INVESTMENT TRUSTS. Although stock exchange deal ings as we know them to-day, originated with the Dutch, the investment trust is essentially a British invention. In the early part of the 19th century, following upon the emancipation from Spanish rule of many portions of South America, there was a flood of foreign government and municipal issues in London, offering rates of interest that were very attractive compared with those obtainable on British Government loans. Numerous defaults occurred and within ten years only one-third of this total was in receipt of interest. A few years later followed the great rail way boom, which was succeeded by the panic of 1847. The result was that British investors of all types were heavily hit, and in numerous cases ruined; but a comparatively small number of people were conspicuous exceptions. These were persons of con siderable wealth who were in a position to command informa tion and expert knowledge, and who had invested largely abroad. The need for some combination of smaller investors who, by co-operation, could secure similar advantages, was evident, and in 1863 (just after an act had been passed limiting the liability on shares in joint stock companies) two investment trust com panies were formed in London. Several other companies of the same description were formed, and by the year 1886 these were sufficiently numerous to cause them to be grouped under the heading of "financial trusts" in the official list of the London Stock Exchange. The investment trust is a form of company that appears to have made a strong appeal to Scottish investors, and from the early beginnings of the movement Edinburgh has been the home of many such companies, most of them having been conspicuously successful.
Although not immune from the vicissitudes of the stock and share markets, investment trusts, as a whole, showed that they could pass satisfactorily through bad periods as well as good. It was not, however, until some years after the World War that a movement towards the creation of new investment trusts became apparent in Great Britain. This movement coincided with one of much greater dimensions that started in the United States. A few new investment trusts were started in London, and older trusts began to form what might be termed sister invest ment trusts under the same management.
It is necessary to rri.:±e a distinction between the investment trust and the finance company. The investment trust is an organi zation holding investments in common on behalf of its share holders and distributing among the latter the income received. Emphasis requires to be placed upon the word "income," for the genuine investment trust never distributes profits made by the sale of its holdings; such profits, according to its statutes, must always be carried to reserve, and are, of course, invested to earn additional income available for distribution. This is the "acid test" of the investment trust. The title of a company is not a sure guide, for, unfortunately, there are some companies, British and others, incorporated under the name of investment trusts, which are ordinary finance or holding companies. In Britain the inland revenue authorities themselves make this dis tinction, exempting genuine investment trusts from payment of income tax on "profits" from sales of securities, regarding them as associations of investors pooling their capital for safety and distributing income, that is, investment revenue only. A com
pany that distributes any portion of such profits as dividends is regarded as an ordinary trading concern and pays tax on the total of its net profits, whether it calls itself an investment trust or not.
The ordinary type of British investment trust starts with an issue of capital divided as to 5o% (sometimes 6o%) in prefer ence stock, and 5o% (or 40%) in ordinary stock. After it has been established some time it issues debenture stock to the extent of perhaps its total share capital, so that roughly its capitaliza tion is 20% ordinary stock, 30% preference and one-half debentures. By this method it obtains cheap permanent capi tal, an advantage which cannot be enjoyed by the private in vestor. The assets behind the debentures of soundly established investment trusts are so considerable as to constitute them practically gilt-edged stocks.
As a result of the excellent method of capitalization adopted by the British investment trusts the ordinary (or deferred, where the ordinary has a fixed dividend) stocks are frequently quoted at a price which represents a market capitalization in excess of what would come to them in the event of a liquidation, based upon the book value of the assets. The reason is that all the advantage arising from the cheap capital provided by the debenture and preference stocks accrues to the ordinary, either in the shape of a steady increase of dividend or bonus shares—or both.
Started when prices were low and favourable to investment, these trusts made great progress, and in 1939 numbered nearly one hundred, with a total capital of L8o,000,000. In the light of experience the tendency has been to make the newer unit trusts less fixed, giving more latitude to the management to change in vestments, but always within a prescribed list of securities. By the Prevention of Fraud (Investments) Act of 1939, fixed trusts have been brought under a certain measure of legislative control.