A History of the Mutual Fund, Part I

Many investors view the mutual fund as a modern invention, which makes sense as the first open-end mutual fund structure in America has its roots in the 1920s.

However, investment vehicles with a similar structure and ideals were offered overseas hundreds of years before.

As with most inventions, the now-common mutual fund was once nothing more than a good idea. Most historians credit the introduction of this idea to a Dutch broker named Abraham van Ketwich, who created a pooled investment vehicle in 1774.

Just prior to the creation of this fund, a global credit crisis had broken out around 1772, as the failure of a bank in London caused some Dutch banks to fail and even caused bankruptcies in the New World. Van Ketwich apparently learned his lesson and created his pooled investment vehicle (known as a negotiatie) called “Eendragt Maakt Magt”, which means “Unity Creates Strength”.

Similar to the closed-end mutual fund of today, this fund allowed average investors to pool their money, reduce risk, and achieve diversification through the fund, a worthy goal in post-crisis Europe.

This fund spread its risk by investing in plantation loans and foreign government and bank bonds. According to a manuscript of the prospectus that survived, investments were restricted to entities such as Danish and Viennese banks, Russia, Sweden, certain British colonies, and Danish American Islands.

In addition to pioneering the idea of achieving diversification through the fund structure, van Ketwich also introduced the annual management fee into the industry, and was paid an up-front commission and annual management fees each year, though the total cost works out to only be about 0.2% of asset each year, which is very low even today.

One other idea pioneered by van Ketwich was the ability of each investor to sell his share of the fund to another person if he so desired. While this seems like an obvious and necessary trait to us, the common type of pooled investment vehicles that existed before van Ketwich’s fund were structured as non-transferable investments, i.e., you invest in a fund and receive dividends until you die, with no opportunity to resell your investment.

By allowing his investors to sell shares after the offering, van Ketwich paved the way for the modern transaction-heavy investing of today.

Moving ahead nearly 100 years, the “Foreign and Colonial Government Trust” was founded in London in 1868, becoming the first pooled investment vehicle of its kind established outside of the Netherlands. Similar to van Ketwich’s fund, the FCGT investing in foreign government bonds. Diversification was the selling point for this fund, and the prospectus stated that the goal of the fund was to afford “the investor of moderate means the same advantages as the large capitalist, in diminishing risk of investing in foreign and colonial government stock, by spreading the investment over a number of different stock”.

During this period pooled investment vehicles, known as investments trusts, were gaining traction all over the world. The famous First Scottish American Investment Trust was launched and invested in United States railroad bonds.

By the 1890s, the creation of investment trusts migrated to the United States, which would forever change the pooled investment fund industry. Join us for Part II of our History of Mutual Funds to see how the mutual fund industry took its current shape.