A History of Investment Vehicles From 1774-2023 with Jamie Catherwood (EP.94)

0:28We all need to make smart decisions with our money. Asset Management, as well as the author of financial history blog, Investor Amnesia, which I think of as a one-stop shop for all things financial history. Jamie also puts out a weekly newsletter filled with financial history literature, stories of human psychology, and bubbles of the past. And the reason I'm such a fan of Jamie's work is that he provides key insights and lessons from our past to help investors avoid repeating the same mistakes. Now, given the breadth and depth of his knowledge, this conversation could have gone in all sorts of different directions, but I invited Jamie on the show specifically to talk about the importance of understanding financial history and take a deep dive into the history of investment vehicles going all the way back to 1774.

1:16As always, you can find links to resources discussed at thelongterminvestor.com. And with that, here is my conversation with Jamie Catherwood. Welcome to the Long-Term Investor. Jamie Catherwood is joining me today. Jamie, thanks so much for being here on the show. Thank you so much for having me. Excited to do this. Well, I reached out to you in response to one of your posts for Investor Amnesia, one of the best, if not the only, maybe, you tell me, financial history websites out there. you kind of came exploding onto the scene with a passion for writing about history in general. So I think that's a great place to kick us off.

1:57How did you come to start writing about financial history? That intro is perfect because it captures the very fortuitous circumstances that I started writing in because history is my passion. It's always been since I was a kid. My family on both sides has a lot of either actual historians or everyone's interested in history. So that was always kind of around me growing up. But I was very lucky when I kind of got into the Twitter sphere and financial Twitter in particular, that there was no website dedicated to only financial history. So that was very convenient for me. So I went to school in London in the UK, went to King's College London, did history.

2:42And then I knew I didn't want to go into academia or something like that after graduating. But my dad's philosophy was, if you think you're going to get an MBA, then do something not business related undergrad to kind of round you out. And you don't have to do the same material twice if you're going to do business undergrad and MBA. So right or wrong, that's what I did. I think that it was a great approach. So I did history. And history, I think, is a great subject because people tend to think of history as the same level as high school maybe or like elementary school where it feels like a lot of just remembering names and dates and that's the whole discipline but obviously there's much more than that and the skill set that I think it gives you is very applicable across basically all industries because if you think about what history it is it's just taking sources whether that be primary resources so you're actually like looking at archival documents or secondary sources so classic books like jstor articles etc and then you're just taking all that information pulling out what you think is important and synthesizing that down into a new format usually like an article or something and using all that information to come up with your own argument and try and convince someone else of it so obviously those skills are useful in every industry.

4:04It's just what the inputs are. At O'Shaughnessy Asset Management, a lot of what I do is writing and putting together content. And it's, to me, the same process. It's just different inputs. So instead of reading about the creation of Palestine as a state in the early 1900s under British rule, it's here's what our factor scores for the fourth quarter last year. Like here's what decile shareholder yield is trading at right now. And then taking that information and putting it into an article or white paper that helps communicate our firm's views to clients. And so long-winded way of saying, after I got into Twitter and saw that there were a lot of people posting great content, podcasts, blogs, et cetera, financial history was the subject that seemed most fitting for me.

4:56because it merged my two interests. But I didn't know there was like this huge financial history field when I was in college. I took some economic history courses, but one of them was interesting. It was on the interwar German economy. So like the whole Weimar inflation period, but another was on British economic history since the 1700s. And it was talking about the productive ways to grow corn and stuff like that and how that changed the Sheffield economy. It's like, this is astronomically boring. And so when I graduated though, I thought there's probably some history of finance, interesting characters or whatever.

5:31And I originally planned on it being like a five article series or something, just mainly because I missed writing. I like researching and writing essays and there was no reason to do that anymore after I graduated. And so this provided a reason. And then to my surprise, people were very interested in it because I think history is something that a lot of great investment writers talk about Morgan Housel, Jason Zweig, et cetera. Jason Zweig knows more about financial history than I ever could, but they are not exclusively writing about that. And so it was just very lucky for me that basically like Neil Ferguson was my only competition and there's no competition there.

6:12And so it's kind of like, I'll be the poor man's Neil Ferguson. So it went from writing some articles on Medium to then launching my own website, InvestorAmnesia.com, because we never learn from the past. And then also launching a newsletter, online courses. And that brings us to now. Well, I appreciate all that background. And one of the things that you find in a lot of the investing classic books is some sort of review of history. As your website says, the tagline, We've been here before. What is it that makes a solid understanding of history so important to successful investing? I think it just really helps you.

6:57It's obvious, but I think it's important. It just puts everything in context. When there's a new innovation that is allegedly going to change the world, not to say that every time that happens, It's just like you're some grumpy history nerd saying this failed before. Nothing's ever going to work. But I think it does give you just some perspective when everybody's saying this is going to change everything. Invest now, blah, blah, blah. When you've read about so many manias and crazes and bubbles throughout history and almost always related to some hot new thing that's going to change the world.

7:33I guess you get less swept up by the hype because you've seen similar versions of the same story before. And so I think it helps you not get carried away with the general excitement in the media, other investors, etc. So NFTs, for example, not to say anything about the long term viability of NFTs, I feel like there's probably something there. but when there was that craze during COVID lockdown I was thinking the JPEG rocks that is a situation where you can just think I can think of like four examples of similar things in history and know how that ended and so it's just what are the odds that these insanely high prices are going to only continue rising or what's the odds that these insanely high prices for a JPEG of a rock are going to go down.

8:22And so I think it's helpful with that stuff. And again, just one of the things I actually didn't think about that Jim Chanos talks about in his course at Yale on the history of financial market fraud is that history also teaches you a valuable skill set, which is going to the source material. So again, obviously you'll use secondary sources in a lot of situations but once you get to the real like academic level when those papers are being written they're doing the original archival work and so i think it just helps you become better at determining your own views and coming up with your own thoughts on a topic or situation from the actual source material instead of relying on secondary opinions which i think is very valuable especially for investing you look at the 10k and then come up with your opinions instead of even reading only everyone else's opinions about a company's 10k or whatever.

9:18So I think that's a valuable skill. You mentioned something about not getting swept up in crazes. And I think a lot of times it's common to hear that greed and fear fuel a lot of investor actions in a, what I'll just call throughout a normal cycle, the greed doesn't always show up unless there is a craze And fear mostly shows up when there are downturns, which are pretty regular. And so I think, at least as an advisor myself, I often find myself setting expectations and using history to help prevent fear for when inevitably there are bad times. With greed, you're telling stories, and those stories sound so ridiculous that if I were to share those with each client, they would probably say, well, gosh, yeah, that was obviously nuts.

10:07But you're right. Every time it seems like the world is going to change, gets everybody's all emotions and they don't want to miss out. And I think what a lot of people miss there is that you can have something that changes the world and also have it be a poor investment. Growth and returns just not really absolutely tied at the hip. And so I appreciate you kind of sharing that. And the other thing I think that sometimes I find helpful with history is it just gives you appreciation for where we are today and how good we have it. And a little bit of what prompted me to reach out to you, invite you on the show is when you put together an article, which I'll surely link to in the show notes at the longterminvestor.com, just on the history of investment vehicles and how far we have come.

10:49And so I would love to give you the stage here and walk us through a little bit of how people used to invest and how we have developed to a place of such high customization and individualization over time. before i go into that i just want to say you reminded me before we transitioned i think one of the important things to remember also with history is that we always tend to view ourselves as superior i feel like to people in history and when i say history i mean if you're going back to like the 30s and before not histories in like the 90s that makes me feel too old enough to the 90s well i guess like technically you know anything is history that's not right now or in the future but I feel like we always tend to view ourselves as smarter, which obviously to a certain extent we are, but not even really smarter.

11:40It's just that we have more, we know more. We have more data. Yeah, exactly. And so I don't think it's that we're naturally smarter. So when we look back at these bubbles, it's almost like they were crazy then, but I don't know how this is really applicable today because obviously we would never make that type of mistake. And it's like, you would. Look at the last two years. And so I think that's important for people to remember is not that you would have been one of those idiots, but have an appreciation that it's not a given that you would be so smart to recognize this is a bubble and not some world changing innovation.

12:20because I'm sure in some of the recent ones, every investor has at least contemplated because it's hard just human behavior when you see all these prices going up. And even if you think it's stupid, part of your brain is like, buy it, buy it. You're like, what if it is the next thing? And I get out on this opportunity to become rich and my neighbor is doing it. And the dad at Carpool that I keep seeing is doing it. Yeah, it's tough. But we're working with the same hardware and wetware that we were hundreds of thousands of years ago. And our silly brains just love good stories. Whereas I think the most important thing in a craze is earth-shaking greatest idea doesn't necessarily mean good returns.

13:03Price that you pay matters a ton. And if you pay too much for anything, it's ultimately going to have lackluster results. With crypto, it's a lot easier to say with the FTX blowup. And I think kind of near the back end of the episode, I do want to touch on this a little bit more. but it's easy even with a blow up to say, well, yeah, obviously all that crypto stuff, the NFT stuff was a mess. And I feel like I was pretty regularly publishing on the intellectual side of it and being like, yeah, I don't really recommend this, but if you do it, here's what you should do. I kept hedging my bets because I might've been wrong, but there were things that did seem silly, like buying pictures of rocks or the bored apes.

13:43look my kid just bought a$50 box of baseball cards he pulled a card that is allegedly worth $150 my instinct is well go sell it because who the heck is actually going to buy$150 for this baseball card of a minor league prospect who may or may not pan out and that's one of those things that the money seems real and then once the money's up you're like well no I'm going to hold it because the world is changing so even those who are in by accident yeah yeah yeah when they caught up in it all. That's funny. All right. Well, I promised we wouldn't have a full on crypto conversation here. Let me get back to your question.

14:16We've been publishing some stuff about it and we definitely want to talk a little bit about that at the tail end, but do want to really hone in on some of how we got to these separately managed accounts and the individualization. I should stop talking and just let you run with it. You've done a decorated background of it all. If we're thinking of investment vehicles, I think that it really starts in 1774. So believe it or not, the world's first mutual fund was launched in 1774 by this Dutch broker named Abraham van Ketwich. And it was, to be clear, like a closed-end mutual fund, but still a mutual fund.

14:56The first open mutual fund was 1924. I think that was the Massachusetts its investment trust or whatever. So in 1774, what had happened is the summer before, so 73, the British East India Company, the share price had tanked, catastrophically plummeted in the summer of 73. And the British banks obviously were heavily exposed. I mean, the British East India Company, for anyone who hasn't read much about it, the kind of, I guess, slogan or unofficial description of the East India Company was that it was an empire within an empire because it was essentially ruling India for like a century. And this was a private company with like an office in London.

15:43And I think it had at one point like a larger standing army than many countries. And this is just a private company. It's an insane organization, but because it was kind of like the pride of Britain, investors and banks, the whole kind of system was, even the government was heavily linked to the British East India Company. And by that, their share price and financial success or commercial success rather. And so in the summer of 73, when the share price plummeted, British banks suffered heavily. But also in this time, the Dutch in the 17th and 18th centuries, They were the hub of financial innovation.

16:23The Dutch financial revolution then spread to other countries, but it was really everything started in Amsterdam. First stock exchange, 1609, first IPO, the Dutch East India Company. Everything starts with financial history in Holland. So all of these Dutch banks were also heavily exposed to the price of the British East India Company stock. So when that fell, there were many banks that were either brought to bankruptcy or brought to the verge of bankruptcy. And it really shook the whole Dutch financial system. And one of the lessons was, OK, these banks and investors more broadly were way too exposed to the British East India Company stock price.

17:09and the company in general, they were not diversified at all. They were way too concentrated with their risk exposures. The other problem though, is that for the average investor, it was pretty difficult to diversify because of the cost of buying shares and buying bonds. There were no like fractional trading. You had to buy the whole thing and it cost a lot of money. And so many people couldn't actually diversify. So you ended up in a situation where they might own like only British East India company stock that plummets and then they're screwed. And so this Dutch broker, Abraham Van Ketwich, recognizes this and obviously he's not doing it just completely altruistically.

17:49He realizes there's a business opportunity here, but he does recognize that there is no great way for the retail investor to diversify their portfolio. And so he comes up with this early mutual fund idea. And so I'm not going to attempt the Dutch name, but the name of this fund launched in 1774 translates to the Unity Creates Strength Fund, which is a pretty amazing name for the first mutual fund, especially because the portfolio consisted of like 50 bonds that were all equally weighted. And so Unity Creates Strength, a bunch of equally weighted, pretty good name, pretty good marketing. So again, he packaged a portfolio together and then sold shares of that portfolio to smaller retail investors so that like a mutual fund today, they could buy a share and then get proportional representation of 50 bonds instead of having to, I can't remember what it was, but it was something, it was like 10 ,000 times more expensive to like buy every bond.

18:51that seems high but it was ridiculously high multiple of price compared to buying one share of the fund versus if you tried to replicate everything yourself 10 000 that's way too high that is very high and it was like prohibitively there's no chance anyone could buy all those shares unless they were wealthy and the fund was popular it had some quirks to it which are also interesting so the first is that essentially when you think about it as an equally weighted passive bond fund. That's essentially what it was. It had different categories of bonds. There were some, I don't know, like turnpike bonds, other kind of muniesque investments.

19:29And then there were more traditional corporate bonds, but you had broad range in bond investments in the portfolio. Like today, the fee on this passive bond fund was only 20 basis points, which is pretty crazy because I think that would be compared to like the ag or something a little higher, but overall, that's a pretty damn good expense ratio for a 1700s. Yeah, that's competitive with any given bond fund today. Yeah. I didn't even think, I was thinking of ETFs and you compare to a mutual fund, that's probably right about there. And so that was one interesting component. The other was that it had like a share buyback scheme, which is kind of interesting.

20:08This lottery component, which I think was Van Ketwich catering to human behavior, knowing something about that lottery. Oh, this is more exciting than just owning some turnpike bonds, which is not very sexy. It made it really interesting because essentially this lottery system would choose certain shares. I don't know what the basis was annually or whatever. And Van Ketwich would buy out that person's shares at a preset premium. and so it was like oh you won the lottery you get to get out at a premium and then after that more of the earnings and income from the bonds went to a smaller pool so it benefited them but it's kind of just an interesting little quirk the other interesting angle on this fund was that to avoid over trading and any nefarious actions by the portfolio managers which there were three The managers locked all of the bond certificates into an iron chest with three locks so that if any decision was going to be made, because buying and selling required having the actual paper, all three managers would have to be in agreement because otherwise they couldn't open the lockbox.

21:22So I thought that was a pretty interesting approach to limiting the active decision making because there was the understanding over trading will lead to subpar performance. And so set and forget, offer this low cost fund and let's go get some investors. So that was the first passive bond fund. And five years later, Abraham Van Ketwich reinvents himself as the first value investor. Not the first value investor, but definitely the first value fund offerer. Doesn't flow as nicely. But in 1779, he launches his second fund, which is like Concordia Pass Crescent or something. I don't remember what it translates to.

22:04But in the prospectus, the fund's objective was specifically stated as buying securities below their intrinsic value, for which we have like every reason to expect positive outcomes. But it was explicitly stated we're buying securities under their intrinsic value and going to sell them when they trend above. So pretty impressive. That is certainly the world's first value fund. And same guy, not too shabby. So that was 1779. And then honestly, it was pretty quiet for a while. 1792 is when the Buttonwood Agreement in the U.S. is signed, leading to the creation of Wall Street. And the kind of American market gets underway.

22:54The first crisis is in 1792 because this guy William Dewar in the treasury. He was doing some insider trading, much to the annoyance of Alexander Hamilton. And there was some sketchy things, Bank of United States going public, et cetera. But that was the next big thing in terms of our American markets. But it wasn't until I think 1868 that the first investment trust, the first emerging markets, at least investment trust was launched. and it was launched in London. And the name of the fund was the Foreign and Colonial Government Trust, which actually still exists today. I want to say that Aberdeen owns the fund that traces back.

23:44All I know is that it's like still in operation today under some massive firm's umbrella, but pretty cool. And so this trust was largely possible. Well, it really only was possible because of the technology that had advanced since the mutual fund days, because Van Ketwich's fund was very local. Here's some Dutch and European bonds. We'll package it together and you can invest in this passive fund. Even with the value fund five years later, that was focused very regionally. Whereas in the time between there, a lot changed. Railways, 1820s, 1830s, first railway manias in the 1830s and 40s, you get alongside the expansion of railways, the expansion of telegraph cables and communication technology.

24:33And so as these rail lines are getting laid, there's cables alongside it that's helping communicate messages. But then also, I think in 1844 is when the telegraph cable is laid internationally, I want to say. So suddenly we can relatively easily communicate information from London, New York, other parts of the world, whereas previously you would get the information at such a lag, it was almost impossible to really invest. So that technology enabled foreign and colonial government trust to found an emerging markets focused fund that was not only emerging markets, but international and mainly emerging because it was all the countries within the British empire, hence why it's called the foreign and colonial government trust.

25:25And so it was wildly popular at the time because when yields were low in the UK on console bonds, which is their equivalent of long-term treasuries, British investors could go and invest in this foreign and colonial funds and access the bonds in countries like Chile, which were yielding like 20 % because it was much riskier. so it was a no-brainer there was this whole craze there were many crazes for like emerging market latin american debt in england in the 19th century in the 1820s british investors were so enthusiastic about all these latin american countries that had gained independence from spain so could now be traded with that they just started sending all these goods to latin america regardless of whether it made sense for that market or not.

26:17There was a company in Sheffield that was sending ice skates to like Argentina or like somewhere that doesn't even have any mountains or like cool ranges. And it's just like, I don't think this is it, buddy. I don't think this is your next market. And, but it just kind of captures that craze. Every time one of these regions became online, as it were, because of technology and we could communicate, learn information about it, transmit information easily. People just got so enthusiastic because it was like each time this is like a paradise, this is going to change everything. But so that technology really led to the creation of the first foreign investment trusts, which became wildly popular.

26:58And that trust form evolved over time. And the next major, I'd say innovation, especially with these trusts, I already mentioned the first open mutual fund in 1924. But in the 1920s, there was a movement called the fixed trust movement, which kind of like Van Ket, which is first fund was designed to give investors access to a fund with a fixed list of securities in the prospectus. So that's where the fixed comes from. And that fixed list was essentially just the index. And you could buy shares in that index like you would with the mutual fund or ETF today. What was interesting is that over time, these funds started to have many different iterations.

27:48One of them was called a fixity trust. I don't know why they called it that. But before long, what started as a fixed trust fund would over time kind of evolve into the fund managers would start sprinkling in like a little bit more active decisions to the fund strategy. And then there were even some cases where what would start as a passive fixed trust would then after like five years convert into an actively managed trust with higher fees. And so it's kind of this like terrible system where a firm would say, yeah, come passive index investment. And then a couple of years later, just change it and say, psych, it's actually an active high turnover, active strategy now.

28:32But what was interesting is that after the 29 crash, there was a huge boom in these fixed trusts because there was such a backlash similar to the 2008 crisis, honestly, how you see really passive assets start really exploding after 2008 because people were just so angry at wall street and active management etc after the 29 crash there was a huge boom in popularity for these fixed trusts for the exact same reason there were economist articles talking about fixed trusts being beneficial because they take the human element and active decision making element out of the equation and there's some line That was something like if we're paying investment managers to understand the market and avoid a 29 crash and we're paying them fees to do that and then they have worse performance than the market.

29:24Why are we paying them fees? And so this fixed trust boom is really the first passive investment boom. The trust that had some problems so they obviously didn't stay or we would be using them. But it's still an interesting idea or an interesting period because it's so closely parallels to what happened after 2008. The other interesting thing is that even in the 1920s, people were concerned, as are some investors today, about, I mean, there's so many conspiracies on Twitter about this, but what the potential problems could be where if you have some giant fund managers like Vanguard, State Street, BlackRock, etc., and they own all these companies because they own them through their funds, does that cause problems, etc.?

30:12And there's an Economist article saying the exact same thing in like 1920 something. So it's just interesting. Again, that's a great example of we always think we're smarter than the people in history. But as essentially passive ETFs became introduced, they immediately started asking the same questions that people are saying today about what's going to happen when three providers, they're the top three holders for like every stock in America. And so I found that fascinating. But that was kind of the next big invention. And ironically, one of the companies that was at the heart of supporting this fixed trust movement was the Standard Statistics Company, which, as you might guess, is what became Standard & Poor's S &P, which obviously has a huge indexing business today.

31:07but it's just interesting to see first time around they were also big proponents and recognized the value and there were also some trusts that were essentially smart beta trusts there were trusts that instead of just saying here's the list of securities there would be like sector trusts where it would say come buy an index of british industrial firms and it would give you the list of 15 stocks they were going to buy. And then you knew like this is going to be the 15 we have. What happened was you started having funds that were smart beta or like factor funds where instead of British industrial firms, it would be British publicly listed firms that have a high dividend yield.