list of widely held common stocks of the sort which actually bulk large in the portfolios of the investment companies in question. The changes in the stocks making up the index occur but infrequently, and new stocks are selected not for their investment appeal, but simply upon their status as leading stocks. There are one or two things about this index which Mr. Bunker did not discuss. In the first place, the index always remains 100 percent invested in common stocks, whereas the investment company is free to keep its fund in cash, in bonds, preferred stocks-any way it pleases. Thus, the investment company can perform better than such an index, that is, exhibit its expertness, by shifting its funds into common stocks, when they are a good investment, and getting out of common stocks prior to a major decline in stock prices. A trust that remained 50 percent in cash throughout the post-1929 depression would, of course, perform much better than the index, unless the remaining investments were extremely bad. In the second place, "expert" management implies the selection of better performing stocks for the portfolio than the investor would be likely to select. In contrast to the index, which contains but 90 stocks, the combined portfolios of these investment companies contained between 1,000 and 2,000 different common stocks. Presumably, management decided upon the selection of this great variety of stocks because these were, in their judgment, better investments. If they were not better investments than a handful of most widely held stocks, it is indicated that the judgment of management is no judgment at all, or that the many abuses of unregulated management more than offset their native good judgment. In either event, it seems reasonable to say that no management can claim to be "expert" or deserving of much compensation if its performance is much worse than the performance of an unmanaged index. We may allow a percent or so in favor of management, since the index is not charged with management's expenses, and still justify the comparison. Analysis of the annual record shows that investment companies managed to lose less money in bad years than the index lost, but failed to make as much as the index stocks in good years. Specifically, the companies performed better than the index in 1929, 1930, 1931, 1932, 1934, and 1937, all years of declining prices; and they performed worse than the index in 1927, 1928, 1933, 1935, 1936, and 1938years of rising prices. Over the 1930-35 period, closed-end companies performed exactly the same as the index, and 12 open-end companies performed slightly better than the index. These figures relate only to our hand-picked group of companies, and not to all companies. Over the 1927-37 period, 33 companies out of 85 managed to perform better than the index over their period of existence, and 52 companies, or 61 percent, performed worse than the index. The general conclusion is that these management companies are unable consistently to "beat the averages." The fact that they do better in years of declining prices and worse in years of rising prices suggests that the decision to make investments other than common stocks is an important factor making their performance as good as it is. In the post-1929 depression, for example, a number of companies had only 50 or 60 percent of their fund in common stocks, and consequently performed much better than the index. If we compare investment-company performance to the performance of a combined index of common stocks, preferred stocks, bonds, and cash, represented by indexes, and blended in the proportions characteristic of the actual portfolios of these companies each year, we can eliminate this aspect of the investment policy and find out whether skill was exercised in the selection of individual securities. If management does no better than such a combined index, it means that there is either no extraordinary skill in the selection of investments or that the money gained through clever investments is somehow dissipated. We found that performance of this combined index over the 1930-35 period was some 30 percent better than the performance of the investment companies we treated. While actual figures are not available for the period subsequent to 1935, it is quite certain that the average company performed considerably worse than the securities in these indexes over the 1927-39 period. Given these facts, we were led at the time of making our study, to the following conclusion: "Using the 90 common-stock index as a basis of comparison, the management of the typical investment company made no substantial performance contributions in the typical year to the investors in these companies." We see no reason to change this conclusion. Thank you. Senator WAGNER (chairman of the subcommittee). Thank you very much. We adjourn now until tomorrow morning because the full committee has a very important meeting this afternoon, which will probably take a good part of the afternoon. Will you gentlemen be prepared tomorrow morning at 10:30? (Thereupon, at 1:15 p. m., an adjournment was taken until tomorrow, Thursday, April 25, 1940, at 10:30 a. m.) INVESTMENT TRUSTS AND INVESTMENT COMPANIES THURSDAY, APRIL 25, 1940 UNITED STATES SENATE, SUBCOMMITTEE ON SECURITIES AND EXCHANGE, OF THE BANKING AND CURRENCY COMMITTEE, Washington, D. C. The subcommittee met, pursuant to adjournment on yesterday, at 10:30 a. m., in room 301, Senate Office Building, Senator Robert F. Wagner presiding. Present: Senators Wagner (chairman of the subcommittee), Herring, Townsend, and Frazier. Senator WAGNER. The subcommittee will come to order. Mr. Bane. ADDITIONAL STATEMENT OF BALDWIN B. BANE, DIRECTOR OF THE REGISTRATION DIVISION, SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D. C. Mr. BANE. Mr. Chairman and Senator Frazier: First, I would like to make two or three corrections in the testimony I gave the last time I appeared before you. I did not have an opportunity to go over it carefully enough before it had to be returned for printing. There are two or three errors in it. First, on page 137, next to the last paragraph on that page, the transcript reads: This one man who had a share at $55 now finds two shares in at $55. The first $55 there should be $59. On page 140, about midway of the page, I said, or the transcript shows that I said: Now, granted, which we do Mr. Chairman, you will see it in the paragraph beginning "On September 11, 1939." Senator WAGNER. Yes. You may go ahead. Mr. BANE. Now, the very next sentence, about the middle of the page: Now, granted, which we do, that September 5 was an unusual day, no one can contend that the market fluctuations on September 11 and September 19 were in any way abnormal. As a matter of fact, over the past 9 years the DowJones industrial averages change more once each 3 weeks than the changes in the market of September 11 and September 19. I was in error, or at least I think that gives an erroneous impression. First, it whould be 6 years instead of 9 years; and, secondly, that should read: Once each 3 weeks on the average. I think the statement as contained in the committee print indicates it changed every 3 weeks that much, which is not true. On page 142 of the committee print, right at the bottom of the page, the last sentence on the page, reads: Of course, on days like September 5 you could buy the shares, pay the full load, sell them back almost immediately, and still make a substantial profit without any chance of loss except to the trust. That statement implies that you could do that with all trusts. It is not true that you could do it even on that day in the case of all trusts, because portfolio values did not advance sufficiently. That statement is true with reference to many of them, but not with reference to all of the 78 of which I was speaking. Senator WAGNER. All right, Mr. Bane. Mr. BANE. When I appeared before you a few days ago, I attempted to explain the two-price system used by most open-end management type investment trusts in selling their shares or interests and the effects thereof on the trust and the investor. I evidently was not as successful as I hoped I might be, for apparently the president of the distributor for the largest of these trusts, who was presented to you as the expert in such matters, doesn't understand it even after my explanation and his more than 15 years in the business. I commented on the evils of the so-called two-price system employed in the day-to-day sales of the securities of these trusts which, as I explained, resulted in a cumulative dilution of the trusts, a dilution from day to day, from year to year, particularly in rising markets. I submitted certain statistics compiled from the answers to questionnaires sent out by my division of the Securities and Exchange Commission to investment trusts of this type, that we knew were actively engaged in selling their securities in September 1939. I tried to make it clear that the comments I was making upon the evils of this 2-price system applied generally to trusts of this type. I stated three or four times during the course of my remarks that more than 60 of the 78 trusts which were active not only allowed the interests of their existing shareholders to be continually diluted but that the 2-price method to which this dilution may largely be attributed was used by such trusts as one of their principal selling arguments. I said: The theory back of these trusts is that the new member should pay for his share an amount equal to the proportionate equity of existing shareholders at the time the new member comes in. To phrase this theory somewhat differently: The existing shareholder has already an interest in securities in the portfolio of the trust; the new shareholder puts in cash which cash when invested in portfolio securities certainly should not reduce the existing shareholders' interest. In other words, when he buys in, if you will come down to what actually should occur, the new shareholder should get as much proportionate interest in the trust as his money buys of the portfolio securities after they are taken in. Senator WAGNER. And he gets more sometimes, does he not; I mean the new shareholder? Mr. BANE. He may, if the market is not declining, and very few shares are sold in a declining market. About 90 percent of the sales are made in a rising market. |