There are four types of pooled investments, technically referred to as investment companies. They are open-end investment companies, closed-end investment companies, exchange traded funds and unit investment trusts.
The most familiar type, the open-end, is what is commonly known as a mutual fund. The shares of the fund do not trade in the market; however investors can quickly and easily purchase and redeem their shares in a mutual fund through the fund sponsor. The net asset value (NAV) of a fund and, hence, the value of its shares is based on the value of the investments in the fund. The NAV is calculated and announced at the end of each day of trading. NAV is the sum of any cash reserves and the closing prices of all of the securities held in the fund less liabilities, if any. That number is then divided by the number of shares held by investors. This price then holds for share purchases and redemptions for the next trading day at the end of which, a new NAV is determined.
A closed-end fund is organized and traded basically as a stock. The fund is offered to investors in a form of initial public offering. Their money is used to purchase stocks, bonds or any other investment assets which the fund is intended to hold. Unlike an open-ended fund, money is not thereafter added or subtracted from the fund. In other words, the fund is closed to new money. The shares of a closed-end fund trade in the market just like a stock. The price of closed end shares may be higher (a premium) or lower (a discount) than the actual NAV of the fund for any number of reasons, such as the basic rule of supply and demand, perceived prospects for future growth or decline of the fund's assets and all the other reasons prices rise and fall in an active market.
Exchange Traded Funds (ETF) are hybrid securities. Essentially, an ETF is a mutual fund; however, it trades in the market just like a closed end fund or a stock. ETFs do not have a mutual fund's NAV set daily. Rather, the value of an ETF fluctuates during the day like a stock. Many ETFs contain a pool of stocks that mirror a market index, like the S&P 500. In fact, the first ETF was an S&P 500 index fund, commonly referred to as a spider since its ticker symbol is SPDR. Some ETFs invest in only certain sectors of the market, such as car manufacturers, health care, emerging markets and virtually any other area of the market you can name. Like stocks, an investor can short ETFs and buy them on margin. The management fees and transaction costs of operating an ETF index fund are generally lower than those of an index mutual fund.
A unit investment trust (UIT) combines several features of the other three types of investment company. Like a closed-end fund, the sponsor offers a fixed number of units in the trust to investors in a public offering. No additional shares in the trust are ever offered again. The offering proceeds are invested in securities which remain the same for the life of the UIT. There is little, if any, change in the portfolio over its life time. Unlike the other investment companies, the UIT has a termination date, at which point the securities in the trust portfolio are sold and the cash is distributed to the investors. Like a mutual fund, units may be purchased or sold. However, the units are traded on a secondary market maintained by the sponsor. The sponsor itself does not buy and sell units.
There are advantages and disadvantages for each of these forms of investment, but a detailed discussion of them is beyond the scope of this post. Here is a link to more information about these investments at Investopedia.
We will examine the most familiar type of investment company, the mutual fund, in the next post.
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