Perhaps the most widely practiced approach to investing today is by doing so through a mutual fund of one form or another. This is perfectly sensible; someone without a lot of money to invest would be greatly handicapped if the diversification benefits of mutual funds were unavailable to them. Exactly how much money is invested this way depends on how you define a mutual fund, but the Investment Company Institute estimated that total assets under management for open-ended funds alone stood at over $46 trillion globally in 2018. Though not as old as stocks and bonds themselves, the acorn doesn’t fall far from the tree. In addition to being the home of one of the oldest stock and bond markets, Amsterdam was also the birthplace of the mutual fund.
Amsterdam
Amsterdam in the 18th century was not just the commercial capital of the Netherlands; it was also a European financial center. True, the city was being eclipsed by other metropolises of commerce, especially London, mirroring the shifting balance of power in Northern Europe. The era when Amsterdam was in its prime, and many of its personages immortalized in Rembrandt’s paintings, was a thing of the past. By the late 1700s, the protectionist policies of other European nations and unsuccessful military engagements had diminished the extent of Dutch trade. Regardless, Holland remained a center of European finance; it was home to a large bond market as foreign nations continued to float their sovereign bond offerings there.
The birth of the mutual fund in Amsterdam came just after one of the 18th century’s largest financial crises. In the early 1770s, surpluses of goods imported from the East led to falling commodity prices. The direct economic impact of these depressed prices was worsened by bank failures. The financial crisis of 1772 was triggered when a London bank lost £300,000 on a trade that involved betting against the shares of the British East India Company. The company was struggling through the oversupply of tea in Britain but was rescued by a £1.5 million loan from the British government. Following the failure of that bank, other British and Dutch banks met a similar fate as credit dried up. However, only the most speculative firms met their end, highlighting the value of diversification in investments. It was following this painful lesson that the first mutual fund was created.
Eendragt Maakt Magt
In 1774, a merchant and broker Adriaan van Ketwich, created an investment fund with pre-identified investment objectives. His creation, outlined in the research of William N. Goetzmann and K. Geert Rouwenhorst from Yale University, is reputed to be the world’s first mutual fund. The fund was called ‘Eendragt Maakt Magt’ which translated from Dutch means ‘unity makes strength’ and its prospectus, or ‘negotiatie’, survives to this day. According to that document, the fund was fairly limited in its scope, was intended to have a fixed life, and was to pay out its returns to investors rather than reinvesting them, suggesting that its investors anticipated a fairly passive approach with little trading. This may have been in vogue following the financial disasters of the previous few years brought on by excessive speculation.
The Eendragt Maakt Magt (EMM) fund was to invest its clients’ money in bank and government bonds as well as debts secured by toll revenue and Caribbean plantations. The fund was thus essentially an international bond fund, investing in Austrian, Danish, Spanish, Swedish, Russian, and German bonds but eschewing those of its home country, the Netherlands. Those foreign bonds paid higher yields than could be found in ‘safer’ countries like the Netherlands or Britain. Despite the higher yielding investments, the fund actually targeted a rather conservative return of 4% annually, to be paid out in dividends to its investors rather than reinvested.
The fund was launched by issuing 2,000 shares for 500 guilders each. Someone buying a single share benefited from the diversification of the entire fund. Considering that the individual bonds in the portfolio often had denominations closer to 1,000 guilders, it is clear that the fund reduced the barriers to diversification for its investors. That being said, even a single share in the fund was quite expensive; 500 guilders was a substantial sum in late-18th century Holland, perhaps just a bit less than a sea captain or lawyer might make in a year. The 2,000 shares comprising the 1,000,000-guilder fund were divided into 20 ‘classes’ of a hundred shares each. Proceeds from each class of shares would be invested in about fifty bonds, roughly equally weighted.
What was most novel about the EMM mutual fund was how it passed on returns to investors. While the fund paid a 4% dividend, the securities it owned paid out more than that, generally between 4% and 6%. This ‘excess spread’ was used rather creatively. The prospectus laid out how any return over 4% would be used to redeem the fund’s shares at a 20% premium. The shares to be redeemed were chosen by lottery. For example, if the 1-million-guilder portfolio earned 5.2% one year, 40,000 guilders would be used to pay the 4% dividend while the remaining 12,000 guilders in returns would be used to redeem twenty randomly selected shares at 600 guilders apiece.
Of course, randomly selecting shares for redemption at a premium seems to introduce an element of luck into investors’ performance. However, this likely served a purpose besides merely satisfying a gambling urge. As a closed-end fund, an investor looking to exit his investment needed to find someone willing to buy his shares. However, by steadily redeeming shares, the fund was able to provide some liquidity to its investors and also served to limit the life of the fund.
Further, redeeming shares using income generated from the fund’s investments meant that dividends to the remaining investors could be increased. Dividends that would have gone to redeemed shares were redirected to remaining investors, but not equally. Rather, dividends were assigned to the adjacent shares by number. As such, if share #50 was redeemed, its 4% dividend would be redirected to shares #49 and #51. This feature seems to have needlessly complicated the fund’s functioning. That said, incorporating seemingly gambling-like features like this into securities was quite common in the 18th century.
As with all mutual funds though, investors had to pay up for the benefits provided by the fund’s managers. However, it is interesting to note just how modest the management fees were on this antiquated, yet innovative, investment fund. Adriaan van Ketwich collected a fee of 100 guilders from each share class for managing the EMM fund. Since each share class consisted of a hundred shares of 500 guiders a piece, the fee amounted to 0.20% a year. This is hardly out of line with the less expensive mutual funds available nowadays. Regardless though, it provided van Ketwich with an income of 2,000 guilders annually for his services as a fund administrator. This was still a hefty income in mid-to-late 18th century Holland.
Performance
The fate of investors’ fortunes turned out differently however, though through no fault of van Ketwich but rather thanks to geopolitical forces well beyond his control. The fund’s returns took a hit during the Fourth Anglo-Dutch War. In 1782, a decline in investment income led to a suspension of share repurchases. The French Revolutionary Wars only worsened matters; the conflict saw the Netherlands defeated by the French and occupied. Meanwhile, the British had cut off from the mother country the Caribbean plantations the fund was exposed to. The EMM shareholders voted to extend the 25-year life established by the prospectus in hopes of a recovery and a future liquidation and redemption at par value. It was for naught though; by 1811, shares in the fund were trading at 25% of their 500-guilder offering price. The final liquidation dividend of 561 guilders wasn’t paid out until 1824.
Lesson
Whatever its differences, the nature of the EMM fund is similar to that of modern mutual funds, especially closed-end funds with a fixed number of shares. Indeed, most early mutual funds were closed-end funds like Eendragt Maakt Magt. The investors who bought up those 2,000 shares of Adriaan van Ketwich’s fund were likely seeking the same things, namely diversification and professional management, sought by most modern mutual fund investors. Even the features of this old fund that are most alien to modern investors tell an interesting lesson. Paying out a conservative dividend and using any excess return to redeem shares rather than give investors the option to reinvest reveals something about the financial sentiments of the era. Indeed, such an approach is a tacit acceptance of the most basic fact of investing, that abnormal returns don’t last.
More from the Tontine Coffee-House
Learn about other Dutch financial firsts, including the first IPO. Also, read up on the financial crisis that immediately preceded the world’s first mutual fund.
Further Reading
1. Goetzmann, William N., and K. Geert. Rouwenhorst. The Origins of Value: the Financial Innovations That Created Modern Capital Markets. Oxford University Press, 2005.
2. Mosselaar, Jan Sytze. “Low Volatility in Historical Perspective: Fund Investing since 1774.” Pure Play Asset Management | Robeco.com, Robeco, 21 Sept. 2016.
3. Ojha, Ritu Kant. Who Was Abraham Van Ketwich and Why Modern Mutual Fund Managers Both Admire and Envy Him. Medium, 30 Sept. 2018.
4. To, Ainsley. “Lessons from the 18th Century.” Finweek, 23 July 2015, pp. 26–27.
5. Rouwenhorst, K. Geert, The Origins of Mutual Funds (December 12, 2004). Yale ICF Working Paper No. 04-48.
Paul Ochman