New Investment Vehicle Takes Firm Root in Canada
BUSINESS & INVESTMENTS
A. W. BLUE
Hundreds of thousands of dollars are lost annually in Canada through careless investment. Fraudulent and worthless securities are being constantly poured on to the market to trap the unwary. A general observance of this simple maxim will assist in the reduction and elimination of this economic waste—
“BEFORE YOU INVEST—INVESTIGATE"
THE present and immediate past will be written down as the romantic age of Canadian financial history. We are living in an era of intensive and hectic speculation, when fortunes are won with singular ease, and the army of speculators, eager to participate in the rewards of our sweeping commercial and industrial prosperity has been swelled by the deserters from the ranks of the conservative investors, and by the entrance of a steady stream of raw recruits without experience in financial matters, but eager to test their mettle with the seasoned veterans.
It is true that the lustre of this “golden age” has been somewhat dimmed by a sweeping and drastic decline in the stock markets of the Dominion, but this is accepted as an inevitable condition during the course of a broad forward movement; and as hope springs eternal it is viewed as an adjustment, a breathing spell, in preparation for a continuation of the markets’ constructive activities. He is regarded as a deep-dyed pessimist indeed, who sees in the recent adverse market condition a definite reversal of the tide. However, we are not primarily concerned here with this phase of our financial situation and a definite answer will be supplied with the passing of time.
EnteT the Investment Trust
MANY new and, indeed, revolutionary ideas have been introduced into our financial and investment practices. We have seen new and unique features and types of securities—new styles to meet new tastes, and old line standard types adorned and garnished to render them more palatable to the investing public. We have witnessed the rise of the common stock as the popular medium of speculation, and the submission of the first mortgage bond and even the preferred stock to the junior equities. But no more notable feature has materialized than the introduction of the investment trust, which has rooted deep in our Canadian soil and flourished exceedingly. It is an after-war product so far as Canada is concerned; the first ventures were popular with the public, and their subsequent careers so satisfactory to all concerned, that the inevitable has happened—a large number of investment trusts have been created within the past year, a veritable deluge, in fact, and all have approached the investment public with their securities and solicited public support. And with so many new potential investment media created, the problem for the investor has intensified, namely, that of selecting for investment, only the securities of the soundest or most likely looking member of the group—for obviously all will not be operated or maintained on the same standard or plane of efficiency. The human element in an investment trust is a primary consideration, because sound management is vital to the success of such an undertaking, and, naturally, wide divergence in executive capacity among the various companies can be anticipated.
Based on Diversified Purchases
Y\ ^HAT is an investment trust—this ' ’ new type of organization that has assumed so prominent a place in our financial structure within such a short space of time? The following broad definition has been suggested by an authority on the subject: The investment trust is an agency by which the combined funds of many investors, both in large and small amounts, are utilized to purchase such a wide variety of securities that safety of principal is attained in diversification, while no control or directive responsibilities result from investment. Furthermore, the investment portfolio is so managed that a good average yield is sought on share and borrowed capital, at the same time that close supervision of the portfolio permits a turnover policy aiming at the realization of capital gains and the avoidance of capital losses.
Or to put it more baldly, the investment trust receives the surplus revenue, the savings of a great variety of individuals, in exchange for its own stock, and uses the accumulated capital to purchase securities in great variety on the market, hoping ultimately to sell them at a profit, a portion of such profits to be returned to shareholders of the investment trust in the form of dividends, and the balance turned back to the reserve account of the investment trust itself, to strengthen its financial position, or to be used eventually in the purchase of further securities when the opportune time arrives.
The investment trust provides a broad degree of diversification, and the consequent increased safety element which the individual investor, through the limitation of his financial resources, could not hope to secure in his own personal transactions. Furthermore, the investor is accorded the benefits of skilled and experienced management, the experience of men who should occupy the same plane in the science of investment, as does the specialist in the science of medicine or surgery. Such men are not only always studying investment situations and buying only after their expert investigation has convinced them of the expediency of doing so, but they study market trends and conditions that are likely to affect markets adversely or constructively. They are in a position to weigh the market outlook and to take advantage both of selling and buying opportunities. The individual speculator usually sells when the market is near bottom and buys when prices are near the top. He has not the time, the ability or experience to fully and soundly appraise the investment situation; consequently, he does the wrong thing at the wrong time and thereby jeopardizes his chance of success. Such has been the practice from time immemorial, or so long as there has been a speculative public in the market. Let the individual examine his own personal experiences and see if he has not followed the crowd in his speculative operations. The investment trust, if properly managed, should be above such practices, and therein lies the opportunity for the small investor.
A Product of British Financial Genius
INVESTMENT trusts have operated in England and Scotland for many decades, but the principle was not formally transplanted across the Atlantic until after the close of the war. The investment trust has taken hold in the United States, and a great number of such enterprises are now operating in that country, all engaged in scouring the security markets not only of their own country, but of the world, for suitable investments.
Comparatively little interest could be aroused in the investment trust principle in either the United States or Canada before the war. It is “the child of prosperity.” It usually comes into being in a developed country which has accumulated a large surplus of capital for investment. There was little opportunity, therefore, to introduce the investment trust into Canada before the war when the public had a minor interest in investment matters. There was comparatively little capital surplus, and investment was confined to limited conventional channels. With the war, and the Victory Loan offerings, however, the public became educated in investment matters and visualized the possibilities of capital appreciation through conservative speculation. Today, we are a nation with huge investments and a steadily accumulating surplus of investment funds. The last obstacle to the successful propagation of the investment trust has been removed.
Trade Follows Capital
PERHAPS one of the influences which has most impressed the investment trust idea upon the American public has been the recognition of the important part played by British trusts in making London the financial capital of the world. They were the agencies for spreading British capital throughout the world and advertising Britain to the uttermost parts of the globe, and it is axiomatic that “trade follows capital.”
There is an interesting story relative to the origin of the investment trust as we see it today. A young Scotch banker, we are told, was forced by failing health to leave Scotland and come to America. A number of friends approached him with varying sums of money, asking him to invest it for them in America, at that time heralded as the land of opportunity. The responsibility of selecting investments that would prove equally profitable and satisfactory to his friends, caused the young banker to conceive the idea of pooling the funds as the fairest and safest way out, arranging that all investments purchased be held rateably for all concerned. The results were entirely satisfactory to all.
In 1880, Mr. Robert Fleming, an eminent British investment trust manager today, came to the United States as a mercantile clerk. He was greatly impressed with the possibility of investing funds in that country, particularly in the railroads. He conceived the plan of borrowing money in England, then available at rates as low as three per cent, and loaning to American railroad companies, taking their first mortgage bonds at rates as high as six, seven, and even eight per cent.
By 1888, eighteen trusts with a capital of £23,000,000 were listed on the London Stock Exchange, and by 1890 a trust mania was under way. As capital in Britain remained cheap it was possible to employ it profitably in other centres. The public, appreciating the possibilities of investing outside the country, and yet distrusting its own capacity or judgment to appraise securities of other than domestic origin, was content to trust its funds to the expert guidance of the investment trust management.
And to this day the soundly managed British investment trust has continued to flourish. It is true that there have been lean and trying periods, but the financial storms only served to stress the importance of the element of management. Just as in an advancing market sound management can earn higher profits on its investment portfolio; so in a liquidating market it may not entirely avoid losses, but can certainly minimize losses by capable administration. And thus it can serve the investor capably under both conditions.
The Typical Investment Trust
'T'HE typical investment trust, as it is conceived in Canada today, will show the following characteristics: It
raises capital by the issue of stock, usually both preferred and common. It may also create bonded indebtedness, and the funds obtained from the sale of these securities it invests and reinvests in a wide variety of securities, distributing risk over many industries, countries and types of issues. It appeals to the cautious investor who seeks capital appreciation as well as a fair return, but who often fears to trust his own judgment regarding an investment situation that is not absolutely gilt-edged. The investment trust offers stocks and bonds in reasonable denominations attractive to the small investor, and it aims to protect the interests of the investor by skilful management of the investment or portfolio, maintaining at all times a thoroughly skilled staff for this purpose. And finally, the investment trust holds out to the owners of its common stock the expectation of a considerable enhancement in the earning power of their shares. This arises primarily from a higher average yield than can be safely obtained with a volume of capital permitting considerable spreading of risk.
As pointed out above broad diversification is the principle adopted as a means of providing maximum safety and a fair return. Of course, there are limits to which this policy can be practised. One Canadian investment trust has more than four hundred different securities in its portfolio. Such extreme diversification undoubtedly ensures the maximum of security, but perhaps so broad a list is scarcely needed to accomplish the same end. For beyond certain limits it becomes increasingly difficult for the executive of an investment trust to keep posted right up to the minute on each member of an extremely broad list of issues. Moreover, the law of averages operates as a safeguard, and the investor is fully secured.
Each investment trust is careful to define the rules that have been laid down for its future operations, and the potential investor should carefully study these regulations and satisfy himself that they are strictly in accord with sound investment practice.
We select the following from the prospectus of one Canadian investment trust as being fairly typical of the restrictions which these enterprises impose upon themselves:
1. The company shall at all times keep fifty per cent of its entire resources invested in such investments as are authorized for the investment of the funds of a life insurance company under the Insurance Act of Canada as amended in 1924, and in bonds, stock or other obligations of foreign governments.
2. Not more than five per cent of the subscribed capital of the company shall be invested in or loaned upon any one security or investment ( other than British or Dominion of Canada government stock and bonds), but securities or investments of different titles or denominations shall not be deemed to be one security or investment by reason only of their possessing or being entitled to guarantee from or by the same state, government, municipality, corporation or other body.
3. The company shall not make any investments in, or loan upon the security of more than ten per cent of the total amount of capital stock or bonds or obligation of any one company, corporation, government, and public authority, except stock bonds and obligations of the Dominion of Canada and of Great Britain.
4. Not more than twenty-five per cent of the resources of the company may be invested in securities of any one of the following classes: banks, insurance companies, investment companies, public utility companies, and not more than 12 y¿ per cent in the securities of any other distinct class of business or industry.
5. Securities owned and ascertained to be no longer eligible under the provisions hereof shall be sold within one year of the date of their becoming ineligible.
6. The company may underwrite issues of securities eligible for purchase to an amount not exceeding in any case twice the amount of such securities which may be purchased for investment, but in no case an amount exceeding ten per cent of its total resources.