The Origins of the Mutual Fund Industry
According to K. Geert Rouwenhorst in the Origins of Mutual Funds, the name of the seminal mutual fund created in 1774 by Dutch merchant and broker Adriaan van Ketwich was Eendragt Maakt Magt, which translates to "Unity Creates Strength." “Following the financial crisis of 1772-1773, the trust aimed to provide diversification at low cost to small investors,” according to a web page about the fund by K. Geert Rouwenhorst, a professor of finance and deputy director of the International Center for Finance at Yale University. “Risk spreading was achieved by investing in Austria, Denmark, German states, Spain, Sweden, Russia, and a variety of colonial plantations in Central and South America. The trust only invested in bonds, as very few equities were listed on the Amsterdam Stock exchange during the 18th century. Notably absent from its holdings were Dutch government and municipal bonds, which means that this early trust was a foreign bond fund.” The trust was liquidated in 1824.
The Foreign and Colonial Government Trust was founded in London, England, in 1868. It was the precursor to the U.S. fund model, although it took 55 more years for the first mutual fund to be launched in the United States. According to the Investment Company Institute (ICI), the trust provided “the investor of moderate means the same advantages as the large capitalists…by spreading the investment over a number of different stocks.” The trust still operates today, and is now known as The Foreign and Colonial Investment Trust.
In 1924, the Massachusetts Investors Trust began operating in Boston. It was the first mutual fund company in the United States. Two years later, it began publishing financial reports for its investors, a practice that all regulated mutual fund companies must follow today. The trust is also known as one of the first organizations to establish an in-house research department.
An article in the July 16, 1926, edition of the Boston Globe described the new mutual fund company:
“The Massachusetts Investors Trust, organized in 1924 to afford the investor an opportunity to purchase a broad list of sound common stocks in convenient units, has grown in the interim from $50,000 paid in to more than $2,500,000 and now numbers just short of 1000 shareholders. Its funds are invested in the common stocks of 136 leading American corporations. The trustees have acquired the holdings of common stocks for permanent investment, not for speculation.” Today, the Massachusetts Investors Trust is known as MFS Investment Management. It manages more than 80 U.S. mutual funds and had $489.5 billion in assets under management as of August 31, 2019. MFS is still headquartered in Boston, but it also has offices in Hong Kong, London, Mexico City, Singapore, São Paulo, Sydney, Tokyo, Toronto, and other cities.
Key Laws Bring Stability to the Mutual Fund Industry
The stock-market crash of 1929 and the Great Depression caused significant economic hardship to Americans and prompted investors to lose confidence in the fledgling U.S. mutual industry and other investment sectors. Federal government intervention gradually calmed investor fears and created the foundations of the modern financial system. The creation of the Securities and Exchange Commission (SEC), the passage of the Securities Act of 1933, and the passage of the Securities Exchange Act of 1934 taken together established safeguards to protect investors: mutual funds were required to register with the SEC and to provide disclosure of risk in the form of a prospectus. The Investment Company Act of 1940, called the “truth in securities” law, laid out the standards by which mutual funds price securities and promote their funds. These laws fueled investor confidence, and by 1951 there were more than 100 mutual funds and over one million shareholder accounts.
The First Retail Index Mutual Fund
The First Index Investment Trust was launched by John C. Bogle (the founder of The Vanguard Group, Inc.) in 1975, and made its first initial public offering (IPO) on August 31, 1976. It was the first retail index mutual fund (i.e., passively-managed fund), and its portfolio held stocks from the Standard & Poor’s 500 Index, an index of stocks chosen for liquidity, market size, and industry grouping, among other factors, and one of the most commonly used benchmarks for the overall U.S. stock market. “The idea that passive equity management could outpace active management—then the mutual fund industry’s universal strategy—was derogated and ridiculed,” recalled Bogle in a 2011 Wall Street Journal article. Some investment professionals questioned the long-term performance prospects of the fund, calling it “Bogle’s folly,” but Bogle felt that the fund, with its low costs, would provide investors with higher market returns than actively-managed funds.
Bogle and his colleagues were confident that the IPO (with a target of $150 million) would be a great success. When the IPO was closed however, they were surprised to learn that it only raised $11.3 million. The fund’s underwriters suggested that the deal be cancelled, but Bogle pushed on. In the WSJ article, he recalls responding “Oh no we won’t! Don’t you realize that we now have the world's first index fund?” Encouraged by Nobel laureate economist Paul Samuelson and other industry experts, as well as his own belief in the merits of the fund, Bogle redoubled his efforts to attract investors and educate the public about this new type of fund.
Interest in the Vanguard 500 Index Fund, as it is known today, grew in the ensuing years. In 1990, the Vanguard 500 Index Fund got its first competitor when Fidelity Investments launched its first index funds. In 1999, the Vanguard 500 Index Fund reached $100 billion in assets. The next year, the Vanguard 500 Index Fund passed the actively-managed Magellan Fund as the largest mutual fund in the world. As of July 31, 2019, it had total net assets of $492.2 billion.
Samuelson provided a great compliment to Bogle and the index fund in a speech at the Boston Security Analysts Society on November 15, 2005: “I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese: a mutual fund that never made Bogle rich but elevated the long-term returns of the mutual-fund owners. Something new under the sun.”
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