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Low Volatility in historical perspective: Fund investing since 1774

21-09-2016 | Research | Jan Sytze Mosselaar, Pim van Vliet, PhD

As portfolio managers of Robeco Conservative Equities, we want to place our role into a historical perspective and learn from the history of financial markets, and mutual funds in particular. History teaches us that good ideas do not necessarily guarantee successful funds. Timing is everything. Still, capital protection, high income and low turnover are timeless factors that are still relevant today.

Speed read:
  • A brilliant investment idea is not enough: timing is very important as well
  • The modern era’s focus on relative performance is a root cause of the low-risk anomaly
  • Centuries-old, prudent investment virtues are very significant today
Studying history, we identify three periods that characterize our industry: pre-modern, modern, and post-modern.

The first, pre-modern era is a rather long period which started in 1774 and ended around the late 1950s. As with many innovations, it is debatable exactly when the first mutual fund in history was introduced. In the 1770s, investment vehicles with all the characteristics of a mutual fund were created in what was the global financial center of the 18th century, Amsterdam.

The first mutual fund: surprisingly modern objectives

We will take a closer look at a financial innovator and probably the first value manager in the world. Abraham van Ketwich owned one of the many brokerage offices in the city. Many of his clients invested in the English East India Company and lost a great amount of money. The prospects of this company were greatly exaggerated, leading to a stock market crash and credit crunch in Amsterdam and London in 1772/1773.

Van Ketwich came up with the idea of offering a diversified fund of bonds that would mitigate the investment risk for small investors. He named his fund Eendragt Maakt Magt (unity makes strength). The prospectus of the fund, called a Negotiatie, clearly outlined the investment strategy:
  • The fund would consist of several share classes and would invest in ten different categories of securities, 50 in total, which were all listed in the prospectus. The categories included government bonds from Russia, Sweden and Denmark, as well as bonds securitizing Danish and Spanish toll revenues, but the fund focused mainly on Caribbean plantation loans, the predecessors of mortgage-backed securities.
  • Dutch government bonds were not included, as their perceived low risk was felt not to require diversification. Equity investments were deemed to be too risky and were excluded from the investment universe.
  • The fund wasn’t supposed to trade much – something which was safeguarded by a strict separation between the investment manager and the broker, Van Ketwich, who handled the trades.
  • The starting point was to equally weight the investments to ensure the benefits of diversification.
  • The fund would pay an annual dividend of 4%.
  • The fund would be terminated after 25 years.
Later on, Ketwich introduced two other funds. Neither of the three funds were a big success though. Ketwich was too early and his investment funds suffered serious headwinds. A few years after the launch of these funds, the Fourth Anglo-Dutch War broke out in 1780. Investors’ sentiment deteriorated and the Caribbean plantation loans suffered as colonial goods could not be shipped back to Holland. In 1795, the situation worsened as the Dutch Republic went to war with France and as a result the Dutch Caribbean colonies were confiscated by the British. The Dutch economic hegemony, already in decline, was now over; London took over from Amsterdam as the financial center of the world.

Eendragt maakt Magt was eventually liquidated in 1824. The other two funds did not fare much better. Van Ketwich’s idea of a diversified investment vehicle for the small investor was brilliant, but his timing was unfortunate given the unforeseen macroeconomic events in the years after his funds were launched. As investors know: timing is everything. You need to be patient in life and when investing, but history shows that in the case of Abraham van Ketwich, even a century is sometimes not long enough…

The objectives of the first funds look surprisingly relevant for investors today. Then too, the focus was on classical investment objectives that benefit clients such as stable returns, high income and low turnover.

The modern period: focus on outperformance

The second investment era, the modern period, starts in the swinging sixties, when the first modern mutual funds as we know them today started to appear. Not only did the industry grow rapidly, the investment focus also shifted from conservatism to outperformance and we saw the rise of ‘star managers’. We consider this to focus on relative performance to be a root cause of the low-risk anomaly.

At the same time, influential capital-market models were developed by academics, leading to the rise of market-weighted indices which became common benchmarks. These developments were all supported by the increase in computational power. Early attempts to build a low-beta fund in the 1970s were unsuccessful.

Post-modern times: the rise of quantitative investing

In the third, post-modern period, starting in the late 1990s, the industry witnessed the rapid rise of evidence-based investing. The simplest rules-based funds just tracked market indices and offered diversification at very low cost. However, academics also started to acknowledge that market indices are not efficient. Based on these insights, new rules-based funds started to target factors such as low-volatility, value and momentum, to achieve a better risk-return profile.

This period is characterized by the co-existence of a range of investment philosophies offered in different fund structures. Three important trends have been heavily impacting the industry: the breakthrough of index-tracking funds; the rise of quantitative funds; and the increase in low-risk funds.

Respect age-old investment virtues

As portfolio managers of Conservative Equities we look at Abraham van Ketwich with a combination of admiration and envy – the former for his financial innovations, the latter because he had no peer group pressure or benchmark to beat. Above all, his story also keeps us humble. His fund, brilliant as it was, eventually did not succeed. We appreciate his focus on the original virtues of mutual fund investing: capital protection, income and low turnover. In an industry obsessed with short-term relative performance and high turnover, we want to preserve, promote and live these age-old investment virtues.
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