Managing my financial journey
Managing my financial journey

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Managing my financial journey

1.2.2 The rise of the investment funds

In the following video Martin talks to Professor Janette Rutterford about the emergence and development of investment funds.

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MARTIN UPTON
Hello. I'm here with Professor Janette Rutterford, who's Professor for Financial Management at the Open University Business School.
Janette's an expert on investment funds.
Janette, how did investment funds first start going in this country?
JANETTE RUTTERFORD
Well in this country they started in 1868 when a company called Foreign and Colonial set up an investment fund. They put money into twenty different government bonds across the world and the aim was to offer the small investor diversification such as the large investor could do himself.
MARTIN UPTON
These funds grew very quickly in the nineteenth and twentieth century. Why was that? Was the financial environment and regulatory environment supportive?
JANETTE RUTTERFORD
Well it wasn't really a regulatory environment. It was just that people had more and more money to save and they recognised the benefits of diversification and so they wanted something which offered them that and they grew. There was a big boom in the 1890s, a big boom in the 1920s and they carried on growing and growing thereafter.
MARTIN UPTON
Now in terms of different types of funds available what sorts of trends did we see in the nineteenth and twentieth century? What are the different types of funds, which were offered to the public?
JANETTE RUTTERFORD
Well it's a really interesting history because originally they were investment trusts which are companies and so you gave money to the company and it invested and it could borrow against that investment. So it could what's called 'leverage up', and they got a very bad reputation in the US in the 1920s because the big, big crash of 1929 was blamed on investment trusts which had had what's called cross-holding. They'd invested in each other. They'd leveraged up. They'd been pretty dodgy all round. It had been heavily marketed to the American small investor. So they were essentially wiped out after World War 2 in the US but the British ones had had a much more conservative strategy with very conservative accounting and they'd been buying conservative securities and they weathered the 1929 storm very well and carried on being quite successful right up to modern times.
MARTIN UPTON
Was that conservatism inbred in that you know they decided themselves to be conservative and then survived the financial crisis at the end of the 1920s? Or was it - was it an external regulator telling them to be conservative?
JANETTE RUTTERFORD
No it wasn't. It was because they tended to be - the people who ran investment trusts in the UK tended to be lawyers and accountants who are naturally conservative and they know about book value, and market value, and they know that if it's lower they reduce the price, that sort of thing. So that's what they did. They were very, very cautious. But the Americans had very big companies with lots of analysts trying to make capital gains, and so on, and they came a cropper in 1929.
MARTIN UPTON
What have been the major trends since the Second World War right up to the current day? I mean what's happened in terms of the different types of funds on offer and which are consumers attracted to and which maybe are a bit passé these days?
JANETTE RUTTERFORD
What happened after World War 2 essentially is that there were two types of trusts. There was the investment trust companies I've already talked about and then there were these new ones post the crash which were called unit trusts and the difference with a unit trust is that it has no leverage and its supply and demand is the function of its size. So if I want to buy units the unit trust grows. If I want to sell my units the unit trust has to give me my money back and it shrinks. And the reason they were popular was because people could get their money back quite quickly with unit trusts. They didn't have to worry about the company going bust or anything. There was a promise that if you wanted your units back you got it back.
And the other thing about unit trusts which is quite interesting is that they are able to market, to advertise themselves very strongly and so one of the things that happened after World War 2 was that unit trusts did a very heavy, heavy marketing campaign in the UK and people bought them because they didn't really know about investment trust companies because they're traded on the stock exchange and it's like buying Tesco or something. It's more complicated than buying unit trusts when your insurance company is handily selling you one of those.
Another thing that happened was regulation so insurance companies and pension funds were promoted by the government to encourage people to save for old age and as a result of that insurance companies and pension funds created funds that people could invest in so they could choose whether to buy a UK trust or a European trust or a global trust or whatever. And so really these funds are now dominated by the institutions.
End transcript
 
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Institutional investment funds

One of the most striking developments in the financial services industry in recent decades has been the rise of the institutional investment funds. These include the pension funds, unit trusts, open-ended investment companies (OEICs), investment trusts and the funds held by insurance companies.

The aggregate institutional holding of UK shares doubled (from 35 per cent to 70 per cent of total share holdings) between the 1960s and the 2000s. Similarly, holdings of UK government securities (also known as gilts) by institutional investors increased from 25 per cent of the total to 66 per cent over the same time period (Rutterford and Davison, 2007, Table 10.1). By contrast, the same period saw an equally marked fall in the direct holding of such investments by individuals.

Table 1 Institutional investment funds

19632014
Rest of the world7.0%53.8%
Individuals54.0%11.9%
Unit trusts1.3%9.0%
Other financial institutions11.3%7.1%
Insurance companies10.0%5.9%
Pension funds6.4%3.0%
Public sector1.5%2.9%
Private non-financial companies5.1%2.0%
Investment trusts*1.8%
Banks1.3%1.4%
Charities, Church etc.2.1%1.2%
Source: Adapted from National Statistics Online and Office for National Statistics (2015a)
* The 1963 data for investment trusts are included in the ‘Other financial institutions’ data.

Although the privatisation of nationalised industries and the conversion of many building societies into banks in the 1980s and 1990s markedly increased the number of shareholders in the UK – from 3 million in 1979 to 15 million by 1997 (falling back to around 11 million by 2009) – most individual investors only have very small holdings of shares. Consequently, as mentioned above, these developments did not change the sharply downward trend line in the percentage of shares directly held by individuals. The main reason for this is that, during recent decades, individual investors have moved from investing directly in shares and securities to investing indirectly via third parties. One reason for this has been the growth of company pension schemes during this period, with individuals paying into pension funds that, in turn, invest in shares and other investments – in effect, on behalf of the individual contributors.

Another major reason for the shift of investment activity away from direct investments has been tax policy, with certain institutionally organised investments offering a better post-tax return. The tax relief applied to premiums paid to those investing in life assurance policies until March 1984, combined with a relaxed regulatory environment for selling these products, established an environment where sales of policies boomed. Additionally, life assurance products that paid lump sums to the policy-holders on the maturity of the policy (i.e. paid out a return even though the investor had not died) provided a means to enhance retirement funds – particularly for those with inadequate pension arrangements.

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