The securities markets are gigantic, complicated, and intimidating for many investors. Investment companies can benefit those who don’t want to put the required effort into investing. Financial professionals working on behalf of these institutions invest their customers’ money.
Investment companies have existed since the 1920s but weren’t formally recognized or regulated until 1940. In the early 1900s, the financial markets were characterized by a lack of information, deceit, and market manipulation. During and after the Great Depression, many financial regulations were signed into law to prevent financial fraud. One prominent piece of legislation was the Investment Company Act of 1940.
This law formally defined investment companies and regulated their activities. In particular, three investment company classifications were created:
As the name suggests, management companies specialize in managing their customers’ money. Investment advisers working on behalf of these institutions invest and manage pools of customer funds according to specified investment objectives (e.g., investing in investment grade bonds). Two types exist:
Unit investment trusts (UITs) also invest their customers’ money. These pooled investments collect capital from investors and invest in a basket of securities created by financial advisers. Unlike management companies, UIT portfolios remain fixed, are not managed continuously, and maintain a maturity date at which the portfolio is typically liquidated and the proceeds are paid to investors.
Face amount certificates (FACs) are the last classification of investment company. A typical version of this product involves investors making periodic payments to the issuer in return for a fixed payout at maturity. For example, an investor contributes $500 monthly to a FAC for a promised payout (redemption) of $100,000 at the end of 10 years.
Another version of a FAC involves an investor making a lump sum payment in return for a promised payout at maturity. For example, an investor purchases a FAC for $10,000 today and is promised to receive $15,000 from the issuer after five years. These are known as fully paid FACs, which work similarly to zero coupon bonds.
FACs are issued with termination (maturity) dates when the security’s face (principal) value is paid out. Investors can hold the security until this date or redeem it with the issuer for a reduced value before maturity.
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