Open-Ended Funds, Closed-Ended Investment Companies

Open-Ended Funds, Closed-Ended Funds, and REITs

I. Open-Ended Funds

• Definition: Investment funds that can issue and redeem shares at any time, expanding or contracting based on investor demand.
• Pro Rata Share: Each investor has a proportional share of the underlying portfolio and benefits from its growth.
• Dealing: Investors buy or sell shares directly with the fund.
  • New shares are issued upon investment.
  • Shares are redeemed (bought back) when investors sell.

US Open-Ended Funds (Mutual Funds)

• Legal Definition: Defined by the Investment Company Act of 1940, legally known as an "open-end company."
• Key Characteristics:
  • Can create and sell new shares to accommodate new investors.
  • Investors buy shares directly from the fund.
  • Price based on the fund’s net asset value (NAV) plus any charges.
  • Portfolios typically managed by investment advisers (registered with the SEC).
• Distribution: Shares sold through brokers, banks, financial planners, or insurance agents.
• Net Asset Value (NAV):
  • Mutual funds value their portfolio daily to determine NAV.
  • NAV is used to set buy/sell prices.
  • Available from the fund, website, and financial newspapers.
• Dealing: Investors buy at NAV plus fees; funds redeem shares at NAV minus fees.
• Redemption: Funds must redeem shares on any business day and send payment within seven days.
• Operating Costs:
  • Funds pass on costs (shareholder transactions, advisory fees, marketing) through charges, which are disclosed in a fee table within the prospectus.
• Taxation:
  • Varies by fund type.
  • Tax-exempt funds (e.g., municipal bond funds) may have tax-free dividends, but taxable capital gains.
  • Other funds have income tax on dividends and capital gains.
  • Funds must distribute capital gains to shareholders if securities are sold at a profit.
• Non-US Residents: Funds domiciled outside the US may be more suitable for them.

European Open-Ended Funds

• Types: SICAVs, unit trusts, and OEICs.
• UCITS: Most funds are structured as Undertakings for Collective Investment in Transferable Securities (UCITS) funds, complying with EU regulations.
  • Allows funds to be sold throughout the EU.
  • Seen as a measure of quality and is recognized in other jurisdictions.
• Authorisation: When funds first seek authorisation, they will usually apply as a UCITS fund.
• Example A fund authorised by the Luxembourg regulator for sale in Luxembourg may also seek authorisation as a UCITS fund so that it may be sold across the EU.

Open-Ended Investment Companies (OEICs)

• Definition: Form of Investment Company with Variable Capital (ICVC), structured as a company where investors hold shares.
• Terminology: Primarily used in the UK, known as variable capital companies (VCCs) in Ireland.
• Dealing: Investors deal directly with the fund when they want to buy and sell.
• Key Parties:
  • Authorised Corporate Director (ACD): Manages the fund (investments, pricing, dealing).
  • Depositary: Independent party responsible for holding investments and overseeing the ACD (similar to the trustee of a unit trust).
    • Depository is the legal owner of the assets, the OEIC is the beneficial owner not the shareholders.

II. Closed-Ended Investment Companies

• Definition: Investment funds with a fixed number of shares issued at launch that are traded on a stock market.
• Capital: Fixed, does not expand or contract.
• Dealing: Investors buy or sell shares on the stock market, not directly with the fund.

US Closed-Ended Funds

• Legal Definition: One of three main types of investment companies (along with mutual funds and unit investment trusts)
• Characteristics:
  • Invest in a wider range of assets compared to mutual funds, including illiquid securities, and can be used when accessing illiquid markets.
  • Subject to varying investment objectives, strategies, and risks.
• Unit Investment Trusts (UITs):
  • Another type of US investment company.
  • Purchases a relatively fixed portfolio of securities, which is held for the life of the fund
  • UIT sponsors will maintain a secondary market to facilitate sales by unit holders.

European Closed-Ended Funds

• Terminology: Usually known as investment trusts or investment companies.
• History: One of the earliest forms of investment funds, established in the 1860s.
• Example: The first investment trust, Foreign & Colonial Investment Trust, is still in operation today.
• Structure: Investment trusts are companies with directors and shareholders, and invest in a range of securities.
• Share Structure: Some investment trusts issue ordinary and preference shares (split capital investment trusts).
• Leverage: Investment trusts can borrow money (gearing or leverage) to invest in more stocks and shares.
• Winding-Up: Some investment trusts have a fixed date for their winding-up.

III. Real Estate Investment Trusts (REITs)

• Definition: Investment companies that pool investors' funds to invest in commercial and potentially residential property.
• Market Size: Over US$400 billion worldwide.
• Key Feature:
  • Provide access to property returns without the previous disadvantage of double taxation.
    • REITs do not pay corporation tax provided certain conditions are met and distributions are taxable on the investor only.
• Advantages:
  • Access to professional property investment.
  • Ability to invest in commercial property.
  • Reduced risk from direct property investments due to diversification.
  • Improved liquidity compared to direct ownership as REITs are listed on stock exchanges and are easily traded.

In Summary

Open-ended funds, such as mutual funds, UCITS funds, and OEICs, offer the ability to easily enter and exit a fund based on the NAV of the underlying portfolio. Closed-ended funds, such as investment trusts, have a fixed share count and are traded on exchanges, whereas REITs provide access to professional property investment in an easy and convenient way. Investors must understand the different structural types, and choose an investment approach that matches their personal requirements.