What are the best types of Diversified Investment Products? There are three types of diversified investment products which are an important element in today’s market place; open-end funds, closed-end funds, and unit investment trusts. The open-end and closed-end funds are managed by management companies and the unit investment trusts are created by investment banking firms.
Open-End Funds (Mutual Funds)
Unit Investment Trust (UIT)
A management company is a firm that, for a management fee, invests the pooled funds of small investors in securities appropriate for its stated investment objectives. It offers participants more diversification, liquidity, and professional management service. There are two basic types of management companies; open-end, better known as a mutual fund, which has a floating number of outstanding shares and closed-end, also known as an investment trusts, which, like a corporation, has a fixed number of outstanding shares that are traded like stock, often on the major exchanges. Both open-end and closed-end investment companies charge annual management fees, typically ranging from 0.5% to 2% of the value of the investment.
The registration statement and prospect of every investment company must state its specific investment objectives. Basically, the companies fall into the following categories: diversified common stock funds; balanced funds (mixing bonds and preferred and common stocks); bond and preferred stock funds (featuring fixed income); specialized funds (by industry, groups of industries, geography, size of company); income funds (high yield securities); performance funds (growth stocks); dual-purpose funds offering a choice of dividend shares or capital gain shares; and money market funds (money market instruments).
Open-End Funds (Mutual Funds)
Mutual funds stand ready every business day to sell new shares directly to investors and to redeem old shares at their current net asset value (NAV). The NAV, the market value of a fund share, is calculated by taking the total value of all securities owned plus all other assets such as cash, subtracting all liabilities, then dividing the result (total net assets) by the total number of shares outstanding. The number of shares outstanding can vary each day depending on the number of purchases and redemptions. NAVs are published daily in many financial publications.
When investing in mutual funds, the higher the amount of invested capital the lower the fees. The owners of the funds are all investors whose capital creates a pool of funds. Mutual funds are managed by professional brokers who invest the money from the pool in stocks, bonds, and other financial instruments.
• The advantage of mutual funds is the possibility of purchasing stocks and bonds with a small sum of money. The minimal capital requirement typically starts at $2,000. Experienced investors buy the funds to reduce the risk of buying individual instruments.
• Professional money management isn’t cheap and these funds have relatively high fee structures. Some of the funds charge up to 1% on the initial investment (load funds), while some don’t charge any fees (no load funds). Some of the funds also charge fees to liquidate the shares (up to 3%). Practically all of them charge a management fee of up to 1% of the money in the pool.
• The aforementioned fees are important while selecting a fund. But more pertinent is finding a fund whose investment goals, as well as performance statistics, are similar to your financial goals. In the years 2002-2015 some mutual funds based on stocks returned over 14% a year.
Closed-end funds are companies organized to pool their shareholder money and invest in a portfolio of stocks, bonds or both. Unlike mutual funds, however, closed-end funds do not continuously offer new shares to investors, nor do they stand ready to redeem shares for cash at any time of a shareholder‘s choosing. Instead their shares are bought and sold on the stock exchange or in the over-the-counter market as any other equity.
The share prices fluctuate either above (at a “premium”) or below (at a “discount”) the net asset values (NAV) of their portfolio. Trading strategies are aimed at taking advantage of these fluctuations. Investors should buy them when their price is discounted and sell them when their price is above the NAV.
Some closed-end funds invest in a wide range of securities, others specialize in industrial sectors. Some buy stocks of foreign companies, or securities of a single country, e.g. Japan Fund, Korean Fund, etc. Japan Fund owns stocks in Japanese companies and Korean Fund owns stocks in Korean firms.
Unit Investment Trust (UIT)
UIT is an investment vehicle created by investment banking firms and registered with the Securities and Exchange Commission that buy a fixed portfolio of income producing securities, such as corporate, municipal, or government bonds, mortgage-backed securities, or preferred stock. Units in the trust, which usually cost at least $1,000, are sold to investors by brokers for a load charge of about 4%. The portfolio of securities remains fixed until all the securities mature and unit holders have recovered their principal. Most brokerage firms maintain a secondary market in the trusts they sell, so that units can be resold if necessary. Since there is no active buying and selling of securities, there is no investment advisor and therefore, no management fee.
In analyzing the advantages and disadvantages of investment instruments, one must take into consideration the following:
• features of the financial instruments,
• capital gains potential,
• income potential,
• tax considerations,
• minimum duration for the investment or liquidity and fees,
• minimum investment required.
An investor obtains capital gains only when he sells financial instruments for more than he paid. The income obtained is in the form of periodically paid interest or dividends.