Keeping Cash Ready at Hand

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A repurchasing agreement between an investor and an open-ended company can, under some circumstances, act as a pool of cash from which the investor can draw funds when needed. Unfortunately, open-end companies have no guarantees like those of the Federal banks.

The method of computing the net asset value for redemption is exactly like that for computing net asset value to determine the offering price, with the exception that the selling commission, or load, is omitted. Thus, if net assets have a value of $10 million and one million shares are outstanding, the net asset value per share would be $10.

The repurchase agreement, in effect, transforms the balance sheet of an investment company into a reservoir from which the investor can draw at will and, in general, without penalty. It is easy to understand the attractiveness of this feature. Investors have found that the assets of an industrial company, railroad, or public utility company as stated on the books are one matter, but it is an entirely different matter to attempt to realize that book value on the market.

The existence of the repurchase provision has exerted some influence on investment policy and excited fears about its consequences in periods of crisis. Investment policy has been influenced in two ways by this unique feature. Management, aware of the withdrawal privilege, has nearly always held fairly substantial cash resources.

Nevertheless, the position of open-end companies has not usually been radically different in this respect from that of closed-end companies. Both groups are eager to hold only a moderate amount of cash in order to avoid a statement showing sizable assets un-invested or represented by short-term bills.

Secondly, investment managers are more likely to confine their attention to well-known securities because of the possibility of being required to liquidate in order to meet heavy turn-ins. In the Securities and Exchange Commission (SEC) the issue was raised whether the redemption provisions would invite liquidation and so create a standing weakness. The question was answered by O. M. W. Sprague, a member of the Advisory Board of Massachusetts Investors Trust this way:

"I should only think it was a weakness to the extent that it might induce us to confine ourselves a bit more, and to a little greater extent, to readily marketable securities than would otherwise be the case. That is insofar as we hold some of the large and well known companies we are able to sell them, and we have a certain amount of cash and borrowing power."

In short, the fear arises that because the open-end investment company in a sense holds itself out as a bank, it may be thought of by the investor as a source of ready cash. But, open-end companies, unlike member banks of the Federal Reserve System, have no institution to which they can turn for assistance.

The Investment Company Act itself protects investors against the suspension of the redemption privilege or postponement of the date of payment of redeemable (open-end) securities for more than seven days except when the New York Stock Exchange is closed, other than customary week-end holiday closings, trading on the New York Stock Exchange is restricted, an emergency exists as a result of which disposal by the company of securities owned by it is not reasonably practicable or it is not reasonably practicable for such company fairly to determine the value of its net assets, or for periods when the Commission orders for the protection of security holders.

Therefore, investors should exercise caution when investing in open-end companies. They are not banks, and they are not guaranteed solvency in the long term.

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