A brilliant paper by David Chambers (University of Cambridge) and Rui Esteves (University of Oxford).
We have quite a few papers on so called first era of globalization (1870-1913). Most of them deal with scale of flows, how UK was a capital exporter and US capital importer, easy flow of capital etc.
But this paper talks about this phase of fin glob from a different perspective. How about those financial firms which actively traded in this first era of globalization? This paper throws light on one such financial firm which apparently was the first emerging market investor.
The Foreign and Colonial Investment Trust (FCIT) is the oldest surviving closed end fund in the world today and was established fully half a century before similar funds appeared in the US of the 1920s. Its early success was related to its identification of a missing market, namely, the provision of a wholesale diversified investment vehicle for the investing public. Whilst much research has been conducted on aggregate international capital flows in this First Era of Globalisation, little work has been undertaken on the prime investment institutions.
This micro-study seeks to fill this gap by undertaking detailed quantitative analysis of the leading investment trust investing widely in emerging markets during the First Era of financial globalisation before WWI. The history of this flagship fund over more than three decades provides an insight into the relative success of this institutional innovation as well as into the risk and returns of investing in global emerging markets over a century ago.
The best part of the paper is the methodology. IN a lot of detail it explains how it calculates the returns, compares the returns with other benchmarks etc.
The lesson on investing and managing portfolio remains as eternal as ever. Buy and hold securities, don’t trade excessive and don’t panic. Keep costs as low as possible. Keynes himself was an investor in the fund:
There could be no higher testament to FCIT’s attractions than the fact that this was the only investment trust share which John Maynard Keynes included in the security portfolio he managed for his father before WW1. FCIT stands as a shining example of a highly successful financial innovation.
Its success was based on the idea of providing the average investor with the opportunity to invest in a globally diversified portfolio at an extremely low cost. Back in the late 19th century, when it would be too costly both in time and money for individual investors to try and replicate such a portfolio, this proved to be a highly attractive and convenient solution for the majority of the investment public.
The investment trust structure permitted the FCIT to exploit fully the benefits of a long-term investment horizon and to pursue its buy-and-hold investment approach. This in turn allowed the board to make heavy investments in emerging market bonds and in the American continent in particular, an investment approach which paid off handsomely. The fund’s NAV averaged returns in excess of British Consols and of the global ex-UK benchmark whilst also offering a better risk-return trade-off. The trust’s deferred shares delivered an attractive 6.9% annual return, exceeding its NAV performance thanks to the leverage provided by the issue of preference shares. Whilst the deferred shares consistently traded at a discount to the NAV of the underlying investments, the level of discount was not out of line with what investors a century later experienced and most probably reflected the exposure to illiquid securities in the portfolio.
The benefits of the investment trust structure also manifested themselves in the trading behaviour of FCIT during the two major financial crises of 1890 and 1907. There was little indication of FCIT contributing to any contagion effects. Mauro et al. (2006) suggest that the institutionalisation of investment activity over the 20th century is crucial in helping to explain the greater incidence of emerging markets contagion in the Second Era compared to the First. The implication of this study is that not all investment institutions are the same. The evidence from FCIT suggests that the investment trust or closed end fund model, unlike its close cousin the mutual fund model, is less conducive to contagion effects. This research question, that of the degree to which the FCIT experience was representative of the investment trust industry as a whole, together with a better understanding of the evolution of the closed end fund discount before the 1920s, seem worthy of further study.
Fascinating to read all this..