Fund management in the interwar period

Dimitris P. Sotiropoulos,
Department of Accounting and Finance, The Open University Business School, UK



Janette Rutterford
Department of Accounting and Finance, The Open University Business School, UK.


Daniele Tori
Department of Accounting and Finance, The Open University Business School, UK.



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The rise of professional asset management and the story of UK investment trusts

There is increasing interest in the history of professional asset management. From small beginnings, when stock market investment was dominated by individuals investing directly, professional asset management has grown to become the backbone of modern finance. And the rise of professionally managed UK investment trusts is one of the most interesting episodes in this history. Initially formed as trusts in the late 1860s, by the 1880s most UK investment trusts had acquired limited liability company status. The sector survived the Baring crisis in 1890 and weathered WWI without major losses or defaults to skyrocket its performance in the turbulent 1920s. The reason of this success was that UK trusts generally employed a global rather than a domestic diversification strategy (and promoted the principles of global ‘distribution of risk’ to the public). As well as successful diversification, investment trusts were pioneers in stock selection, market timing, and embracing equity well ahead of other major UK institutional investors, such as insurance companies.

Why the 1920s

These are some of the findings from our study, which explores the portfolio techniques of UK investment trusts in the 1920s. The choice of this period is perfect to test skills of professional asset managers when they had to deal with dramatic changes in their investment opportunities. The outbreak of WWI reversed the globalisation trend of the late 19th century and radically reshaped the world’s economic and political order. Investors encountered unprecedented challenges, risks, and uncertainty. At the outbreak of war, the UK government’s policy of non-interference in economic and financial activity was very quickly replaced by massive intervention in the workings of the financial markets – an approach that continued after the war. A big wave of inflation between 1915 and 1920 (when prices rose a total of 150%), followed by a deflationary period in the 1920s (when prices fell by a total of 30%), replaced the relative stability of pre-war prices in the UK. Between 1914 and 1925, Britain left the gold standard, with sterling no longer fixed against gold. Exchange risk thus became a much more important factor when making investment decisions.

In our analysis, we explore how UK investment trusts navigated the new post-war socioeconomic landscape and how the unique historical circumstances of the 1920s affected their asset management decisions. We draw upon a unique hand-collected dataset of 41 UK trust companies, comprising 40,875 portfolio holdings between 1914 and 1928.

The three shifts in asset allocation

Figure 1 provides an overview of the global distribution of portfolio assets in nominal values for the trusts in our sample. It starts from 1900 to provide longer-term trends for comparison with the 1920s. A first finding is a significant heterogeneity in the underlying individual portfolio selection. Individual investment trusts had very different portfolio objectives and were far from following a single benchmark, such as the stock market. Despite this heterogeneity, our results also reveal three common shifts in asset allocation of the sector, indicating a clear paradigm change in portfolio strategies in the 1920s.

Figure 1. Investment trust portfolio allocation in different world regions.

Sources: Our paper.


Notes: Our calculations are based on the reported nominal values in the investment trust annual reports. The chart area before WWI has been shaded to highlight the difference in the 1920s. North America includes the US and Canada and Latin America the rest of the American continent.

The first major shift is that in US securities. Whilst the portfolio exposure to Latin American securities does not change, US portfolio investment has a striking fall. By the end of the 1920s, US securities, the most popular pre-war portfolio investments, had almost disappeared from investment trust portfolios. The second shift is that UK trusts became more interested in domestic securities after WW1 and the third is a marked rise in the appetite for European securities in the second half of the 1920s – a radical departure from the pre-war indifference to Europe. In our analysis we show how each one of these shifts was driven by the economic and political conditions of the new world order.

WWI triggered the collapse of the gold standard. The British pound (GBP) heavily depreciated against the US dollar (USD) immediately after the end of the war. The UK re-joined the gold standard in 1925 in the pre-war rate, but, in between, UK investment trusts found a unique opportunity to sell their USD holdings and realise significant capital gains in GBP. This exit from the US market meant that about a third of the average portfolio value in nominal terms had to be redirected to investment elsewhere. A new wave of domestic industrial security issues, accompanied by a parallel wave of amalgamation and rationalisation of the UK industry, made domestic securities more attractive. However, there were other markets with higher growth prospects. This view encouraged UK investment trust managers to bet heavily on the economic prospects of the European post-war restoration. The reintroduction of the gold standard after 1925 was linked to the return of financial stability, economic revival, and international trade in Europe and this persisted until 1929. From the perspective of the mid-1920s, Europe appeared to investment trust managers to be the most promising investment region for the application of the ‘global distribution of risk’ strategy.

Final thoughts

The focus of research in economic history has traditionally been the study of aggregate financial flows at the macro level. More recently, researchers have turned to the micro-level in an attempt to understand investors’ decision-making. In this line of research, our study adds to the growing literature on the history of fund management by both institutional and individual investors. It also analyses professional investment decisions in a period that has many similarities with the post-Covid world: the rise of geopolitical tensions, increased FX risk, economic uncertainty, and the struggle to regain stability through reliance on high-interest rates. Facing similar challenges, UK institutional investors successfully weathered the turbulent 1920s, but this required a decisive departure from pre-war investment conveniences, practices, and norms, a lesson perhaps for contemporary debates in the financial industry.


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