The Investment Trust Rampant

FOUR or five years ago the investment trust was almost unknown in the United States. Where and when obtruding, it required explanation and apology for existing. To-day, particularly during the past half year or so, it is the single very popular investment medium. Because shrewd and capable banking houses have appreciated this fact, they have produced the goods that bear the salable label. The newspapers and the current financial weeklies and monthlies chronicle in detail the amazing reception given to the offerings of investment trusts and trading corporations, the statistics of whose volume of capital are astounding.

Equally astounding is the apparent moneymaking ability of the managers of these new creations. Measured by market price, which in some cases has been rising with extraordinary rapidity week after week until the market break in October, the sure golden road to quick wealth has been discovered. Not a few of our new rich owe their dollars to the fortunate choice of an investment trust. That break drastically deflated the inflated trusts - with wreckage still to be appraised.

Of course the background of the stock market during this period has been unusual. While it has not been a consistent bull market, it has been a strong market for the obviously strong stocks, and mergers have had a large share in the sweetening of profits. Investment trusts, particularly those most loudly advertised, have at times excelled the wildest dreams of the most sanguine operators for the rise. But signs prevail that sobered second thought is bringing changes. Money simply cannot be made as easily as the market increases of some investment trust shares indicate. And the sponsors of the sedate, conservative, and financially sound investment trusts, alarmed at the orgies conducted in the name of the institution they serve, have been taking steps to inform the public as to what is really going on.

INVESTMENT trusts can be organized for any one of three purposes: first, chiefly tor the profit of the organizers; second, chiefly for the profit of the shareholders; or, third, mutually for the profit of the organizers and managers and the public as shareholders. Various other motives may of course interfere, but these are the central economic impulses to be considered.

The trusts that are started principally to make money for their starters are not, of course, so denominated. It is, however, a relatively simple task to determine whether their capital structure unduly favors promoters, and if you are a humble investor your interests require that you look into this situation with discrimination. If you discover that the relationship of equity stock to preferred or to bonds is against you, or if you find that the organizers are retaining a large block of free stock for themselves, the conclusion is obvious. If they grant themselves options to buy stock at low prices after the trust has had success, the conclusion is not so obvious, but reflection will make it patent. If the promoters are permitted to profit by selling securities to the trust, then it is not a trust at all, but a trading corporation or pool. If any one of these things takes place, the fund is handicapped in favor of the organizers and managers and against the public shareholders.

Take the second alternative - namely, that the trust is organized with an eye mainly to the advantage of the stockholders. Odd as it may seem, there are such trusts. Scattered about the country are private investment associations, somtimes clubs, which have grown up in natural response to the need for the coöperative management of individual funds. In such trusts costs are low and rarely include salaries and never have to cover insiders’ preferred participation. Shares are sold at actual value.

Take, now, the third variety, the mutual investment trust.

Aside wholly from the methods and technique of management, the framework of such trusts is simple. It differs not at all from that of the investment club except that there are paid managers and paid distributors. Common practice is to determine a rate of compensation for management which is related either to capital, to capital gains, to income, or to two or more of these factors in combination. Practice also sanctions a moderate percentage ‘mark-up of the shares over and above their actual liquidating value to pay the cost of maintaining a ready market, advertising, commissions to retailers, to general distributors, and to salesmen.

In trusts of the mutual type there is as a rule a single class of stock, every share representing cash put into the trust; none presented for services and none sold cheaply. The promoters or or ganizers are usually also the managers, and their return is not from bonus stock or options, but from management fees and net profit over and above the cost of distribution.

THE investment trust market to-day contains specimens of each of these varieties of trust. Our experience with investment trusts has been so short in the United States that any chart or curve of their progress as a whole is hardly indicative of anything. So far the failures have been few and obscure. The extraordinarily pyramided trusts and trading corporations have had the advantage of intimate connection with high-pressure banking groups, and the miracles in market prices which several of them have worked, unsubstantial as they appear to some spectators, may not be entirely imaginary. Chief among the nonsuceessful investment trusts have been those which neglected to provide real management and those in which the organiz ers followed cast-off fashions of capital strueture.

No business, certainly no investment trust, can well fulfill its objects unless two things are right: management and structure. There is a popular bromide that ‘everything depends on the management.’ It is half true. The management depends on the management, but the ablest managers cannot compete fairly with indifferent managers if they have a poorly built machine to manage. I have in mind, for example, the officials of a very worthy bank who advertised an investment trust of their own manufacture. They made the mistake of employing it as a market for the securities sold by a subsidiary, and as a result the trust suffered some inexcusable losses. But the rigging of the capital structure was such that, alter the passage of two years, for every dollar of appreciation for the public the bank profiled six dollars. No amount of expertness in management can ever make up this discrepancy. This trust was organized, not for the profit of the public, but for that of the bank.

The profound unwillingness of many investors to dig at all deeply into financial matters and the general ignorance of the public of the significance of ordinary financial language are the things that make it possible for outrageous investment trusts to flourish. As investment trusts absorb more and more capital and come to have a larger and larger market influence, it is plain as day that the problem presented affects not only investment trust buyers but buyers of other kinds ol securities. Neither the law nor the gospel will ever stop the exploitation of investors who prefer not to think when investing or prior to investing.

A very few understandable inquiries put to the salesman who markets investment trust shares will reveal within five minutes whether the trust is mutual or the opposite. These questions are: —

1. What does the trust own?

2. What is the property of the trust worth per share of the trust ?

3. What do the shares of the trust sell for?

4. Who gets the difference and why?

5. Are there any favored stockholders? Any holders of options?

6. How is the price of the shares of the trust fixed ?

7. What is the management’s rale of compensation?

8. Does the management make money selling securities to the trust ?

9. Are capital gains treated as income or put into capital reserve?

10. Has the shareholder the right to compel liquidation of his shares by the trust itself?

If the answers to these questions are generally favorable to the shareholder, the trust is probably built right. Beyond and over and above sound structure is the question of experienced, alert, and continuously resourceful management. That, however, is another story and not this one.

APPARENTLY what is taking place here to day is the boom period of investment trusts. Five years ago neither Wall Street nor Stake Street regarded investment trusts as anything but toys for children. Thai attitude vanished when the public approved the trust. Now the plan is to give the public what it wants, — as to name, but at a steep, a dangerously steep price both to the public and, in the long run, to the investment bankers.