Part of the reason that IOS got away with many of its extravagant claims is that the investment record of an open-end fund can be looked at in a number of different ways. It is, of course, simple enough to calculate the 'net asset value per share' of a fund at any given point: it is simply a question of dividing the current value of the fund's cash and investments by the number of fund shares outstanding. The resulting figure governs the price paid by new investors coming in, and old investors going out: it may also be compared with past net asset value figures, to show whether the value of the fund is going up or going down. So far so good. But at this point, the issue is affected by complexities such as the rate of growth of the fund, and the period of time examined.
The most obvious complexity, for an ordinary customer trying to assess IOS fund performance is that IOS consistently falsified the records of 'IIT, an International Investment Trust', which in the end was their biggest fund, IIT was launched in December 1960 at $5 per share, and in the first year of operation IIT slid down to a net asset value of $4.87 per share. Then came the collapse which we analysed in Chapter 6 and by October 1962, IIT was down to $3.53 per share.
This early performance made it almost impossible to sell IIT and for two or three years the maximum effort went into peddling the Fund of Funds. By early 1965, IIT had crept back to launch level of $5 per share. Then, in the middle of 1966, helped by a booming US stock market, IIT got up to $7.23 per share.
At this point, the IOS men turned the early disaster into an advantage. They began to compute the new rises against the trough of 1962: they pretended systematically that IOS only began to manage IIT when it was at $3.53, and implied that someone else was responsible for it before then. The device of sawing off the embarrassing parts of the record 'made it easier to sell IIT', as Ed Cowett put it, blandly.
The sophistry IOS used to conceal the first 21 months of IIT's life is analysed elsewhere. It certainly made a striking difference to the 'performance'. Between December 1960 and December 1969, IIT shares grew in value by 77% - a meagre performance at best, and the 1970 crash was still to come. But between October 1962 and December 1969, irr shares went up by 151%, which was comfortable. Even on the true figures, there are difficulties about comparing the performance of IOS funds with those of regulated funds in the United States. This is because there is a basic difference in operation. American funds normally distribute to their investors the capital gains they make on the investments and the dividend income they receive. The IOS funds, however, reinvested all such gains and income, which would tend to make their assets grow faster, by comparison, in periods of rising markets - although the income of IOS funds was not usually large because of the heavy charges they had to bear: for instance IOS even used fund income to pay part of the costs of its lawsuits with the sec.
For our comparisons between IOS funds and domestic US funds, we used the analyses of investment companies prepared by Wiesenberger Financial Services. Wiesenberger's calculations of net asset value take into account both capital gains and dividends earned by the funds, but assume that, while the customer reinvests his capital gains distributions, he takes his dividends in cash, forfeiting any further appreciation on this part of his money. So comparison on this basis is somewhat favourable to the IOS funds.
Wiesenberger divides American funds into categories, and then gives net asset value records both for individual funds, and for the average of each category. The most suitable category for comparison with itt and the Fund of Funds is Wiesenberger's 'large growth funds', which, like the two big IOS funds, had assets of more than $300 million at the end of 1969. There were seventeen of these, including Dreyfus, Fidelity Capital and the Enterprise Fund. It is also interesting to compare the IOS funds with Wiesenberger's category of 'smaller growth funds' of which there were 107. Their investment objective is maximum capital gain, and their average net asset value per share rose slightly faster than that of the large funds.
Wiesenberger gives figures for ten-year periods, and then breaks up each decade into sub-periods of one year to ten years in length. Thus, although none of the IOS funds have run a full ten years, it is possible to make the crucial examination of fund performance through time - rather than looking only at particular moments of spectacular performance. Sharp gains can readily be made in rising markets, and the IOS funds often did so. But what matters more, especially to the 'small saver' IOS claimed to be serving, is the effect at the end of the day.
The life of IIT between 1960 and the end of 1969 - we are not yet examining 1970 - can be cut up into nine periods, ranging between one and nine years in length. In four of those periods IIT's value did better than the average of large US growth funds, and in five of them it was worse. (It only exceeded the smaller growth funds in 1969.) The four periods in which the IIT figures exceeded the large US funds' average are: from the end of 1963 to the end of 1969; end 1964 to end 1969: end 1965 to end 1969; and end 1967 to end 1969. In other words, IIT had a period of sharp increases in value per share during the mid-Sixties, and this appears clearly if one looks at individual years. There were three, 1965,1966 and 1968, during which IIT's net asset value per share rose faster than the average of the large US growth finds.
But over the
whole
nine years, IIT had a dismal performance. Between December 31, 1960 and December 31, 1969, the average growth of net asset value per share in the large US growth funds was 134%, getting on for double IIT's true figure of 77%. The small growth funds, with 145.5%, beat IIT still more comfortably. Indeed, if adjustment is made for reinvestment of dividends, the average increase of an investment in a large US growth fund would have beaten an investment in IIT by more than twice, IIT's amazingly mediocre performance was not very much better, up to 1969, than the rise of Standard and Poor's index of 500 shares, which rose 58 %. The Dow Jones Industrial Average rose only 30% in that period, but it is not such a good comparison because it only contains thirty industrial stocks. Both the Dow Jones and Standard and Poor's are, of course, 'unmanaged' and do not include reinvestment of income.
IOS rewarded itself for this dismal achievement by removing $11 million from the fund in management fees.
But there are further curiosities about the IIT record - ones which Cornfeld claimed to be 'impossible' when we discussed them with him. The argument begins by stating three points the IIT investment record:
1) Between December 1960, and December 1969, IIT bought shares to a total value of nearly $2.5 billion. At December 31, 1969, the fund still held $558 million worth of these investments, and this market value at that date stood roughly $6 million above their purchase price.
2) During the same nine years, IIT
sold
about $1.9 billion worth of shares. The aggregate proceeds of all these sales came to $12 million less than the aggregate purchase price. In other words, after a vast series of share transactions, which helped increase the value of Arthur Lipper's stockbroking business to $14 million, the small $6 milhon of unrealized gains mentioned in paragraph (1) did not cancel out the losses made on buying and selling shares over the whole nine years.
3) The total of nine years' income from IIT's investments came to $10 million. This was a truly pitiful performance on a fund which averaged $164 million in size during those years, and ended 1969 at $704 million. But it was just enough to cover the losses on capital and leave a minuscule $4 million profit on nine years' operation.
In other words, the worth of IIT's investments had scarcely increased at all at the end of the period 1960-69. Yet the audited net asset value per share, which stood at $5 when the fund began, had gone up to $8.85 by 1969 - the 77% rise mentioned earlier. When we asked Cornfeld how the net asset value could increase in a period when the underlying investments did not do so, he said he could not understand it. The answer, in fact, has something to do with a curious gearing effect in a fund which expands very fast when stock markets decline.
The efforts of the IOS sales force did not slacken when markets fell. Indeed, they were taught to impress the prospects with the concept of 'dollar cost averaging' - which said that if it was good to buy into an up market, it was even better to buy into a down-market. 'For Associates,' declared an IOS workshop session, 'a market decline is a time for increased service calls… a strategic time to encourage clients to increase their investments.' It was never right for an IOS salesman to say anything except:
'Buy.'
In the United States, it becomes difficult to sell mutual fund shares when the markets are declining: but the men who sold IIT were often operating among unsophisticated customers who were well insulated from Wall Street.
So in 1968 and early 1969, there was a gigantic inflow of new money into IIT - about $430 million in eighteen months. The hordes of new investors mostly came in at prices of around $9 to $10 per share, which reflected the rather short-lived surge in IIT's net asset value, and took in the last fling of the stock-market boom of the Sixties. Much of this new money was not invested, but was kept in cash.
When the decline began, it was only the
invested,
part of the fund which declined. In the process, gains made on share transactions in earlier years were wiped out - but the enormous sum of cash which had just been inserted into the fund retained its value, and was available as a 'cushion' to spread over the whole fund. Therefore, the net asset value of the whole fund sank relatively gently from the high of $10.21 down to $8.85.
To some people, a decision not to invest cash inflow from the sales force may pass as investment management. But it might as easily be argued that a mutual fund management facing a period of decline should ease up on its sales effort. Shovelling in new money can only work to the disadvantage of the new investors who come in at peak prices: their money goes mainly to cushion the fall for the existing investors.
Admirers have claimed that the large cash proportions of IIT and other IOS funds were due to 'courage and foresight' on the part of IOS investment managers. The reply to that is perhaps best made by the IOS investment chief, C. Henry Buhl III, who said to us that he had been guilty of 'weakness' during this period. In particular, he said, he regretted that he had not opposed the loading down of IIT with almost $100 million of Colorado Corporation, King Resources, Commonwealth United, Four Seasons and Giffen and other such rubbish which was about to become virtually unsaleable. The figures support Mr Buhl's self-deprecation.
During the first six months of 1969, the cash proportion of IIT rose to 32 % of the whole fund, which was achieved partly by leaving a lot of new money uninvested, and partly by liquidating some $90 million of existing investments. But taking the year as a whole IIT managers actually
increased
their investments overall: they bought $936 million worth of shares, and sold §722 million worth. This meant that, net, they put $214 million into the market. In doing so, they realized $50 million of losses, and the value of shares remaining in the portfolio fell by $38 million. So over the whole year the increase of cash in the fund came from new shareholders. They were providing, to their cost, a 'cushion' which was about to be badly needed.
The record of the Fund of Funds, up to this point on the edge of crisis, is even worse than that of IIT.
The Fund of Funds was launched in autumn 1962. From December 31, 1962 to December 31, 1969, the net asset value per share of the Fund of Funds grew by 127.2%, considerably worse than the average of either large or small US growth funds over the same time. In each of the periods covered by Wiesenberger's figures, FOF's record is below the average of the large growth funds; only in 1969 was it better than the smaller.
If the seven years are examined individually, FOF did better than the average of large funds in two separate years: 1963 and 1968. And it did better than the small funds' average in 1963, 1964 and 1969. Yet even this is an unreal comparison: in reality, the Fund of Funds only performed respectably when it was invested in public mutual funds in America. Its best years were at the start. Then came the period of speculative 'proprietary funds', and the rest of the record is distorted by the Arctic revaluation. If that is removed, then the net asset value per share comes down by a disastrous 25 % during 1969 alone. That brings FOF's seven-year record down to 100%, hopelessly inferior to the average of US funds.
The Fund of Funds, unlike IIT, did not have a big flow of new money in 1969. The sales emphasis in the latter Sixties switched to IIT - largely because, on the basis of its truncated records, it could be shown as having a better growth rate! During 1969, the Fund of Funds increased its cash by liquidating some $400 million of investments, and nearly a third of the total fund was in cash at the end of the year. Since, during the year, there were net redemptions of $50 million, and $40 million had been expended on trying to support the sagging price of ipi, the real estate fund, and another $50 million punted into the Natural Resources Account, FOF by the year's end could hardly be called a fund with a strong liquid position.
So both IIT and FOF began 1970 in remarkably poor condition. In the early part of the year, Wall Street dipped again, instead of making the hoped-for recovery, and something like panic gripped IOS. Investment managers were dismissed abruptly, vast blocks of shares were thrown on to the market - depressing their prices even further - and IOS became, not just a victim of the market crash, but an important factor in knocking the bottom right out of things.
Now the speculative rubbish in the IOS funds blew away - and took large segments of the customers' investments with it. IIT had to write off whole blocks of securities: $60 to $70 million was stuffed into a 'special account' as there was really no other way to get rid of it. Even the remaining shares were difficult to sell when cash was needed to meet the rush of redemptions.