The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

INVESTMENT COMPANIES

Investment companies (ICs) include open-end mutual funds, closed-end funds, and unit trusts. Shares in ICs are sold to the public and the proceeds invested in a diversified portfolio of securities. There is a wide range of ICs that invest in different asset classes and with different investment objectives. ICs can be actively managed or passively managed versus an index. Actively managed ICs offer investors to generate alpha returns as well as beta returns. Passively managed ICs offer only beta returns.

Types of Investment Companies

There are two primary types of ICs: open-end funds and closed-end funds.

Open-End Funds (Mutual Funds)

Open-end funds, commonly referred to simply as mutual funds (MFs), are portfolios of securities, mainly stocks, bonds, and money market instruments. There are several important aspects of MFs. First, investors in MFs own a pro rata share of the overall portfolio. Second, the investment manager of the MF manages the portfolio, that is, buys some securities and sells others.

Third, the value or price of each share of the portfolio, called the net asset value (NAV), equals the market value of the portfolio minus the liabilities of the MF divided by the number of shares owned by the MF investors. That is,

For example, suppose that a MF with 20 million shares outstanding has a portfolio with a market value of $315 million ...