An investment company is formed to allow its owners / shareholders to pool their funds in order to help them access a broader portfolio of investments than they might otherwise be able to do if they were to invest on their own. Investment companies are public companies, listed on a stock exchange, where investors can buy and sell shares in them in exactly the same way that they do when investing in any other public listed company. They are well established, having been around for over 150 years. An investment company will aim to generate returns for its shareholders both in terms of capital growth and dividend growth, but the relative importance of each will vary from company to company. Typically, the board of directors of the investment company will appoint an investment manager to select and manage the portfolio of investments owned by the company. Unlike most large public companies listed on a stock exchange, where pension funds and investment funds own the majority of the shares, investment company are frequently largely held by private investors.
Unlike unit trusts and most Open-Ended Investment Companies (OEICs), an investment company has an independent board of directors which makes decisions about its investment manager and monitors its performance. They answer to the shareholders and stand for re-election on a regular basis.
The benefits of an investment company:
- Investment company permit private investors access to diversified portfolios of investments which can helps to spread their investment risk.
- The Ordinary shares of an investment company typically convey voting rights.
- Investment companies are traded on a stock exchange. The share price reflects the collective views of the market and the demand for and supply of the shares. This can lead to the shares trading below (“at a discount”) or above (“at a premium”) to the to the value of the underlying assets. If you buy at a discount, you might hope that in addition to any increase in the value of the portfolio, the discount might reduce, enhancing your return. If the discount widens / the premium reduces, then the return you receive will be lower than the return on the portfolio’s assets .
- The existence of a premium / discount, particularly when compared to other similar investment companies, provides investors with an indication as to how the market collectively views the prospects of the company and the market or assets into which it invests.
- Investment companies invest in a wide range of different asset classes including equities and bonds, but also they are particularly suited to investing in illiquid, long-term investments, such as property, infrastructure or private equity.
- They provide the investment manager with a permanent pool of capital, which allows more of the investment capital to be invested as cash does not have to be held to fund redemptions.
- Investing alongside other investors allows you to benefit from economies of scale, and be able to employ a professional fund manager to manage the portfolio on your behalf.
- Investment companies can borrow to increase the size of the investment portfolio, much like a mortgage. This is referred to as gearing. The theory is that over the life of the borrowing, the return from the portfolio will more than cover the cost of the borrowing (the interest on the loan). The surplus return will accrue to the investors. Negative returns however may be increased due to the existence of gearing.
- Investment compnaies do not have to distribute all the income that they receive in a year and can retain up to 15% of their income each year and place this into a reserve. Any such surplus income held can be used for smoothing purposes and allow the company to boost the dividends that they pay in years when the income generated has fallen. This provides greater certainty to shareholders that the income they receive can increase or be maintained year on year. A few investment companies have a track record of having increased their dividends in each of the last 50 years.
- Investment companies will not create more shares without the express approval of their boards – and shareholders, thereby ensuring that your holding is not diluted.
To find out more about Investment Trusts (also called investment companies), please visit the Association of Investment Companies website where you will also find news and industry research.