The securities markets are enormous and complex, which can make investing feel intimidating. Investment companies can be useful if you don’t want to research and manage investments on your own. These financial institutions pool customers’ money and hire professionals to invest it on the customers’ behalf.
Investment companies have existed since the 1920s, but they weren’t formally defined or regulated until 1940. In the early 1900s, financial markets often suffered from limited information, deceit, and market manipulation. During and after the Great Depression, lawmakers passed several regulations aimed at reducing fraud and protecting investors. One key law was the Investment Company Act of 1940.
This law formally defined investment companies and regulated their activities. It also created three classifications of investment companies:
Management companies focus on managing customers’ money. Investment advisers working for these institutions invest and manage pooled customer funds according to stated investment objectives (for example, investing in investment-grade bonds). Two types exist:
Unit investment trusts (UITs) also pool investor money and invest it in a basket of securities selected by financial advisers. Unlike management companies, a UIT’s portfolio is generally fixed: it isn’t continuously managed, and it has a stated maturity date. At maturity, the portfolio is typically liquidated and the proceeds are paid to investors.
Face amount certificates (FACs) are the third classification of investment company. In a typical FAC, investors make periodic payments to the issuer in exchange for a fixed payout at maturity. For example, an investor contributes $500 per month to a FAC for a promised payout (redemption) of $100,000 at the end of 10 years.
Another version involves a lump-sum payment in exchange for a promised payout at maturity. For example, an investor buys a FAC for $10,000 today and is promised $15,000 from the issuer after five years. These are known as fully paid FACs, and they 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 that date or redeem it with the issuer before maturity for a reduced value.
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