British Investment Trusts--a Warning

THE investment trust, conservatively managed and definitely committed to a sound investment purpose, offers the investor an opportunity to diversify his holdings and to secure the benefit of constant, informed supervision of his resources. But there is nothing magic in the words ‘investment trust’ which will protect him; and, with new trusts coming on the market every day, it may be worth while to review a period when British investment trusts underwent trial by fire.

In the years 1888 and 1889, a situation arose in England somewhat parallel to that which is developing in America. It was a time when the British Government was converting a part of its public debt, as our Government is now doing, and when security prices had displayed a sustained upward movement similar to that which we have been experiencing. Because of this interesting parallel, and further because, in nearly every prospectus describing a new investment trust, reference is made to the success of British and Scottish investment trusts as a reason for subscribing to the new offering, it seems appropriate to quote briefly from comments made at intervals in the London Economist during the years from 1889 to 1896.

These quotations can do no more than call the reader’s attention to a situation which deserves the closer study of bankers contemplating the formation of investment trusts and of investors who wish to discriminate between trusts in which they can have confidence and those which are more likely to suffer the unfavorable consequences that befell some of the less conservative of the British trusts.

The articles quoted were written during three phases of an investment trust ‘craze’: first, a period of enthusiasm; second, a period of disillusionment and trouble; and third, a period of gradual recovery for the more conservative trusts which had held closer to sound principles of investment management.

Enthusiasm for the creation of investment trusts broke out in London in 1888, and in 1889 it became epidemic. The Economist of April 6, 1889, referred to the ‘boom’ in trust companies, as investment trusts are called in England, tabulating 19 companies, with a capital of £25,075,000, organized in the first three months of that year, compared with 15 companies, with a capital of £9,500,000, organized in the whole year of 1888. The article continues: —

Of the above companies nearly all have met with a large amount of public support.

. . . But although successful with the public, the companies have not, in some cases, been able to make a very favorable start in business, for they have followed so fast upon each other’s heels that they have experienced great difficulty in purchasing proper investments. The supply of really sound securities is in many directions so very limited that any decided increase in the demand at once causes a considerable advance in prices. . . . Indeed, so rapid has been the advance that it is stated several of the new trusts have been unable to effect purchases, and are now rather doubtful as to the direction in which their money shall be invested.

In the issue of January 31, 1891, some apprehension is expressed, with particular reference to underwriting trusts: —

Where a trust company announces a per cent, 6 per cent, or 7 per cent, — as some of them are doing on their deferred shares, — there may be reasonable grounds for anticipating that such rates may be continuous, especially if the capital is for the greater part placed in moderately wellselected securities. But if the bulk of that capital is kept, for underwriting new companies the time must come when the trust will be saddled with securities it cannot sell, and then its profits must come down to the prosaic level, or, worse still, losses may be incurred by holding depreciated investments. We have nothing to say against the principle of a well-conducted trust. If the investments be well-selected, sufficiently distributed, the working charges be kept down within moderate limits, and the leech-like founders are not allowed to suck the lifeblood out of the concern, there is a good field for trusts which shall average dividends and enable small shareholders to obtain a good security and fair interest. But underwriting companies, however powerful they may be, offer an investment, or risk, of a totally different character.

As yet, investment trusts in America have not to any great extent taken the form of underwriting companies such as are here referred to, though trusts closely affiliated with banks or houses of original issue, and operating under charters or indentures containing no restrictions against the acquisition of securities sponsored by their organizers, stand in some danger of being used as repositories for securities which might otherwise abide overlong upon the shelves of the parent concern.

But even the less speculative British trusts fared ill in these earlier years, for they appear not to have kept any part of their resources liquid during a protracted period of high security prices. Says the Economist for May 2, 1891 :

It has now been made very evident that the trust companies would, as a whole, have fared much better if, instead of buying in 1889 at the top of the wave, they had simply let their funds lie idle until the present time, and gone in for their securities when the inevitable drop had followed. Instead of that, they operated when securities were sustained by the glamour cast over them by a previous long-continued rise, and combined together so as to carry that rise still further. Even when the investors began to hold back, they still went on, and the result is that, when they were so full up that they could absorb no more, prices came down with a run, and they must now hold on in the hope of a recovery at some future time. . . . Whereas even twelve months back practically the whole of these companies stood at a premium in the market, many at a high premium, as we write the majority are at a discount, and only those which were early in the field and began buying before the rise had taken full effect are at a premium.

By February 4, 1893, the commentator in the Economist had evidently reached the point of despair. He writes:

Of many of the trust, companies which were formed in such rapid succession a few years ago, when the mania for this form of joint-stock enterprise was rampant, it may be said with truth that, having sown the wind, they are now reaping the whirlwind. Week after week evidence accumulates, proving only too forcibly that those responsible for the management of these trusts have based no inconsiderable part of their operations upon false principles, with the inevitable result that, after a more or less brief period of apparent prosperity, losses and difficulties have arisen, and unless greater foresight and ability is displayed in the future than has been shown in the past, it is highly probable that collapses of a disastrous kind will take place.

It may be recorded that a number of serious collapses did take place, principally, however, among the underwriting trusts and those whose managers were compensated by sharing disproportionately in profits over and above a normal return to their investors.

Thus closed the second act of the somewhat melodramatic performance of British investment trusts in the years 1888 to 1893. Three years elapse before the happier ending of the third act is recorded in the Economist of May 23, 1896: —

It is satisfactory to observe that the upward movement in prices of trust securities generally, which went on more or less intermittently during the second half of 1894 and the first half of last year, has since made more regular progress, for it shows that the companies have, as a rule, improved their positions, and that investors are exhibiting more confidence in them. Only a few years ago the very name of trust had come to be a byword and a reproach. . . . There were, of course, honorable exceptions; but the stocks of even the soundest and most ably administered of the trust undertakings were more or less depreciated. . . . Many of the companies are still suffering from the effects of the ill-judged policy with which they commenced operations; but in the majority of instances the evil reputation which clung to them for a while has been successfully lived down; the investment part of the business has been consolidated and cultivated.

The final outcome for those trusts which survived the storm of 1893 in Great Britain has been a long career of valuable service to thousands of investors. Let us hope that the organizers of the ever-increasing number of investment trusts which are being presented to the American public will read deeply into the record of this period of British trust-company history, and will take pains to insert in their trust indentures restrictions against their own and their successors’ activities, so framed as to make impossible a repetition of the unfortunate experiences which befell the directors and investors in some of the British trusts organized under the spell of enthusiasm.

But restrictions alone will not provide sound management. There must he sincerity and a conscientious aim on the part of directors to protect the values entrusted to their care, rather than any ambition to reap large and quick profits through the control and manipulation of capital belonging to others. A clear-sighted investor examining the descriptive circulars of newly formed trusts will be able to identify those in which he may safely invest.