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 loan 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.
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 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
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ratio determined by the relevant authority.
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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