2018 marks the 150th anniversary of the formation of the UK’s oldest investment trust, Foreign & Colonial. Historian JOHN NEWLANDS describes how this first pioneering example of an enduring new type of investment vehicle came into being.
March 19th 1868 is the date on which Foreign & Colonial (F&C) launched what is generally regarded as the first investment trust. It did so into a world that was still in the process of coming to terms, politically, socially and financially, with the consequences of the Industrial Revolution. While there were railways, steamships and telegraphic cables, there were also 50,000 horses on the ill-lit streets of London, creating a 900-ton pollution problem every day. The telephone, the motor car, wireless communication, and the light bulb had yet to be invented; the Suez Canal was not yet in use. The opening of the London Underground in 1863 had been greatly lauded, until it was realised that steam locomotives running in tunnels created a real danger of travellers choking to death between stations. On the other side of the Atlantic, Colonel George A. Custer’s defeat at the Battle of the Little Bighorn, at the hands of Sitting Bull and Crazy Horse, was still eight years away. In short, the Industrial Revolution had produced a thin veneer of modernity, but the so-called ‘developed’ world was a long way off.
The small investor could be forgiven for thinking that the same was true of the financial markets. The world was full of opportunities and risk. Some early financial disasters, such as the South Sea Bubble, were so severe that it took decades, if not generations, to restore the confidence of investors. The first half of the 19th century had seen several speculative boom/bust cycles, in commodities, in railway stocks and even in foreign loans. In the 1820s foreign loans boom, it proved possible to issue gullible investors with bonds for an imaginary country, called Poyais, mysteriously located “somewhere in Central America”. Fraud was common, usually involving false accounting and the issue of bogus shares. There were three major fraud trials in the 1850s alone. Until 1855, investors had faced unlimited liability in the event of a company’s failure, but even after limited liability was introduced, the rash of company formations – 4,859 between 1856 and 1865 – produced many new failures, frequently through mismanagement or fraud. Then in 1866 the Overend & Gurney bank collapsed, creating what a later historian described as “the greatest financial strain the City had experienced, in time of peace”. Little wonder, then, that Victorian novelists were moved to denounce the financial world in print: “so common were references to frauds, swindles, and bankruptcies in literature that … only a peculiar variation on the theme could guarantee a response”.
The solution for the rich investor, one who could afford the best professional advice, was to build up enormously broad portfolios [that combined holdings of government stock with] scores of high-yielding but individually risky overseas stocks. These portfolios were akin to investment trusts in miniature. One or two failures would not sink the ship, and, even if such failures occurred, the average yield would still be better than that available on safe investments at home. The following list, taken from a real private portfolio of the time gives a flavour of the kind of securities that a rich man would be likely to own in the late 19th century:
Abbontiakoon Mines Ltd.
Anglo Argentine Tramways Co.
Atchison, Topeka & Santa Fe Railroad Co.
Chicago, Milwaukee & St Paul Railroad Co Ltd
(Wisconsin Valley Division).
Consolidated Gold Fields of South Africa Ltd.
Hokkaido Colliery & Railway Co Ltd.
Imperial Russian Government Loan, 5%.
Imperial Japanese Loan, 6%.
Kansas City Electric Light Co.
Matador Land & Cattle Company.
Mexican National Railroad Co.
Tanganyika Concessions Ltd.
Wyoming Cattle Ranch Co Ltd.
Ural Caspian Oil Corporation Limited.
The small investor could not hope to spread his risk in this way. It is essential to realise that investment, until the turn of the 20th century, was all about income rather than capital growth. Interest rates were low and inflation, once the Napoleonic Wars had finished, was negligible. In any case, investment in ordinary shares was often reserved for a company’s proprietors, and was regarded as far too risky for all but the wealthiest. Other investors had very few options. They could invest in Consols – safe but unrewarding UK government stocks, which, staggeringly, yielded more than 3.5% only twice between 1830 and 1914. Banks offered no more than 4.5%, and “the enormous accumulations of the insurance companies have hitherto been managed on the footing that anything beyond 4% is unsafe”.
Overseas government stocks were yielding double, or three or more times, the return on Consols and justifiably so, because of their higher risk. Diversification could, however, reduce the risks. If it is true that the simplest ideas are often the best, then a pooled and managed investment scheme that owned a wide range of such stocks – carefully chosen, naturally – certainly meets the description. That is why Philip Rose, Samuel Laing and James Thompson Mackenzie, the three founders of what became Foreign & Colonial, went to work on creating a new vehicle to do just that and how, in the process, investment trusts were invented.
Philip (later Sir Philip) Rose was an accomplished City lawyer. He had a meteoric rise to fame and fortune during the 1840s railways boom and became financial advisor to Benjamin Disraeli. By the 1860s, Rose had become a specialist both in arranging and investing in overseas loans. Samuel Laing was a wealthy financier and politician. A former Minister in India, Laing was a qualified barrister, and a member of the founding family of stockbrokers Laing & Cruikshank. James Thompson Mackenzie was described in the prospectus as “Deputy Chairman of the East Bengal Railway”. He was Laing’s business partner, and a shrewd entrepreneur. Both Mackenzie and Laing had already made a good deal of money in the railway boom. The three men had, by 1868, worked together for five years, forming and managing the General Credit & Finance Company (GCFC). The GCFC, to all intents and purposes, was effectively a trial run for the Foreign & Colonial Government Trust and many valuable lessons were learnt from it.
The three men already made a strong team and they were determined that their new venture would be presented as the very epitome of trustworthiness, reliability and integrity. The trustees were selected with this aim in mind. For the trust’s chairman, Rose, Laing and Mackenzie went to the top. Lord Westbury was “the most brilliant barrister of his generation … a man who was as respected for his integrity as he was feared for his intellect”. Formerly Richard Bethell, QC, he had held the positions of Solicitor General, Attorney General and Lord Chancellor. He was also a Member of Parliament and a Privy Councillor. Yet his was a far from privileged background. When he was six, his father, Dr Richard Bethell, lost his life’s savings through investing in an unlimited liability clothing company which collapsed. For a time, the family were deeply in debt and Dr Bethell almost ended up in a debtors’ prison. The event had a profound effect on the young man.
Richard Bethell’s abilities had, to say the least, been recognised early. At 14, he was accepted by Wadham College, Oxford. By the age of 17, he had broken a number of records by simultaneously taking a first in classics and a second in mathematics. By his early 20s, he had become a Fellow of Wadham, and at 23 he left academia for the Middle Temple and the Bar. Bethell’s wit, turn of phrase and cutting satire soon became a legend. News of his ability to demolish opponents with such phrases as, “What he pleases to call his mind” soon spread, gaining him many admirers, and not a few enemies.
In Parliament, the prospect of listening to his verbal exchanges with Gladstone ensured a full house. He could be especially scathing about judges and the clergy. On one occasion, when asked why Lord Cranborne always sat with the Lord Justices, he replied, “I take it from a childish indisposition to be left alone in the dark!” When Bishop Wilberforce proved to be a tougher opponent than he had anticipated, Lord Westbury ventured that he “had never met a clergyman, with the exception of your Lordship, who had a mind”. Westbury’s professional income in the 1860s approached £30,000 – an astronomical sum in those days. Despite this, he could be an exceedingly frugal man, who put tuppenny pieces aside to use as tips.
The most important of the other trustees was Lord Eustace Cecil MP, who brought with him “the most distinguished lineage, and his own achievements as a prominent Member of Parliament”. Lord Eustace Cecil was to be involved with the Foreign & Colonial for 51 years, including 32 years as Chairman. The two final trustees, apart from Philip Rose himself, were George Sandiford, who was another prominent MP, and George Woodhouse Currie, a well-known banker. The team, as a whole, had a formidable breadth of expertise and influence, as well as, in Rose’s personal relationship with Benjamin Disraeli, access to a man who had just become Prime Minister for the first time a month before the launch. Few ventures can have been so well-founded.
The trust’s initial ‘Schedule’ of investments
The prospectus for the new vehicle, though aimed at those of modest means, could not be described as a light read, running to a daunting 76 pages. The Foreign & Colonial Government Trust – the word ‘Government’ would be removed from the name in 1891 – was structured initially with a fixed ‘Schedule’, or portfolio, of investments. All the stocks purchased were to be deposited, for safety, with bankers Glyn, Mills, Currie and Co. Changes in the portfolio were not expected to be a regular feature: “…a power of sale, under special circumstances, will be vested in the Trustees and a committee of five certificate holders, to be chosen at general meetings, held annually for this purpose, and for receiving a report and accounts from the Trustees”.
The trust was initially planned to have a fixed life of 24 years. The offer was in the form of £100 certificates at £85, repayable at par, giving an expected yield of 7% on a forecast dividend of 6%. Detailed estimates of future income and capital prospects were given, having been checked by Mr C. Jellicoe, former President of the Institute of Actuaries. Mr Jellicoe calculated that the actual return on the portfolio, assuming there were no defaults, would be 8%. The surplus funds thus generated would allow the creation of a “sinking fund”, which would be used for “repaying certificates at par by annual drawings”. As the Schedule shows, the launch sought to raise just over £1m for a fund investing in a spread of 18 foreign government bonds or fixed interest stocks.
Although the coupons of these bonds varied from 3 to 8%, they were nearly all bought at well below par. The actual yields, therefore, were higher, and varied from 5.05% (New South Wales 5 per cents stock – clearly very creditworthy) to 13.69% (Turkish 5 per cents – credit rating not so good). Italian ‘five per cents’ were purchased for £49.75, so the initial yield was just over double the ‘five per cents’ coupon, at 10.11%. Nova Scotia 6%, on the other hand, clearly had a much higher credit rating, and was bought for £102.75. The yield was in this case 5.84% – slightly less than the coupon.
Every one of these overseas stocks looked tempting on a yield basis. Consols, comfortingly secured on the massive assets of the Bank of England, were in 1868 yielding a mere 3.3%. Future prospects therefore depended on how safe the foreign loans really were. Foreign securities were often regarded, with good reason, as high-risk vehicles in dubious emerging markets, including the United States. There had been several defaults on foreign bonds before 1868, some producing a total loss for investors. There was, therefore, bound to be a degree of scepticism in some quarters about the F&C’s likelihood of success.
“To provide the investor of moderate means the same advantage as the large capitalist in diminishing risk in Foreign and Colonial stocks by spreading the investment over a number of stocks.”
Stated objective of the Foreign & Colonial Government Trust, 1868
Initially the new trust scarcely received any publicity. On the launch day itself, a small paragraph, well down the ‘Money Market and City Intelligence’ column of The Times mentioned that: “It is understood that a new company for the investment of capital in all the principal dividend-paying foreign securities is about to be brought forward, so as to enable persons to employ money in this manner without incurring the entire risk incidental to any one particular stock. As a rule, foreign securities have produced a good average return, while there have been some deplorable instances of individual loss”.
No more details were provided, not even the new company’s name. It was a subdued start to what was to become a great financial institution and far from newsworthy. Over the next few days, advertisements for the Foreign & Colonial Government Trust were published, and coverage in the financial columns increased. The Times was an early supporter: “The scheme in its principle supplies a want that has long been felt”. The Scotsman, however, was more sceptical: “A prospectus has appeared of a Foreign & Colonial Loan Trust scheme for £1,000,000, based on the principle of average risks. Investments in low-priced foreign securities look very tempting on paper, but recent experience should induce caution before adopting new speculative projects.”
The Economist noted the originality of the new venture, saying “…the shape is very peculiar; it is not a company, and yet it is to do things like a company; it promises great gains without risk; the exact idea upon which it starts has never been used before. In our judgment, the idea is very good”. It was more sceptical about some of the forecasts made in the prospectus. It did not care for the intention to put over a quarter of the trust’s funds into Danubian, Egyptian and Turkish stocks, or what it called “loans to semi-civilised states … which will go on borrowing as long as they can, and when they cease to borrow, they will also cease to pay interest.” Some of the promises, in fact, were “far too sanguine to ever be performed”.
The Economist’s point about the Foreign & Colonial being like a company, but not a company, is an important one. Rose, Laing, Mackenzie and Westbury used their unique combination of experience and talents to ‘invent’ the investment trust. The fact that the Foreign & Colonial exists to this day, and flourishes, is a tribute to their ingenuity. On the other hand, all modern-day investment trusts, as we colloquially describe them, are really investment trust companies. In the legal sense, they are not trusts at all. The Foreign & Colonial, however, was a trust and not a company until 1879. (Having been registered as an unregistered common law trust, it changed to a corporate form in 1879, following a court judgement, later reversed on appeal, that investment trusts were illegal, being “associations of more than 20 persons for the acquisition of gain”.) This was at least partly for marketing reasons. In the financial panic of 1866, many shareholders and creditors had lost everything, and companies had, not for the first time in history, gained a bad reputation. As The Economist went on to observe, the trust form was “an evident attempt to avoid the now unpopular name of company”.
The stock market in late March 1868 was variously described as idle, dull and inanimate. There were also fears of an early general election. It did not help that the newspapers were still full of articles reviewing the Overend & Gurney collapse and losses incurred in the latest railway mania. At first, the rate of applications for the new trust was slow, but, as a more favourable press developed, subscriptions picked up. The Standard suggested that “in consequence of the manner in which this proposal has been received, it is said that other trusts will be formed for general securities, with a view to paying average dividends on invested capital”. How right it was!
By the end of the subscription period, just over half of the £1,176,500 stock offered had been taken up. It was a slow start, but the concept of a professionally managed trust, smoothing out the investor’s risk and enhancing his rewards, rapidly found favour. Within eight years, 17 other investment trusts had been launched and were quoted on the Stock Exchange. The Foreign & Colonial Government Trust itself made five separate issues of trust certificates, raising the total subscribed to £3,500,000, and in 1873 the F&C’s managers also launched a second trust, the American Investment Trust, specialising in US railway stocks.
Having started life perceived as a high-risk venture, the Foreign & Colonial Investment Trust has long since proved its staying power and vindicated the vision and investment philosophy of its founders. It remains today, 150 years later, one of the largest UK investment trusts, with total assets of over £3.5bn and a highly creditable and consistent long-term performance record. As far as The Economist’s “semi-civilised states” were concerned, only one of the original 18 government stocks defaulted, namely the Spanish New, 3 per cents. The stock missed its coupon payment in 1875, reducing the trust’s income for the year by £4,099. In the finest tradition of a soundly managed investment trust, the deficiency was by then so well-covered by reserves, and by the success of other stocks, that the investors could be forgiven for not having noticed.
JOHN NEWLANDS is the author of Put Not Your Trust in Money, a history of the investment trust industry from 1868 to the present.