Financial History 143 Fall 2022 - Page 23

about each investment company .
Interest in mutual funds was slow to develop , but the 1950s bull market was the initial impetus for the expansion of the mutual fund business . By the end of 1951 , the total number of mutual funds surpassed 100 , and the number of shareholder accounts exceeded one million for the first time .
By 1954 , net purchases of mutual fund shares exceeded that of corporate stock . It was the perfect moment for the American investor , and fortunately there was some brilliant work being done on investing at the time .
Wall Street Enters the Computer Age
In 1959 , Louis Engel , then vice president of Merrill Lynch , Pierce , Fenner & Smith , funded a study done by Professor James H . Lorie at the University of Chicago . Engel was interested in knowing what the investment performance in the stock market relative to other types of investments had been .
Engel had an obvious motivation : if stocks did outperform other investments , it would be a valuable marketing tool to an investment firm like Merrill Lynch . But no one seemed to know the answer to the question .
This led to the creation of the Center for Research in Security Prices ( CRSP ) in 1960 . Lorie set about gathering the first comprehensive database of the prices , dividends and rates of return of all NYSE stocks since 1926 .
When the initial database was completed in 1964 , it was estimated to contain between two and three million pieces of information . Lorie ’ s database enabled an accurate calculation of how much return an investor was getting from the stock market . From 1926 to 1960 , the rate of return on NYSE listed stocks ( with reinvestment of dividends ), was 9 % per year .
Lorie did not directly answer Engel ’ s initial question about how stocks performed against other investments , but that 9 % figure was high enough for Lorie and his co-author Lawrence Fisher to proclaim : “ These rates are substantially higher than for alternative investment media for which data are available .”
That was good news for Engel , who promptly made the results public and pushed the investing public to put more money into stocks .
Hanna Holborn Gray Special Collections Research Center , University of Chicago Library
Alfred Cowles III , founder and president of the Cowles Commission for Research in Economics .
The Evidence Mounts : Wall Street Can ’ t Pick Stocks
Engel may have liked the absolute returns stocks were generating , but he certainly did not want to hear that this mountain of data was beginning to generate some disturbing implications for Wall Street .
By the mid-1960s , the evidence was mounting that most investors ( and investment professionals ) were , as Cowles had suspected , terrible stock pickers , and that the cost of fees and commissions substantially ate into any profits that were made .
Even mutual funds were coming under fire . In a 1968 paper , Michael C . Jensen at the University of Rochester College of Business evaluated the performance of 115 mutual funds from 1955 to 1964 .
His conclusion : “ The evidence on mutual fund performance discussed above indicates not only that these 115 mutual funds were on average not able to predict security prices well enough to outperform a buy-the-market-and-hold policy , but also that there was very little evidence that any individual fund was able to do significantly better than that which we expected from mere random chance .”
This was a serious problem . It was one thing to say that the public were terrible stock pickers . To a certain extent , this played into Wall Street ’ s hands . Don ’ t know how to pick stocks ? Let a professional pick them for you through a mutual fund .
And yet , there was now growing academic evidence that even mutual funds
Louis Engel , vice president of Merrill Lynch , Pierce , Fenner & Smith . In 1959 , Engel funded a study by University of Chicago Professor James Lorie to evaluate investment performance in the stock market , relative to other types of investments .
weren ’ t able to generate excess returns , once fees and commissions had been deducted .
At the same time , there was even more evidence that investors were better off avoiding stock picking altogether .
Diversification : The Only Free Lunch There Is ?
In 1952 , Harry Markowitz was a Research Associate at the Rand Corporation . As a student at the University of Chicago , he had worked at the Cowles Foundation for Research in Economics . In 1952 , he published a dissertation called Portfolio Selection in which he mathematically demonstrated that diversifying across a large number of stocks reduced risk for investors .
It didn ’ t sound like much , but the implications were revolutionary . Financial Times Global Finance Correspondent Robin Wigglesworth summarized Markowitz ’ s thesis in his book on the history of indexing , Trillions : How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever :
Markowitz suggested that all investors should really care about was how the entire portfolio acted , rather than obsess about each individual security it contained . As long as a stock moved somewhat independently of the others , whatever its other virtues , the overall risk of the portfolio — or at least its volatility — would be
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