Final reminder to register for my conversation this Tuesday (October 11th) with Ted Seides and Frederik Gieschen on the past, present and future of institutional investing.
Ted Seides is an absolute expert on institutional investing, having worked under David Swensen, managed a successful fund of funds, and now the host of famed podcast Capital Allocators. Frederik Gieschen is one of the best finance writers currently publishing online, and has been doing a deep dive on the history of institutional investing.
THE ORIGINAL JACK BOGLE?
In the first installment of this new series last week we studied Tokushichi Nomura II, founder of modern behemoth Nomura Holdings. Today’s edition covers a man that could be considered “the original Jack Bogle”.
While few investors are familiar with Abraham van Ketwich, he is one of history’s most innovative financiers. You will soon learn why, but first we start with the great “Credit Crunch” of 1772.
THE 1772 – 1773 FINANCIAL CRISIS
Innovations are often born out of crisis, and the “credit crunch” of 1772-73 is a perfect example.
The East India Company (EIC), one of Britain’s most controversial institutions, was founded in 1600 as a trading company with exclusive rights to trading with India. However, the EIC’s operations soon “expanded” into ruling India through territorial conquest and regime changes.
By controlling India’s taxes and revenues, for years the EIC provided investors with juicy dividends and high returns. Yet, developments like the Bengali famine of 1769-1770 (which the EIC itself caused) lowered tax revenues for the EIC, consequently impacting EIC revenues.
Ignoring their financial troubles, the EIC unexplainably kept paying out higher and higher dividends. Enamored by the sizable dividends, investors looked past the disconnect between EIC’s dividends and financial reality and enthusiastically speculated on EIC shares. However, British and European banks’ concentrated exposure to EIC stock would prove ruinous. Financial historian Peter Koudijs wrote:
“For years, the directors of the EIC had paid out dividends that were far too high considering the worrying financial situation the company was in. In 1772 the bomb finally burst. In the spring of that year the EIC had to suspend payments on a loan obtained from the Bank of England and the bad state of the company was finally revealed.” (Peter Koudijs)
The collapse in EIC’s share price was swift:
The falling EIC stock price impacted banking institutions far beyond London’s city limits. One of Amsterdam’s storied financial houses, Clifford & Sons., was plunged into bankruptcy as a result of over speculating in EIC stock. The failure of this prestigious bank had significant knock-on effects. Financial institutions in Amsterdam that had transacted with Clifford & Sons were now left holding mountainous losses, and brought to the brink of bankruptcy themselves.
After the Amsterdam financial system was practically ruined by volatility in one stock, Dutch investors learned a market principle the hard way: diversification is crucial to good risk management.
There are many historical examples of “passive” investment strategies/vehicles growing popular after market crashes caused by speculation.
For example, following the Great Financial Crisis (2008) there was a significant shift towards passively managed funds.
After the 1929 Crash, many investors were angry and disillusioned with actively managed trusts. If the fees for “active management” still produced sizable losses in a market crash (in most cases worse than the broader market), why pay fees at all? With this mentality, investors embraced “Fixed Trusts”, an early form of Index Funds that only invested in the securities printed in their initial prospectus. Investors purchased ‘units’ of Fixed Trusts like shares of an ETF today.
After the 1772-73 Credit Crunch, a Dutch broker named Abraham van Ketwich recognized similar sentiments in Amsterdam’s financial community. Sensing an opportunity, van Ketwich launched an innovation that satisfied demands for both diversification and passive management. Importantly, van Ketwich’s innovation also targeted average investors and not the wealthy elite.
Eendragt Maak Magt (1774)
Today, we recognize van Ketwich’s innovation as the world’s first mutual fund. The Eendragt Maakt Magt fund, which translates to “Unity Creates Strength” (good name for a diverisified fund!), was established by van Ketwich in 1774.
A key innovation of van Ketwich’s fund was the concept of pooled investment vehicles. He realized that while smaller investors could not afford all the portfolio’s underlying securities individually, he could pool assets into one investment vehicle offering diversification and sell shares for partial ownership. That is exactly what van Ketwich did.
“The bonds in its portfolio had a face value of 1,000 guilders, and replication of the portfolio by purchasing these securities in the open market was only feasible for investors of considerable wealth. Eendragt Maakt Magt created an opportunity to obtain portfolio diversification in portions of 500 guilders.” (Geert Rouwenhorst)
With a stated motive of providing diversified portfolios to investors of moderate means, Eendragt Maakt Magt held roughly 50 bonds spread across 10 categories (depicted below). To ensure that the end-investor was truly diversified, the fund’s prospectus stated that the securities should be weighted to “observe as much as possible an equal proportionality”. In other words, an equally-weighted portfolio.
To prevent the fund’s managers from developing an “active” approach and overtrading, van Ketwich also implemented some unique governance policies. In the Eendragt Maakt Magt prospectus, van Ketwich assured investors that the fund’s securities would be stored in an “iron chest with three differently working locks”. Therefore, any investment decisions (i.e., trades) would require all three fund managers unlocking the iron chest with their respective keys. This policy acted as a safeguard against overtrading and rash decisions by one of the fund’s managers.
Amazingly, the Eendragt Maakt Magt management fee was incredibly low – even by modern standards – at 0.20%. Thus, like any passively managed mutual fund today, van Ketwich offered small investors diversified market exposure at a low cost.
“Because the prospectus allowed little flexibility with respect to the fund’s investment policies, it is unlikely that Van Ketwich aimed to attract investors by offering superior returns through professional portfolio management… The negotiatie [fund] was likely aimed at smaller investors, who would be unable to achieve this level of diversification on their own account.” (Geert Rouwenhorst)
Despite founding the world’s first mutual fund, Abraham van Ketwich’s innovations did not stop there.
Concordia Res Parvae Crescunt (1779)
Just five years after debuting his first fund, van Ketwich launched his second “mutual fund” in 1779: Concordia Res Parvae Crescunt. This fund would also prove innovative, and distinguished itself from Eendragt Maakt Magt in its utilization of active management (gasp!).
The fund’s prospectus (shown above) stated that the portfolio would invest in:
“solid securities and those that based on decline in their price would merit speculation and could be purchased below their intrinsic values… of which one has every reason to expect an important benefit…”
Yes, you read that correctly. Instead of succumbing to a “sophomore slump”, van Ketwich followed up his first innovative mutual fund with another revelatory innovation: the world’s first value fund. The investment strategy of Concordia Res Parvae Crescunt was to purchase securities trading at prices “below their intrinsic values”.
While performance of this fund was less than stellar, Concordia Res Parvae Crescunt continued operating until 1894, when the final distribution to shareholders was made. After existing for 114 long years, historian Geert Rouwenhorst argues that van Ketwich’s value fund “is probably the longest mutual fund to have ever existed”.
THE LEGACY OF ABRAHAM VAN KETWICH
While it cannot be argued that van Ketwich had a direct impact on the mutual funds launched in the 20th century – beginning with the Massachusettes Investment Trust in 1924 – Abraham van Ketwich certainly kickstarted an era of innovation in investment vehicles.
Dozens of funds similar to van Ketwich’s were launched in Amsterdam over the following decades, and less than a century later a group of London financiers launched Foreign & Colonial Government Trust, the first of its kind. The structure and prospectus of the Foreign & Colonial Government Trust were markedly similar to that of Eendragt Maakt Magt.
A key lesson for investors today is that every crisis presents opportunities for innovation to those that are looking. In a moment when the entire Amsterdam financial sector was reeling and facing widespread bankruptcies, one broker seized the opportunity to launch one of the greatest financial innovations in history: the mutual fund.
As many of you know, I am quite interested in financial history, economic data, and where they intersect. That said, keeping up with all of the economic data that comes out is a full-time job. One of my favorite “shortcuts” is the Daily Edge by Invictus Research.
The Daily Edge is a 6-10 minute video that covers all of the most important economic data and market moves from the day prior. It’s short, consumable, and 100% focused on connecting the dots between the economy and the markets (i.e. making you money). It’s like having a professional hedge fund analyst working for your portfolio… For the cost of a cup of coffee.
Missed Part I of the “Legends of Market History” series? Click here to learn about Nomura’s founder: Tokushichi Nomura II
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