The Investor’s Dilemma
By Louis LowensteinSummarized by Cale Smith, Managing Partner, Islamorada Investment Management
Reproduced with permission of the publisher
Introduction “There is something rotten in the mutual fund industry.” That’s how Louis Lowenstein begins – by relaying his core belief about the mutual fundindustry: the industry has betrayed investors by changing the goal and character of theindustry. Originally designed to support the well being of investors in the long term,mutual funds have become instead a large repository of cash and funds to be abused bymanagers whose primary concern is not to invest wisely, but to accumulate assets undermanagement to fatten the coffers of the management company. The industry, accordingto Lowenstein, has abandoned its fiduciary duty to investors and has instead turned into amarketing machine, “making a nice business for themselves.” Chapter 1- Mutual Funds: A Painful Birth Chapter 1 examines the birth of the mutual fund industry and the changes to the industrysince its established foothold in the 1920’s. Lowenstein explains that although theindustry has seen various abuses and scandals since inception, the original idea of poolingfunds was a simple and good one that delivered many benefits to investors.Unfortunately, mutual funds no longer deliver those benefits today. The industry began in late 19
century Britain, when a pool of funds opened for smallerinvestors who were willing to purchase government debt. The idea was not new: it wasbased on an earlier idea held by the Dutch who correctly reasoned that pooled moneywould give investors the opportunity to diversify, enter into large markets which wereotherwise inaccessible, and afford them greater liquidity. The pooled money industry hada heyday in the 1920’s, when a complete lack of any meaningful regulations enabledeverything from dramatic fund implosions to outright embezzlement. Soon after, the newSecurities and Exchange Commission expressly outlawed the more egregious practices of the funds. In 1924, with the birth of the Massachusetts Investor’s Trust (MIT), the beginning of themutual fund industry as we know it today formally began. This MIT fund was unique inthat it was the first “open end” fund, which provided a degree of liquidity and fairnessthat had not been present before. In an open-ended fund, investors wishing to cash outtheir holdings in the funds could sell their stake back to the issuer at a price that reflectedthe price of the portfolio securities divided by the shares outstanding at the time. Thevalue of the idea, other than increased liquidity for investors, came in the form of greatertransparency (disclosure of securities present in the fund) and greater liquidity.