Chapter 5: Investment

Companies

Definition: Investment companies are

financial intermediaries that sell shares
to the public and invest the proceeds in
a diversified portfolio of securities.
Each share sold represents a
proportional interest in the portfolio of
securities managed by the investment
company on behalf of its shareholders.
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 Types of investment
companies/funds

1. Open-end funds: These are the portfolios of securities

such as stocks, bonds and money market instruments.
Features of this fund are instruments in this fund own
a pro rata share of the overall portfolio, managers
actively manages the portfolio and value of each
share of the portfolio is called net asset value (NAV)
per share that equals the market value of the portfolio
minus amount of liabilities divided by the number of
shares owned by the mutual fund investors. For
example a mutual fund contains 5 million shares
outstanding thats portfolio value is Tk.200 million and
liabilities of Tk.100 million. So NAV is Tk.20.
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 Types of investment
companies/funds

2. Closed-end fund: This is limited number of shares

issued by an investment company through an
underwriter where after initial issue there are no
sales or purchase of fund shares by the fund
company. The price of the share is determined by
the supply and demand in the market. Net asset
value per share is calculated by dividing the
difference between value of the portfolio and
amount of liabilities by number of shares in the
fund.

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 Types of investment
companies/funds

3. Unit trust: In this fund a limited number of unit

certificates are issued by the investment
company that are not tradable in the secondary
market that is held by the trustee until they are
redeemed by the issuer. It has fixed termination
date and investors know that the portfolio
consists of specific securities.

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 Islamic Unit Trust
The contract for sharing of capital between the
shareholders to carry on business with a view to making
profits that will subsequently be shared among them is
known as Islamic unit trust. In this trust fund, partners
are the unit holders, the fund that is contributed by them
is the capital and the investment activity that is being
undertaken by the fund is the subject matter of the
business. The profit is represented by the dividends paid
to each of the unit holders while the application to buy
the unit is the offer and acceptance is the authentication
by the manager on the sale of the unit by the fund

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 Open-end fund vs Closed-end
fund

1. The number of shares of an open-end fund varies

because the fund sponsor will sell new shares to
investors and buy existing shares from shareholders,
whereas closed-end funds have a constant number of
shares outstanding.
2. For changing number of shares in open-end fund net
asset value per share is considered as price of the
share, whereas price per share of closed-end fund is
determined through demand and supply of shares.
3. No premium or discount in case of open-end fund but
there may be premium or discount in case of closed-
end fund.
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 Fund sales charges

Commission and fees paid by the

investor to the broker for trading shares
in the fund are known as sales charge.
The fund requires charge for trading is
known as load fund and the fund does
not require charge is known as no-load
fund. This sales charge may be imposed
at the time of purchase that is called
front-end load and at the time of sale or
redeem that is called back-end load.

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 Annual operating expenses

The expenses deducted by the fund

sponsor from the investors or fund
holders account balance each year
for maintaining account, giving
investment advice and other services
are known as operating expense. For
example, service charge or excise
duty.

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 Economic motivation for
fund

1. Risk reduction via diversification

2. Lower cost of contracting and processing
information
3. Professional portfolio management
4. Liquidity
5. Variety
6. Payments mechanism

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Types of funds by investment
objective

1. Stock fund
2. Bond fund
3. Money market fund
4. Asset allocation fund
5. Hybrid fund
6. Balanced fund
7. Convertible bond fund

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 Taxation of mutual funds

mutual funds must distribute at least 90% of their net

investment income earned exclusive of realized gains or
losses to shareholders to be considered a regulated
investment company and thus not to be required to pay
taxes at the fund level prior to distributions to
shareholders. Taxes are paid on distributions only at the
investor level, not the fund level. Mutual fund investors
have no control over the size of these distributions and
as a result, the timing and amount of the taxes paid on
their fund holdings is largely out of their control.

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 Regulation of fund

It means what type of fund can be issued by a particular

investment company at what level for what amount and
how the issue process will be dealt, how the issued
funds will be managed and how the fund holder will be
distributed part of profit as benefit. For ensuring these,
funds are regulated according to following laws:
1. Securities Act
2. Investment Company Act
3. Investment Advisors Act

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 Structure of fund

1. Board of directors
2. Investment advisor
3. Distributor or broker/dealer
4. Other service providers such as
independent public accountant,
custodian and transfer agent.

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 Exchange Traded Funds

Exchange traded funds consists of investment

companies that are similar to mutual funds but trade
like stocks on an exchange. When they are
introduced, then they are similar to closed-end
funds, which have very small premium or discounts
from their net asset value. In this fund, it is the
investment advisors responsibility to maintain the
portfolio such that it replicates the indexs return
accurately, because supply and demand determine
the secondary market price of these shares, the
exchange price can deviate from the value of the
portfolio and as a result, may provide some
imprecision in pricing. Dividend income and capital
gains realized from this fund are taxable to the
investor. 5-14
 Islamic Exchange Traded
Funds (IETF)
An Islamic exchange traded funds only tracks an Islamic
benchmark index whose constituents comprise companies that
are shariah compliant. An IETF will be managed under
shariah principles and guidelines and overseen by an
appointed shariah advisor or committee. The shariah advisor
will conduct regular reviews and audits on an IETF to ensure
strict compliance with shariah principles and practices. A
comprehensive shariah-screening methodology is performed
in order to qualify as an IETF. This involves sector screening
to determine that the fund invests only in companies with halal
businesses and that if these companies are involved with non-
permissible activities, the ratio of income from non-
permissible activities to total income should not exceed the
stipulated ratio determined by the relevant authority.
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Commercial banks and mutual
funds

Commercial banks have a dual

relationship with mutual funds, both
distributing mutual funds from other
fund sponsors and managing their own
funds. Commercial banks also can deal
with funds either its own or others for
charge or fees.

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