Origins of the Modern Mutual Fund

Before the mutual fund, there was the investment trust: a pool of capital, raised through the sale of a fixed number of shares, which professional money managers then used to purchase stock in a range of companies. A closed-end fund, the investment trust did not allow redemptions on demand; rather, investors needed to buy and sell shares on the open market.

The idea of pooling investors’ money and spreading risk across a range of investments originated in Britain in 1868, when the Foreign & Colonial Investment Trust became what is believed to be the first such fund in the world.

The concept made its way to the United States in 1893 with the founding of the Boston Personal Property Trust, but the idea did not really take off with American investors until the late 1920s, when investment trusts boomed. In 1924, there were just 49 such trusts; by March 1927 the number had jumped to 179. In 1928 and 1929, the market exploded, with more than a billion dollars flowing into investment trusts in the first eight months of 1929 alone.

In principle, investment trusts offered diversification and professional management to institutional and individual investors alike. In the late 1920s bull market, they also promised access to stocks that were fast becoming unattainable by other means. But most of these trusts were also highly leveraged through debt and preferred stock that was financed by brokers’ loans, which made them especially vulnerable to a fall in stock prices.

Brown Brothers had served as underwriters for English and Scottish investment trusts going back to the 1890s, in which capacity it received a commission for the shares it sold to investors. By the late 1920s, the firm had become underwriters for a number of U.S. investment trusts, including the National Investors group of investment trusts (a fund of funds) in 1929. While it is unclear whether Brown Brothers managed any of these funds, they did not engage in margin trading that ultimately doomed many of the investment trusts themselves in the 1929 stock market crash.

The crash also breathed new life into the modern mutual fund. The first such fund is believed to have come in Philadelphia in 1907 with the launch of the Alexander Fund, which issued an unlimited number of shares and allowed shareholders to redeem those shares at full net asset value whenever they wanted. By 1929, 19 open-ended funds were competing with nearly 700 closed-end funds—after the crash, the open-ended funds found favor in the more conservative investment climate that followed.

As it happened, it was one of the earliest open-ended funds, the Massachusetts Investment Trust, that helped launch Brown Brothers into the fund custody, accounting, and administration business in 1934.

 

For Further Reading

  • Matthew Fink, The Rise of Mutual Funds: An Insider’s View. Oxford: Oxford University Press, 2011.
  • William Goetzmann and K. Geert Rouwenhorst, eds. Origins of Value: The Financial Innovations that Created Modern Capital Markets. Oxford: Oxford University Press, 2005.
  • Norton Reamer and Jesse Downing, Investment: A History. New York: Columbia University Press, 2016.
  • Barrie Wigmore, The Crash and Its Aftermath: A History of Securities Markets in the United States, 1929–1933. New York: Greenwood, 1985.

 

200 Years of Partnership

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