REGULATED INVESTMENT COMPANIES-NATURE OF

OPERATIONS

Herbert R. Anderson, National Association of Investment Companies,
New York, N.Y.

My name is Herbert R. Anderson. I am president of the National Association of Investment Companies, 61 Broadway, New York, N.Y., The National Association of Investment Companies has a membership of 155 open-end investment companies and 24 closed-end investment companies. All of its members are registered with the Securities and Exchange Commission under the Investment Company Act of 1940 and the securities which they issue are registered under the Securities Act of 1933. Member companies account for over 90 percent of the assets of publicly held, diversified management investment companies in the United States. Most of the members of the NAIC have elected to qualify, for tax purposes, as regulated investment companies under subchapter M of the Internal Revenue Code of 1954.

THE NATURE AND FUNCTION OF REGULATED INVESTMENT COMPANIES

Regulated investment companies (sometimes referred to as "mutual funds") perform two basic functions in our economy. They provide a medium of intelligent equity investment for persons of moderate means, who might otherwise be precluded from including equity investment in their financial plans. The second function they perform is a related one: they bring to our Nation's capital markets funds for equity investment which might otherwise not be available. Most people, I believe, will agree that a sound equity investment program requires diversification of investment under competent professional management. Persons of wealth are able to avail themselves of an equity investment program with these attributes since their capital enables them to diversify their investments and they can afford to retain professional investment advisers. The individual of moderate means, however, finds it difficult to develop a sound equity investment program. Diversification of investment is not available to him if he invests directly in corporate securities because he lacks sufficient capital, and as a practical matter he cannot obtain professional investment advice because of its cost in relation to the size of his investment.

A regulated investment company by providing a medium which combines, for investment purposes, the funds of many investors, makes available to the person of moderate means the opportunity to secure the same advantages as wealthy investors. The regulated investment company invests the funds of its many investors in a diversified portfolio of securities which are carefully selected and continuously supervised by professional managers.

Regulated investment companies have brought to the capital markets the funds of many hundreds of thousands of individuals who, without the diversification and the professional management which are inherent features of investment companies, would have had neither the funds nor the inclination to invest in equity securities. Thus whereas the total assets of the members of the National Association of Investment Companies at the end of 1940 were approximately $1 billion, held in 762,000 shareholder accounts, these total assets had grown to $16.7 billion as of June 30 of this year, held in 4.3 million shareholder accounts.1

There are two basic types of investment companies, closed end and open end. Both invest in the securities of business and industrial corporations. The two types of investment companies differ chiefly with respect to capitalization, and the manner in which an investor acquires and disposes of shares in each.

(a) Closed-end companies

The closed-end investment company normally has a fixed capitalization with a fixed number of shares outstanding in the hands of investors. The shares of closed-end companies are traded on organized securities exchanges such as the New York Stock Exchange, or in the over-the-counter market. There is considerable variety in the capitalization of closed-end companies. Some have only one class of securities outstanding-common stock. Others have in their capital structure, in addition to common stock, debt securities, preferred stock, or a combination of these. As of June 30, 1959, the 24 closedend member companies of the NAIC had total assets of $1.7 billion. (b) Open-end companies

The open-end company derives its name from the fact that the number of its shares which are outstanding is continuously changing. Most of these companies continuously offer new shares to the public, and all of them stand ready to redeem their shares on demand.

The current market value of an open-end company's underlying investments is used to determine the price of an open-end company's shares. The "net asset value per share" is determined by most companies twice a day by dividing the current market value of the company's total assets (less liabilities) by the number of its own shares

1 The following tables illustrate the growth of total net assets of members of the NAIC from 1940 through 1958, and the growth of shareholder accounts in member companies during the same period:

outstanding. The offering price of open-end company shares is usually the current net asset value per share plus a sales charge to cover the costs of distribution. "Net asset value per share" is generally the price paid by the company when a share is redeemed.

The 155 open-end members of the NAIC had total assets of $15 billion as of June 30, 1959. Investments in additional shares of openend investment companies during the year 1958 totaled $1.6 billion. Redemptions of shares during 1958 totaled $511 million.

DISTRIBUTION OF INVESTMENT COMPANY SHARES

Methods of distribution of investment company shares differ from company to company and between types of investment companies. Closed-end company shares are distributed in much the same manner as those of most publicly held industrial corporations-through an underwriting all at one time, or at least on infrequent occasions. Thereafter, the outstanding shares of closed-end companies are traded on national securities exchanges or over the counter.

Open-end shares are distributed to investors in a variety of ways. The majority of companies issue their shares through underwriters who distribute them to independent dealers as orders are placed by members of the public, and the dealers in turn distribute them to the investors. Others issue their shares through underwriters which have their own sales organizations which distribute them to members of the public as orders are placed. There are a few open-end companies which issue shares directly to members of the public.

THE INVESTMENT COMPANY AND ITS SHAREHOLDERS

Pooling the funds paid in by its shareholders, the regulated investment company achieves diversification by spreading its investments over a large number of issues so that any loss in a single issue or group of issues can have only a minor effect on the overall investment results. Its investment personnel constantly review its investments. Thus, the holder of one share of an investment company is, in effect, an owner of a fractional share of a professionally supervised portfolio of securities consisting of investments in the shares of as many as 50, 100, or even more business and industrial corporations.

Investment through purchase of investment company shares is understandably appealing to the person of moderate means. His investment company holdings generally are, and should be, a part of an overall program which includes savings accounts, savings bonds, and insurance.

Studies made by the National Association of Investment Companies indicate, for example, that the median investment company shareholder in an open-end investment company who is investing on a periodic basis has life insurance coverage of $11,950 and has $5,560 in savings accounts and other investments, of which $1,890 are invested in investment company shares. Thus, for this median investment company shareholder, investment company shares are an important part of his overall financial plan.

The prospective investor can choose between various investment companies having differing investment objectives to accord with his own needs. There are investment companies with objectives of high

47060-59-pt. 3-10

current income, others with objectives of capital appreciation, others which seek both capital growth and current income.

Investment policies differ between companies, too. Some invest almost entirely in equity securities, some stress balance in their portfolios between equity and senior securities; others specialize in senior securities. Some investment companies concentrate their investments in particular industries; others concentrate geographically. Thus, the investor can choose an investment company or companies which best fit his own financial program.

The investor may also select his own method of investment. He can make a lump-sum investment or he can invest small or large amounts on a periodic basis or he can invest at nonperiodic intervals.

One of the more significant developments in the investment company industry in recent years has been the widespread acceptance of various forms of investment purchase programs with provisions for regular investment on a periodic basis. The use of these programs to acquire open-end company shares on a systematic basis has continued to grow, reaching consecutive new highs in each year.

A total of 243,077 new periodic investment programs were opened by investors during 1958. At the year end, investors in open-end member companies were maintaining 878,147 such accounts with a market value of approximately $1.3 billion. These plans represented 24.2 percent of the total number of all shareholder accounts with openend companies. This growth pattern has, incidentally, continued into 1959.

Closed-end investment company shares represent a popular group among investors using the New York Stock Exchange's monthly investment plan. Under this plan, a person invests as little as $40 a month in the security of his choice listed on the exchange. During 1958, plans for the accumulation of closed-end investment company shares increased from 3,707 to 4,702, a gain of 26.8 percent. Shares of 16 closed-end member companies of the National Association of Investment Companies are eligible for purchase under the monthly investment plan.

These periodic investment programs enable persons of moderate means to acquire stock ownership by investing relatively small sums on a systematic basis. Most of the purchasers, according to studies by the NAIC, are investing with specific long-range objectives in mind, such as building an estate, planning for retirement, or preparing for the costs of educating children.

way

It is the policy of most investment companies to distribute to their shareholders substantially all of the income which they receive in the of interest and dividends, and to distribute to their shareholders net capital gains which they realize on the sale of their portfolio securities. Many of them distribute realized capital gains through the so-called optional stock dividend, with respect to which the shareholder may elect to receive either cash or the equivalent value of additional shares of stock in the investment company. Thus, in most companies the investor, at his option, may elect to receive all income dividends and capital gain distributions from his investment in cash or he can reinvest income dividends and accept capital gain distributions in additional shares or he can adopt some modified arrangement. Many investment companies have also developed procedures

under which the investors may invest stipulated amounts periodically over a designated number of years, with systematic withdrawal thereafter.

Thus, regulated investment companies have appealed to investors as a useful medium of investment not only because they offer diversification and professional investment management but also because they have developed special services which help the individual investor meet his own particular needs.

FEDERAL AND STATE REGULATION OF INVESTMENT COMPANIES

Investment companies are regulated on both the Federal and the State level to insure that the interests of persons investing through the medium of such companies are protected. Under Federal law, the offering and sale of securities issued by investment companies are subject to the provisions of the Securities Act of 1933. The investment companies themselves are regulated under the Investment Company Act of 1940. On the State level they are subject to the blue-sky laws of the various States, as well as to the detailed regulations of several States which pertain to the management of investment companies whose shares are offered in those States.

The basic Federal statute regulating investment companies is the Investment Company Act of 1940. This measure was enacted by Congress on August 22, 1940, following an exhaustive study of the investment company industry by the SEC. Representatives of the investment companies which later formed the NAIC cooperated with the SEC in the drafting of the bill which became the Investment Company Act of 1940, and both the SEC and most members of the investment company industry urged its adoption. The bill was passed by both Houses of Congress without a single negative vote. The act sets forth specific standards with respect to the formation of investment companies, their capital structures, transactions, management, and underwriting contracts and affiliations, and, in many respects, their day-to-day operations.

Many of the provisions of the act are designed to protect investors and shareholders through disclosure requirements. Thus, investment companies, among other things, are required—

(a) To file a detailed registration statement with the SEC, including therein a recital of fundamental policies which cannot be changed without stockholder approval;

(b) To file with the SEC financial statements, reports of portfolio holdings, and annual reports;

(c) To report to their shareholders on at least a semiannual basis.

Other provisions regulate the practices and activities of investment companies. Thus, the issuance of senior securities by closed-end companies is restricted and open-end companies formed after 1940 are limited, in general, to a single-capital structure. A majority of the directors of an investment company must be independent of the company's sales-distribution organization. At least 40 percent of the members of the board of directors must be persons who are neither officers, employees, nor investment advisers of the investment company.