One hundred years following the establishment of the inaugural open-ended equity fund, modern actively managed mutual funds appear to grapple with an ambiguous future.
Between early 2021 and late 2023, investors extracted over $1 trillion from active funds, as reported by the fund research organisation Morningstar. Concurrently, more than $2 billion was allocated to ETFs and other passive vehicles. A solitary positive note was observed in February when a net $13 billion flowed into active mutual funds, marking the first net inflow in two years. Nonetheless, the prospects for active funds are more promising than recent developments might suggest.
Open-end Fund
The Massachusetts Investors Trust, initiated on 21 March 1924 by Edward Leffler, was the first mutual fund in the contemporary sense. Initially, Leffler traded stocks but predominantly earned his income through door-to-door sales of aluminium cookware. The Massachusetts Investors Trust was dedicated to investing in shares, unlike the then prevalent closed-end funds, which issued a fixed number of units. The units of the Massachusetts Investors Trust were traded on the US stock exchange, often deviating significantly from the net asset value, with private investors frequently forced to sell at a considerable discount due to the lack of liquidity and transparency.
The innovation introduced by Leffler was the ability to issue or redeem shares based on market demand, thus creating an ‘open-ended’ fund structure where investors could trade units at the portfolio’s intrinsic value.
Mutual funds have gained significant popularity in the United States, with over half of US households utilising them to accumulate wealth for retirement provisions or home purchases, thanks to their ability to efficiently diversify across various stocks, bonds, or other instruments.
Eendragt Maakt Magt
However, the Massachusetts Investors Trust is not the pioneer mutual fund; that accolade belongs to Eendragt Maakt Magt. Founded in 1774 by the Amsterdam merchant Abraham van Ketwich, this closed-end fund aimed to diversify risk by investing in bonds from various nations and plantation loans in Central and South America. This fund is arguably the world’s first absolute return bond fund, having raised capital through the issuance of 2,000 shares, each valued at 500 guilders.
Eendragt Maakt Magt provided a fixed annual return of 4 per cent, marginally below the prevailing nominal interest rates, with the surplus used to create a buffer against potential defaults. Additionally, some units were annually redeemed at a 10 per cent premium, and dividends on other units were slightly increased, with the intention of winding up the fund after 25 years.
Management costs and portfolio changes
In recent years, the preference has shifted increasingly towards ETFs, primarily due to actively managed mutual funds consistently trailing behind benchmark returns. Research by S&P Global indicates that over the past decade, 87.4 per cent of funds with the S&P 500 as their benchmark and 92.3 per cent of funds investing in European equities have underperformed their respective indices. The disparity in returns is largely attributed to the higher costs incurred by active mutual funds, which diminish net returns, whereas ETFs are cheaper due to reduced management requirements.
This shift has driven two principal changes in the fund landscape. Firstly, the management costs of actively managed equity funds have decreased by 58 per cent over the past 26 years, as reported by market researcher ICI. Secondly, many active funds are now opting for a distinctive, concentrated portfolio approach, featuring fewer positions to enhance their market performance relative to averages. For instance, Robeco Sustainable Global Stars Equities, the oldest open-end equity fund in the Benelux, now operates with just 40-50 shares.
Moreover, the first closed-end equity fund, introduced in Belgium in 1836 by Société Générale under the complex name Société des Capitalistes Réunis dans un But de Mutualité Industrielle, was not commercially successful and was liquidated in 1873.
Unity makes small business grow
Despite its historical significance, the Massachusetts Investors Trust, still actively traded on Wall Street under the ticker MITTX, does not hold the record for the longest-lasting mutual fund. That title is held by Concordia Res Parvae Crescunt, founded in 1779 by Abraham van Ketwich. This fund, whose name means “Unity makes small businesses grow”, operated until 1893, when the last shareholders received 430.55 guilders per share, against a nominal value of 500 guilders.
The first investment fund in Luxembourg was launched in 1959. Various references are made to the fonds commun de placement FCP Eurunion as being the first Luxembourg fund, offering investments in companies of the six European Community countries. According the the Belgian Revue de la Banque publication, the fund was inspired by 1957 Belgian legislation and was also listed on the Brussels stock exchange. It was backed by Caisse d’Epargne, a group of French savings banks.
FCP Eurunion was broadly inspired by English trusts that gained popularity during the 1940s and 1950s. FCP Eurunion was built around three components. It included a depositary bank that was responsible for keeping the securities in safe custody and for overseeing their management. A management company was responsible for managing and building up the portfolio. And finally, the unitholders as the joint owners of the portfolio.
The early Luxembourg funds included an innovation over the English trust model, according to a 2009 book titled ‘Collective Investment Schemes in Luxembourg’ by Arendt & Medernach partners Claude Kremer and Isabelle Lebbe. The grand duchy added an additional step that allowed companies to repurchase their shares indirectly from their shareholders, using a ‘repurchasing company’. This offered investors an opportunity that the English investment companies were not able to provide.
By 1964, the number of Luxembourg funds had risen to nine, according to Revue de la Banque. The total “inventory value” of their portfolios could be estimated at over six billion Luxembourg francs (about 150 million euro in today’s terms). “However, caution must be exercised not to draw hasty conclusions about the scope and volume of securities savings in the Grand Duchy of Luxembourg,” wrote the Revue de la Banque in 1963. “In fact, these are invariably international mutual funds, which, despite being domiciled within the walls of the ancient city of Luxembourg, conduct their main activities on foreign financial markets and each is sponsored by a series of powerful banking groups representing the major financial centers of Europe, or even the world.”
The archive of the Dutch financial daily FD includes one reference to the Eurunion fund, highlighting net assets of about 814 million Luxembourg francs (about 20 million euro) per 30 September 1985, the end of its fiscal year. The fund at that time was managed by Banque Brussels Lambert, acquired in 1998 by ING Group.