In the early days of the Trust companies, when their history was chequered by the ailments of infancy, they were described by a city wit as institutions formed to hold collectively securities which no individual would look at. It was a pleasant gibe with just a spark of truth in it, because it is in fact quite possible for companies handling large funds, and consequently able to diversify risk on a large scale, to take investment risks which the prudent private investor should avoid. But it was said very many years ago, and the securities of the well conducted Trust companies have now established themselves as in many ways the finest form of investment that one can want.
And so they ought to be. As we have seen, the investor is born to risk and uncertainty as the sparks fly upward, and his chief refuge from these dangers is diversification. The Trust companies can diversify diversification. Shares in big industrial combines give diversification, and so still more widely, as has been shown, do shares in banks and discount companies and insurance companies, and a Trust company can hold all these things and many others, so that their shareholders acquire partnership in diversification carried to the highest possible point.
In security of income, derived from a well-chosen collection of investments in all parts of the world, and yielding a revenue many times as large as the interest on the debenture stocks, the debentures of the best Trust companies are hard to beat. Their preference or preferred stocks come not far behind; and the ordinary or deferred stocks and shares, when one can get them, give one a share in revenue earned by highly trained skill and experience in investing, and a share in capital value which grows by constant allocations to reserves.
Moreover, Trust companies have two great advantages over the ordinary investor; they do a considerable business in underwriting new issues, and thereby either increase their revenue or get, at the underwriting price, securities that they wish to hold; and also, as a Trust company chairman lately expressed it, "many of the best things are offered privately to the investment Trusts before they are put upon the market."
The business of managing a Trust looks easy to an outsider who has never tried it. If one were to start to-day, with the right people behind it, it ought to be able to raise a million capital and split it into £600,000 5 per cent. preference and £400,000 ordinary; whatever it could earn above 5 per cent. on its investments would thus be available after paying that rate to its ordinary shareholders, for dealing with preliminary expenses and starting a reserve fund, the return from which as invested would increase the income of the ordinary shareholder. And profits, if any, from underwriting new issues and from realizations of securities, would be available for the same purposes. If the first few difficult years are passed, the rest of the life of the concern should be one of increasing income, as long as it steadily adheres to the principle of always dividing less than it earns and putting the balance into well-selected securities.
It looks easy, but the career of Trust companies has been by no means uniformly successful. An interesting pamphlet[1] on British Investment Trusts, by Mr. Leland L. Robinson, American Trade Commissioner in London, says that "fully one-quarter of the investment trusts have been remarkably successful," which shows very clearly that the purchase of their securities is not a thing to be done with one's eyes shut, and makes one wonder why the proportion of professional success, on an apparently not too difficult job, should have been so low. Perhaps there is a temptation to think that diversification is all that matters, whereas without skill and care it is useless. With skill and care it works wonders. Mr. Robinson gives a most interesting analysis of the highly successful career of the Edinburgh Investment Trust, which began with a dividend of 8 per cent. on its deferred stock for 1890, came down gradually to 2 per cent. for 1895 and 1896, and since then has gone ahead steadily to 20 per cent. in 1916, and now pays a dividend of 12 per cent. on a deferred capital more than doubled by the capitalization of reserves. It has in all distributed to its deferred shareholders £278,000 of deferred stock, £64,000 in debentures and £58,000 in preferred stock.
It is a wonderful record of success, and this is not the most successful of the Scottish Trusts in the matter of past record, its career having begun, like that of many of the English Trusts, at a bad moment, just before the 1890 crisis, which led to an American panic of 1893, complicated by difficulties in Australasia. Scotsmen maintain, and with good reason, that they know better than anyone how to manage investment Trusts, and that the remoteness of Edinburgh from London is by no means a disadvantage.
The Edinburgh Investment Trust does not publish a list of its investments, but Mr. Robinson was able to tell us that its policy "has been to invest considerable funds in common shares." Its chairman told him that the secret of investment Trust management is to "avoid losses on holdings and allow a portion of net revenue to accumulate at compound interest." This, of course, is the "reserve fund policy," the benefits of which have been so often shown in previous pages. In its report dated March 28, 1925, it stated that its investment funds are distributed over 397 investments, an average of £3,620 in each. According to the usual valuation the investments at the close of the company's year (March 15) were worth over £340,000 more than the amount at which they appear in the balance-sheet, which amount was £1,438,226 6s. 1d.
From the point of view of the curious inquirer, it is much to be regretted that so few Trust companies publish a list of their investments. It has been stated that only about a quarter of those quoted in London Stock Exchange official lists give this information. Mr. Robinson, in his bulletin quoted from above, says that it is felt that the companies "would be handicapped in realizing on their holdings if knowledge of the extent of these holdings were public property." And practical Trust company men do not see why they should give away the secrets of their business.
These reasons may be sound, but reticence on the point is the more unfortunate because an attack on the investment policy of the Trust companies, in one important particular, was made by Mr. Harman of the Rock Investment Company in a speech reported in The Times of September 3, 1925; since it is always useful to investors to hear criticisms, let me give Mr. Harman's words:—
"We feel," he said, "that there is something fundamentally wrong in one investment company—except in quite exceptional circumstances—making permanent investments in the junior stocks of other investment companies. I know that the practice is a common one, but I am sure it is a very bad one. . . . My real objection is that it tends eventually to lead to a fool's paradise. I am sure very few of you realize to what a large extent certain investment trust companies purchase one another's stocks. The purchases are usually made because of knowledge that the 'break-up' value is such-and-such a figure, whereas the market price is only such-and-such. However, if all the investment companies will continue to buy one another's junior stocks, naturally the break-up values of all will go up and up, until one fine day, when the buying movement is replaced by a selling movement, they will go down and down. . . .
"This financially incestuous buying of one another's junior stocks has in my opinion arrived at such a point that careful investors ought now to discriminate between stocks of those companies which make a practice of it and those which do not. . . .
"I think many will agree with me that in view of the large amount of capital invested in investment trust company stocks the market in them is extraordinarily restricted, which is a great pity from many points of view. The prevailing tendency to which I have referred intensifies the narrowness of the market. . . .
"As we all know, investment trust companies—have for some time past been having a very good time. However, most of the older of the companies have at some stage or other in their history had to go through periods of difficulty, and it would be foolish to think that such difficult periods cannot recur. Accordingly, in my view, companies should be extra careful at this moment of their prosperity to correct, while they are able to do so, any basic errors in their policy, such as the one to which I have drawn attention, thereby putting themselves in a better position to meet the period of depression which, as experience teaches us, usually succeeds a period of elation."
It follows from the nature of the work done by these companies that their expenses are extremely minute. Our friend, the Edinburgh Investment Trust, shows, in its revenue account, interest and dividends received, less income tax £86,950, and management expenses £4,600; this leaves £82,350 as total net revenue before paying debenture interest. As debenture interest, less tax, requires £12,400, it is more than six and a half times covered. As far as capital security goes, the investments, as we have seen, stand at £1,438,000, and are valued at £1,778,000, so that at the date of the balance-sheet the £400,000 of debentures was secured on assets worth more than four times as much. Even the preference stock's dividend is covered more than five and a half times, its capital more than 3.8 times. The ordinary shareholders get 12 per cent. on a capital that has been more than doubled by bonus share distributions, to say nothing of the income that they get from bonus distributions of debenture and preference stocks. With these results and with the great diversification of risk secured, and the reserve fund policy that is the corner-stone of sound Trust company finance, it is clear that those who invest in Trust companies have done extremely well, as long as they have invested in the right ones. But then, as has been shown, the stock of the good ones very seldom comes to market, and there are plenty of companies which have been unfortunate.
In London, as might be expected, the expenses are at a higher ratio to income. The Industrial and General Trust, in its report to March 31, 1925, showed total income £362,706, and its expenses included rent, salaries, office and general expenses £17,448, directors' fees £12,500, legal expenses £299, auditors' fees £525, special disbursements £567, trustees for debenture holders £350—a total of £31,689; and there was also £766 for staff pension fund. This company paid 14 per cent. on its ordinary stock for the year, absorbing £135,625 out of a divisible balance (after paying the preference dividend) of £212,566, leaving about £77,000 to be added to reserve or used for extinction of debenture stock, rebate and expenses. It not only gives a detailed list of investments, but the following very interesting classification, showing among other things that it has, like the Edinburgh Investment Trust, been a practical believer in the benefit of a diversified holding of ordinary and deferred stocks and shares:—
Summary of Investments of the Industrial and General Trust
I.—Showing Manner of Distribution Amongst Different Classes of Undertakings
| Industrial | 47.67 per cent. |
| American and Foreign Railways | 19.01 per cent.„ |
| Banks and Financial | 11.74 per cent.„ |
| Government Securities and Municipal Loans | 10.15 per cent.„ |
| Home and Colonial Railways | 5.67 per cent.„ |
| Tramways and Omnibus | 3.46 per cent.„ |
| Land and Property | 1.42 per cent.„ |
| Shipping | .88 per cent.„ |
| 100.00 |
II.—Showing Classification According to Localities
| Great Britain | 38.13 per cent. |
| South America, excluding the Argentine Republic | 14.35 per cent.„ |
| Argentine Republic | 13.07 per cent.„ |
| British Dominions and Dependencies | 12.73 per cent.„ |
| United States of America | 9.05 per cent.„ |
| Europe, excluding Great Britain | 4.87 per cent.„ |
| Asia and Africa, excluding British Dominions and Dependencies | 4.36 per cent.„ |
| Mexico and Central America | 3.44 per cent.„ |
| 100.00 |
III.—Classification According to the Denomination of the Securities
| Bonds, and Debenture and Guaranteed Stocks | 40.29 per cent. |
| Preference Shares and Stocks | 17.42 per cent.„ |
| Ordinary and Deferred Shares and Stocks | 42.29 per cent.„ |
| 100.00 |
- ↑ Published by the Bureau of Foreign and Domestic Commerce, U.S. Dept. of Commerce, Trade Information Bulletin, No. 88, April, 1923.