Within days of Britain’s EU referendum vote, the country’s largest property unit trusts had closed to redemptions and slashed their asset values, or both. The promise of easy redemption resembled the umbrella that is recalled when it begins to rain. Open-ended property funds are not fit for purpose as retail investment vehicles. Perhaps it is time to query the dominance of open-ended vehicles in the savings market more generally.
The Foreign and Colonial Investment Trust, which will celebrate its 150th anniversary in 2018, is often celebrated as the first pooled investment fund. It enabled British savers of modest means to acquire a diversified portfolio of foreign and colonial government bonds.
The Foreign and Colonial Trust was a closed-end fund – the number of units was fixed and holders could realise their investment only by selling their shares to another saver on the London Stock Exchange The shares might therefore trade at a premium or discount to their asset value. And until the Wall Street crash, most pooled investment funds were of this closed end variety.
I first encountered Goldman Sachs as a student. But this was long before the days when undergraduates thronged to hear the Goldman Sachs recruiter tempt them with more money than God as they drank the company’s wine and gorge on its canapés. I was introduced to the vampire squid in a chapter of JK Galbraith’s witty and perceptive account of the Great Crash entitled In Goldman Sachs we trust.
In the later stages of the stock market boom of the 1920s Goldman had been the most active promoter of new investment companies. The Goldman Sachs Trading Corporation offered to make the rich pickings of stock market speculation available to the common man. The company was launched in December 1928 and its share price doubled in only two months, a rise assisted by the Corporation’s substantial purchases of its own stock. The success of the Goldman Sachs Trading Corporation led the company to sponsor new entities – the Shenandoah and Blue Ridge Corporations. In September 1929, the last month before the crash, around $600m of investment company securities were issued(almost $10billion in current prices). In these vehicles, leverage from conventional borrowing was enhanced by cross holdings and self investment. When the market crashed, these companies became virtually worthless.
And that was pretty much the end of closed-end investment funds in the United States. Massachusetts Investors Trust, the first mutual fund – an open-ended vehicle whose managers would regularly issue and redeem units at asset value – had been established in 1924. Pooled investment vehicles achieved a steadily increasing share of US savings in the decades that followed but the growth occurred in mutual funds, not investment companies.
British investment trusts, conservatively managed, survived the crash. But M&G brought the Massachusetts innovation to Britain in 1931 and launched the first British mutual fund, or unit trust. The open-ended sector – free of the restrictions on advertising and payment of commissions which limited the marketing of listed securities – grew rapidly as the investment trust sector stagnated. In due course the hedge fund – open-ended but commonly with restrictions on subscription and redemption – and the ETF – a hybrid of closed and open-ended funds – would become important parts of the investment scene.
An open-ended fund can deliver on its promise of instant liquidity at asset value only if it confines its holdings to shares in large listed companies. That raises two, quite different, questions:
(i) Can exchanged-traded funds provide the liquidity they appear to offer in the face of a substantial market setback? Is it possible that the ETF sector is at the centre of the next financial crisis?
(ii) Are closed-end funds a better instrument for enabling long term savers to access long term investments than open-ended vehicles which must confine their holdings to a limited pool?
Two themes to which I will return.