The Origins of Mutual Funds

The founding of the Foreign and Colonial Government Trust in 1868 is often regarded as marking the beginning of modern day mutual funds. However, by that time investment trusts had been in existence in Holland for almost a century. In 1774 a Dutch merchant Adriaan van Ketwich invited subscriptions from investors to form an investment trust (Negotiatie) under the name of Eendragt Maakt Magt (translated Unity Creates Strength). Following the financial crisis of 1772-1773, the trust aimed to provide diversification at low cost to small investors. 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.

In today's terminology Eendracht Maakt Magt was a closed-end trust. It had an initial capitalization of about 1 million guilders divided over with 2000 shares with a par value of 500 each. By early 1775, almost all shares were placed and became freely tradable on the Amsterdam exchange. The daily management of the investment portfolio was entrusted to two directors, who had limited freedom to choose the composition of the portfolio. The prospectus specified ten different groups of bonds to choose from, and required that the portfolio be diversified across groups. To avoid a conflict of interest, Van Ketwich was not personally involved in the daily investment decisions, but only managed the administration of the fund.

To appeal to small investors, the trust contained an embedded lottery, which is typical of many 18th century Dutch investment funds. Eendragt Maakt Magt promised a statutory dividend of 4 percent per annum to its shareholders, slightly below the average nominal interest rate on the bonds in its portfolio. Therefore, as long as the bonds did not default, investment income would exceed the promised dividend payments. The difference accrued in a Cash Reserve, which was used to retire a specified number of fund shares each year by lot at a premium of 10% over par, and to increase dividends on the "neighboring" shares. For example if share number 100 was retired, its next dividend would be equally split among shares numbered 99 and 101, which would then earn 6 percent. The gradual decline in the outstanding shares implied a growing contribution to the Cash Reserve over time, and accelerated share redemption. After 25 years the trust was to be dissolved, and the liquidation proceeds from its investment portfolio divided among the remaining shareholders.

The initial success of Eendragt Maakt Magt invited followers. In 1776 a consortium of Utrecht bankers founded Voordeelig en Voorsigtig (Profitable and Prudent), and in 1779 Van Ketwich started his second trust under the name Concordia Res Parvae Crescunt (Small Matters Grow by Consent). The structure of Concordia Res Parvae Crescunt permitted considerably more freedom to its portfolio managers. The prospectus did not mention a list of the securities from which the managers had to choose. Rather, the trust would invest in "solid securities and those that based on decline in price would merit speculation and could be purchased below their intrinsic values." This certainly reminds us of a value investor! The prospectus promised a statutory annual dividend of 4%, and a flexible repayment schedule: as many shares as practical would be redeemed annually at a 20 percent premium.

Things did not go as planned: A war with England caused default of colonial bonds and sharply reduced investment income. Van Ketwich suspended share redemption in 1782, and several years later lowered promised dividend payments. By the end of the century the funds had disappeared from the official published price record of the Amsterdam stock exchange, and transaction prices show up only at irregular private auctions by securities brokers. During this period Van Ketwich regularly offered to buy back shares in the open market well below their par value.

Eendragt Maakt Magt was liquidated in 1824, but Concordia Res Parvae Crescunt existed for 114 years until 1893, when it was officially dissolved. In 1894, a final distribution of F430.55 per share of F500 was paid, or 87% of the original investment. The picture is a liquidation receipt for 3 shares issued to Mr Jan Kol.