Introduction and summary:
This article seeks to explain what an investment company is, and what the main differences are compared to mutual funds. If you do your due diligence, we believe investment companies are a better choice than most mutual funds because of these reasons:
Investment companies are better than mutual funds because they take an active role in their holdings, think long-term, have little portfolio turnover, have low management costs, offer skin in the game, and have an agnostic investment view.
If you read this article you might be interested in our portfolios. It’s a work in project and many more portfolios will be added in the coming months.
What exactly is an investment company?
An investment company is a company that simply invests in other companies, both private and public. It’s a very simple business model anyone can understand. There is no difficult technology to understand, no brands you need to worry about, no evaluation of a moat or competitive advantage, and no industry analysis required. You simply invest in a small group of people that allocate capital. No operating skills from the management are required.
Typical investment companies are for example Berkshire Hathaway, Markel and Swedish Investor AB. Sweden has many investment companies which we cover in later articles.
The management of an investment company simply look for the best investment opportunities there is within their circle of competence. The approach is more likely an active one than a passive one. Obviously, the aim of the portfolio is to create long-term values, and hopefully better than the main stock indices.
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Most of the Nordic investment companies are Swedish. According to the Swedish Internal Revenue Service (Skattverket) there are three criteria to be classified as an investment company (according to Swedish rules):
- The business of the company is to manage securities and similar investments.
- The company offers the owners diversification. No position or ownership must be too big in relation to the overall portfolio.
- There are many shareholders in the investment company. How many? Swedish courts have ruled 80 investors are not sufficient, while above 500 has been given a green light to start.
The historical performance
All investors know the historical performance of Berkshire Hathaway: 19% annual return for over 60 years. Markel has been almost just as good but over a shorter time period.
If we look at the Swedish investment companies we see the same pattern. As a group they have outperformed the overall market:
The chart is taken from Ib Index, an index that tracks all listed investment companies on the Stockholm Stock Exchange. The index has a rather peculiar weighting: the more discount to net asset value, the higher the index weighting and vice versa.
Six investment companies index (SIXRXFIIF) is another index, but has a bit longer history:
The tendency over the last 15 years is one of outperformance, but most of it has occurred during the last 6 years.
Investments are made into both public and private companies
Most investment companies own both private and public companies. Investor AB, for example, has a core of public companies listed on the Stockholm Stock Exchange, and at the same time has a substantial value of unlisted companies. Overall, they own stakes in 12 public companies and 11 private companies.
Obviously, public companies are easy to value via public quotation. For private companies, the valuation is a bit more tricky and normally the earnings multiples are used as valuation.
Investment companies are like an active mutual fund
Most readers probably understand by now that an investment company in practice is like a mutual fund. A mutual fund is required to have a certain diversification: In Norway, for example, a mutual fund needs to have at least 15 positions and none can be more than 10% of the fund.
Perhaps the most common mistake among small private investors is the lack of diversification. This is a non-issue if you own an investment company: you indirectly get a broad diversification even if you own just one investment company. As such, you can own just a small number of investment companies and be extremely diversified. However, compared to a mutual fund an investment company normally has a more concentrated portfolio than a mutual fund.
An investment company thus might offer you exactly what you need: If you invest in Investor AB, for example, you own indirectly 23 companies. Even better, Investor AB has managed to beat the Swedish main index for more than 100 years!
Due to regulation, it’s expensive to run a mutual fund. As always, when consumer rights and strict regulation are implemented, it both creates less creativity and more costs and serves as a barrier to entry for small companies. Big businesses always want regulation so they can shake off troublesome smaller and creative players.
Investment companies are in a position where they have fewer restrictions on how and where to invest. We believe this is a big advantage in the long/term.
A mutual fund normally has the mandate to invest in certain industries or niches of the market, be it for example commodities, value, growth, etc. An investment company has normally a much wider mandate. Investor AB has for example no limits on what they can invest in. They are agnostic investors, something we like. If an investment makes sense, they go for it.
Active vs. passive management
Investment companies often take an active role in managing their holdings, while mutual funds do basically nothing. A mutual fund might own 1% of a company, and be a 100% passive owner, while an investment company usually wants to own more to gain a significant influence. An investment company thinks long-term, more or less always longer than mutual funds. We believe this pays off for the shareholders.
In short, investment companies think like owners. Mutual funds don’t.
However, many investment companies choose to not get involved in their investments at all. Many companies are simply well managed and work very well with a hands-off management style. This is of course a reason to invest by itself – to own a stake in a successful business and just leave it alone. Then the investment is much more of a passive character than an active one. This is the cornerstone of Berkshire Hathaway’s business model. Warren Buffett lets the managers run their business but instructs them to send the profits to the Omaha headquarter for allocations.
Investor AB, the investment vehicle for the powerful Wallenberg family, seeks to have a board representative for every investment they make. This is not necessarily to change the direction of the company but could be just as well to care of their investment.
Because investment companies think like owners, the turnover of their portfolios is in general much lower than for mutual funds. Mutual funds are almost exclusively passive investors and do little to get involved in strategic decisions. If they are not pleased, they sell their positions. This is in contrast to investment companies that often hold their positions for years and decades. As an example, Investor AB has been a shareholder in the Swedish bank SEB for over 125 years and owned the fantastic company Atlas Copco for 100 years. Why would they sell a good business?
Easy to buy and sell investment companies
Another feature is that you can easily buy and sell shares in a publicly listed investment company. It takes one second. With a mutual fund, you most likely need to wait at least three days until you know your transaction price. You literally buy and sell at unknown prices. If the market is volatile when you send your order, you risk the market going against you by many percent within all is done. Of course, it could also turn to your advantage.
Skin in the game
Most investment companies have one or several owners that own a significant part of the company, and they are either in the management or on the board. As a rule of thumb, this is very good.
First, you invest alongside managers that have just as much at stake as you. Thus, there is no agent-principal conflict. If you lose, management suffers as well.
Second, the management in many investment companies is influential. In Sweden, both the Wallenberg and the Lundberg families exert tremendous power that might be beneficial for their companies (we’re not indicating corruption). Warren Buffett, for example, is offered much better deals than you ever will.
Third, by owning a big piece of the company the management is in it for the long-term.
Fourth, skin in the game usually means they have developed a culture of successful investing. A successful manager in an asset management fund might jump ship for better pay at a competitor, while a manager with skin in the game is unlikely to do that.
Low management costs
A passive index fund has management costs from 0.1 to 0.4%. This is for purely passive management where a computer rebalances the portfolio from time to time.
For active funds, the fee usually starts at 0.8% and goes all the way up to 2%. In addition to this, many funds levy a success fee if they manage to beat the reference index. Of course, they never pay the unit holders if they underperform.
This is why many want to start a money management business: it’s extremely lucrative if you do well. Only 1-2 people can manage a huge amount of capital, and thus the overheads are small and the managers get filthy rich. However, due to increased regulation, you need assets under management to be at least 25 million USD to make it worthwhile. But as soon as you reach that limit, most of the proceeds end up at the bottom line. The costs of managing 25 or 200 million are not much different.
In addition to that, there are indirect costs in mutual funds in relation to the turnover of the portfolio. When you sell or buy a stock you not only pay a commission. The “hidden” cost in the form of the difference between the buy and sell price is higher than the commissions paid. Very few mutual funds are transparent about these costs. One of the few mutual funds that actually care is Terry Smith’s Fundsmith, which provides an annual figure on this cost. The more turnover there is in the portfolio, the more costs for the unitholders.
Sadly, most active funds underperform their reference index by a wide margin. Perhaps this is to be expected: everyone can’t beat the index.
Investment companies offer a much better deal costwise. The table below shows a select few Swedish investment companies and their overheads in relation to the market cap:
|Management costs (%)|
All of the companies have lower costs than a normal actively managed fund. As a group, they charge less for management, and at the same time, they have beaten the reference index. Not bad.
The differences in costs are usually due to the size of the companies. Berkshire, Markel and Investor AB are huge investment companies, and thus offer scale. A select few people can manage a lot of money and thus offer scale. Traction is the exception in the above table. It’s pretty small, but still very low overheads.
Sit on your ass
To find a good stock and hold onto it should be the goal of any aspiring investor. Charlie Munger calls this “sit on your ass investing”: A truly good stock is the one that lets you sit on your ass and do nothing.
After an investing career, your biggest regrets are probably the stocks you sold too early and not the one you bought. To sit on your ass sounds simple, but it’s not. If you invest in an investment company, it might be easier to hold onto the stock because it’s diversified.
The case for investment companies is very appealing. Let’s summarize this article in this table:
|Investment companies||Mutual funds|
|Management||Active||Active or passive|
|Costs||Small, 0.05-1%. The cost is a charge on the profit and losses.||Quite high: 0.1-2% Deducted from the returns.|
|Number of positions||10-20||15-100|
|Strategy||The Board decides the strategic vision. The portfolio can be very mixed.||The mandate is strictly regulated.|
|Active management||Yes, very.||Takes a passive position in their positions.|
|Shareholder structure||Many owners, but one or more usually has huge influence via ownership or voting rights. You as an owner can ask questions at general meetings (and of course vote).||Many unit-holders. You can’t influence the portfolio at all.|
|Buy and sell||Buy and sell in seconds on the exchange.||Buy and sell once a day, but transactions take 1-3 days to complete.|
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.