusetts Investors Trust in 1924 was the first mutual fund for small investors; an version still trades as MITTX.
Investment companies can be socially responsible by focusing on SRI strategies, investing in positive-impact companies and avoiding harmful ones. They also support philanthropy through donor-advised funds (DAFs), letting you donate while controlling investments and distributions tax-efficiently.
The Bottom Line
Investment companies are regulated entities that pool your money to invest in securities like stocks, bonds, and commodities, governed by the 1933 Securities Act and 1940 Investment Company Act. They include closed-end funds, mutual funds, and UITs, each with unique features, benefits, and risks. You must review offering documents, performance, and risks before investing.
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