Financial History 141 Spring 2022 - Page 33

Concordia Res Parvae Crescunt certificate , dated 1893 . Introduced in 1779 by Amsterdam broker Abraham van Ketwich , it was one of the world ’ s earliest mutual funds .
could be purchased below their intrinsic value … of which one has every reason to expect an important benefit .” This strategy sounds much like today ’ s value investing , pioneered by Ben Graham and his most famous disciple , Warren Buffett .
While these types of investment trusts or closed-end mutual funds eventually spread outside of the Netherlands , first to London in 1868 and then to the United States in the 1890s , a new investment concept eventually developed . In 1924 , Massachusetts Investors Trust became the first US open-end mutual fund . Such open-end funds allowed for the continuous issuance or redemption of shares at a fair price to the underlying securities . Coincidentally , it was a Fortune magazine article a quarter century later featuring the Massachusetts Investors Trust that caught the eye of a young Princeton undergrad , Jack Bogle , who was to revolutionize the mutual fund industry by founding The Vanguard Group and creating the first index mutual fund .
The investment theories of the 1930s were surprisingly sophisticated , even from a contemporary perspective , and included such ideas as net present value , the dividend discount model , arbitrage pricing and a precursor to the famous Modigliani-Miller theorems on the irrelevance of capital structure . None was more sophisticated or ambitious than Keynes ’ s The General Theory of Employment , Interest and Money , which attempted to integrate investment theory with macroeconomic policy and subsequently served as the user manual for most central banks until the late 20th century . However , even Keynes had to punt when it came to describing the behavior of financial markets : he likened the stock market to beauty contests and attributed price fluctuations to “ animal spirits .”
Keynes performed exceptionally well managing his Cambridge College endowment , but none of his investment strategies made it into any of his writings . Give people a fish , and you feed them for a day ; teach people to fish , and you feed them for a lifetime . Keynes provided Cambridge with many fish , but when he died in 1946 , he took his rod and reel with him . This state of affairs changed permanently in 1952 .
The art of investing turned into a science with the seminal publication of Harry Markowitz ’ s Portfolio Selection in 1952 . Markowitz created an investing framework that showed how the correlation of stock returns drove the overall riskiness of a portfolio , and showed how diversification could improve an investor ’ s reward-to-risk ratio . Modern Portfolio Theory , or MPT , has just surpassed its 70th anniversary , and Markowitz ’ s efficient frontier analysis — finding assets with the least amount of risk for a given level of expected return — is still the backbone behind the determination of portfolio asset allocation among stocks , bonds and other assets .
Following Markowitz , Bogle put the concept into practice in a low-cost manner . A web of contributors followed these trailblazers . Conceptual advances in investment theory continued with Nobel laureates William Sharpe , Markowitz ’ s student ; Eugene Fama , who brought Markowitz ’ s theories into the classroom at the University of Chicago and coined the phrase “ efficient markets ”; Myron Scholes , Fama ’ s student and co-creator of the famous option pricing model that bears his name ( along with Fischer Black ); Robert Merton , Scholes ’ s colleague at MIT and another co-creator of the option pricing model ; and Robert Shiller , an MIT grad who challenged Fama ’ s notion of efficient markets .
Other pioneers who shaped the way in which we invest include Martin Leibowitz , known as the Bond Guru , who changed the way stodgy bonds were viewed ; Charley Ellis , known as the Wisest Man on Wall Street , founder of the consulting firm Greenwich Associates , and an early proponent of index funds that helped inspire Bogle ; and Jeremy Siegel , The Wizard of Wharton , best-selling author of Stocks for the Long Run and lifelong friend and classmate of Shiller . The pursuit of the “ perfect portfolio ” continues , building on a rich investment history .
Andrew Lo is the Charles E . and Susan T . Harris Professor of Finance at the MIT Sloan School of Management and the author of many academic articles in finance and financial economics . Stephen Foerster is a Professor of Finance at the Ivey Business School at Western University . He has published over 50 articles in journals such as Journal of Financial Economics , the Journal of Finance and Financial Analysts Journal . This article has been adapted from their book , In Pursuit of the Perfect Portfolio : The Stories , Voices , and Key Insights of the Pioneers Who Shaped the Way We Invest ( Princeton University Press , 2021 ).
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