1.5 Funds & Investment Companies
This chapter covers the structures a pooled investment can take under the Investment Company Act of 1940: management companies (open-end and closed-end), unit investment trusts and face amount certificates. It then follows the mutual fund from its parties and expense ratio through voting rights, disclosures, pricing and share-class fees. A client’s costs and liquidity depend on which structure and share class they hold, which is why exam questions on these topics are so numerous.
What each topic covers
Investment Company Categories explains that the Investment Company Act of 1940 created three categories: management companies, unit investment trusts and face amount certificates. Open-end and closed-end funds are both sub-types of management companies, not separate top-level categories. UITs differ because their portfolios are fixed and unmanaged, and face amount certificates are largely gone today.
Mutual Fund Structure & Expense Ratio shows that purchases create shares and redemptions destroy them, so mutual fund transactions are primary market transactions. It names the sponsor, Board of Directors, investment adviser, fund manager and custodian bank, and gives the $100,000 net worth minimum and the 75-5-10 diversification test. The expense ratio bundles management, custodian, legal and administrative fees. Mutual fund shares cannot be bought on margin or sold short.
Mutual Fund Voting & Disclosures covers shareholder rights, with one vote per dollar invested. At least 40% of the Board must be independent. The initial advisory contract runs no more than two years, and renewal needs either the Board or a majority of shareholder votes. It also lists the four disclosures: the prospectus, the statement of additional information, the annual SEC report and the semi-annual shareholder report.
NAV, POP & Forward Pricing defines NAV as net assets divided by shares outstanding. Orders placed before 4:00 pm ET receive that day’s NAV, and later orders receive the next business day’s. For a loaded fund, POP equals NAV divided by 100% minus the sales charge percentage. The maximum sales charge is 8.5% of POP, and redemptions must be paid within 7 days.
Class A, B & C Share Loads compares a Class A front-end load, a Class B declining back-end charge and a Class C level load. It explains breakpoints, the 13-month letter of intent, rights of accumulation, the combination privilege and breakpoint sales. The 12b-1 fee is capped at 1% a year, split into 0.75% distribution and 0.25% service fees. A fund charging more than 0.25% cannot call itself no-load.
Closed-End & Interval Funds contrasts closed-end funds, which have a fixed share count and trade at market price with commissions, with mutual funds that trade at NAV. Closed-end shares can be bought on margin and sold short. Interval funds are legally closed-end but are bought from the issuer at NAV and redeemed only at set intervals, usually capped at 25% of outstanding shares, with redemption fees of up to 2%.
Fixed Portfolios & UITs shows that a unit investment trust is redeemable at NAV with the issuer, like a mutual fund. The difference is management: a professional picks the portfolio once, and it generally stays fixed afterward. That means no management fees, but the trust cannot respond to changing markets. The lesson ends with side-by-side tables of the three investment company types and of open-end versus closed-end funds.