were Massachusetts Investors Trust , State Street Investment Corporation and Incorporated Investors . These mutual funds differed from closed-end funds in three important ways :
1 . The funds were required to buy back ( redeem ) their shares upon a shareholder ’ s request at a price based on the current value of the fund ’ s portfolio . Therefore , fund shares did not trade at premiums or discounts .
2 . The funds issued only common stock . Thus , the funds did not employ leverage through the issuance of senior securities .
3 . The funds were managed by small groups of individuals , not securities firms . Thus , the funds did not raise the problem of dumping .
The leaders of the three Boston mutual funds wanted the public to distinguish between their conservative mutual funds and risky closed-end funds .
The 1929 stock market crash reinforced their belief that mutual funds were superior . The three mutual funds went down with the market , 70 – 80 %. Closed-end funds did far worse due to reverse leverage and shares moving to deep discounts . American International fell from 84 to 6 ; Goldman Sachs Trading Corp . from 110 to 2.5 ; and US and foreign securities from 64.5 to 1.875 .
By happenstance , a proposed income tax law gave the heads of the three Boston funds a way to help the public distinguish mutual funds from closed-end funds .
Historically , federal income tax law provided a 100 % exclusion for dividends received by one corporation from another corporation . Therefore , investment companies did not pay tax on dividends they received from portfolio companies .
In 1935 , Congress reduced the intercorporate exclusion to 90 %. Investment companies now had to pay tax on 10 % of the dividends they received . Thus , fund shareholders received lower returns on their funds than if they owned securities directly . Investment companies feared this would cause investors to reject investing in funds .
In March 1936 , President Franklin D . Roosevelt proposed a new tax scheme under which a corporation would receive a 100 % deduction for dividends it paid to its shareholders . Leaders of the first three mutual funds saw this as a “ godsend ” that could both solve their tax problem and help the public distinguish mutual funds from closed-end funds .
They proposed to the administration a provision under which an investment company with redeemable securities ( that is , a mutual fund ) which distributed all of its income to shareholders would be ignored for tax purposes . Administration officials proposed conditions that the three mutual fund leaders readily accepted , since they mirrored their funds ’ existing practices . One condition required that the fund ’ s portfolio be diversified . Another was designed to prevent fund control of other companies . A third limited short-term trading .
The final Revenue Act of 1936 granted mutual funds that met these conditions , but not closed-end funds , a full exemption from taxation . Thus , mutual leaders had taken a major first step toward distinguishing mutual funds from closed-end funds and creating a distinct mutual brand .
Mutual fund leaders realized that the Revenue Act of 1936 did not incorporate two other key characteristics of the first three mutual funds — the absence of fund use of leverage through issuance of senior securities and fund sponsors not being able to sell securities to their funds . Four years later , mutual funds supported enactment of the Investment Company Act of 1940 precisely because it required all mutual funds to have these two characteristics .
After enactment of the Investment Company Act , the mutual fund brand was complete — every mutual fund was required by law to provide daily redeemability of its shares , not issue senior securities , not purchase securities from its
Assets in Mutual Funds
Billions of dollars
Year-end
Note : Data for funds that invest primarily in other mutual funds were excluded from the series Source : Investment Company Institute www . MoAF . org | Fall 2024 | FINANCIAL HISTORY 29