Investment Management

Each branch of the investment management industry began at different points in history in response to economic opportunities or needs. Most are fairly young financial fields that emerged within the last century.

Hedge Fund Sector

The hedge fund sector, as we know it today, began in 1949 when Alfred Winslow Jones, a journalist and sociologist, founded one of the first hedge funds. Jones was researching a story on stock-market forecasting when he became fascinated by the process and started his own hedge fund. According to Hedge Funds and Managed Futures: Performances, Risks, Strategies, and Uses in Investment Portfolios, Jones was “the first to use short selling, leverage, and incentive fees in combination,” which generated better-than-average investment returns. In 1967, the term “hedge fund” was coined by a writer for Fortune who profiled Jones’s financial success. The financial industry was impressed by Jones’s achievements and began to create hedge funds. Within a few years of the article’s publication, the number of hedge funds grew from a handful to more than 100. Today, there are about 10,000 hedge funds in the world.

Mutual Fund Sector

The first mutual fund was started in 1774 in Holland by a Dutch merchant and broker named Adriaan van Ketwich, according to K. Geert Rouwenhorst in the Origins of Mutual Funds. He reports that van Ketwich “invited subscriptions from investors to form a trust…to provide opportunity to diversify for small investors with limited means.” Another early mutual fund was the Foreign and Colonial Government Trust, which was founded in England in 1868. It is now known as the Foreign and Colonial Investment Trust.

A form of mutual funds was first introduced in the United States in the 1880s and 1890s, but mutual funds did not become popular until the 1920s. The Massachusetts Investors Trust was introduced in Boston in 1924. It was the first mutual, or “open ended” fund in the United States. (An open-ended mutual fund is one that allows investors to sell back their shares to the fund at the end of each business day.) According to the 2012 Investment Company Fact Book, the trust “introduced important innovations to the investment company concept by establishing a simplified capital structure, continuous offering of shares, the ability to redeem shares rather than hold them until dissolution of the fund, and a set of clear investment restrictions and policies.”

The mutual fund sector grew slowly—especially in the wake of the stock-market crash of 1929, which caused the public to lose confidence in the financial sector. Government regulation of the industry—specifically the Securities Act of 1933 and the Investment Company Act of 1940—renewed investor confidence. In the 1950s, mutual funds began to grow in popularity. The total number of funds surpassed 100, and there were more than one million shareholder accounts. By 1990, mutual funds had become very popular investment options, with shareholder assets topping $1 trillion. By the end of 2011, mutual fund firms managed $17.1 trillion in assets for more than 98 million U.S. investors.

Private-Equity Sector

We can get an idea of the history of private equity by examining the leveraged buyout, one of the principal acquisition techniques of private-equity firms. In a leveraged buyout, a private-equity firm that is interested in acquiring a company does not put up the entire purchase price with its own money; it also takes out bank loans and raises capital from investors. This spreads out the risk and increases the chances of profitability after the acquisition is completed. The Center for Economic and Policy Research reports that the earliest use of a leveraged buyout, to take a publicly traded company private, occurred in 1933, when managers at United Parcel Service (UPS) purchased all of the company’s shares and turned UPS into a private company.

The era of large leveraged buyouts began in 1979 when the private-equity firm Kohlberg Kravis Roberts & Co. bought out the Houdaille Corporation, a Fortune 500 conglomerate. The deal was a major success for shareholders and prompted a decade of massive buyouts of publicly traded companies. Financial malfeasance at some private-equity firms and increased government regulation eventually slowed growth in the private-industry sector. The industry began to bounce back in the late 1990s. In 2011, private-equity and venture capital funds had approximately $2 trillion in capital worldwide, according to Wharton Private Equity, up from about $8 billion in 1991.

Venture Capital Sector

Individuals and companies have provided funding to companies for centuries. For example, the Ford Motor Company was partially financed by Alexander Malcolmson (a coal dealer who was an acquaintance of Henry Ford), Pan American Airways was partially financed by the wealthy Vanderbilt family, and Eastern Airlines was partially funded by the Rockefellers.

The venture capital (VC) sector as we know it today began in 1946 when Georges Doriot (who is considered the “father of venture capital”) and others started American Research and Development Corporation, the first publicly owned venture capital firm. Arguably its best investment was the $70,000 it spent in 1957 to help fund Digital Equipment Corporation; eleven years later, that investment was valued at more than $355 million after the company’s initial public offering.

The VC sector grew rapidly in the 1970s and early 1980s until the market for initial public offerings slowed; the stock-market crash of 1987 also put a damper on activity in the sector. VC firms experienced strong growth from 1995 through 2000 as a result of the Internet and technology boom.

Laws and Regulations

Investment management companies in the United States are increasingly being regulated and supervised—especially in the wake of financial scandals in the last 15 years and the U.S. financial crash of 2008–2009. The rules of the modern financial industry can be traced back to the early 20th century. Since that time the government has passed a series of laws to establish, expand, and later regulations that control the rules of investing. Key laws include the Securities Act of 1933, Securities Exchange Act of 1934, Trust Indenture Act of 1939, Investment Company Act of 1940, the Investment Advisers Act of 1940, the Small Business Investment Act of 1958, the Hart-Scott-Rodino Antitrust Improvements Act of 1976, Sarbanes-Oxley Act of 2002, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Many of these laws were passed in response to specific financial crises or scandals. To monitor the financial industry and enforce these regulations a number of regulatory/supervisory agencies have been established in the United States. These include the Federal Reserve, Department of the Treasury, Securities and Exchange Commission, Commodity Futures Trading Commission, National Futures Association, Comptroller of the Currency, Financial Stability Oversight Council, and the Federal Deposit Insurance Corporation.

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