Lecture 16: Institutional InvestingMigration of Capital: Main Street to Wall StreetFinancial Assets of US Households 2000-III in $BillionsPrivate Pension Funds’ Assets 2000-III in $BillionsState & Local Employees’ Retirement Funds 2000-III in $BCommercial Banks’Assets 2000-III in $billionsS&Ls’ & Savings Banks’ Assets 2000-III in $billionsCredit Unions’ Assets 2000-III in $billionsMutual FundsMutual Fund HistoryStructure of Mutual FundRecent Mutual Fund ScandalsETFs vs. Mutual FundsBank Personal Trusts & Estates Assets 2000-III in $BillionsTrusts Not Always InstitutionalLife Insurance Companies’ Assets 2000-III $BillionsRest of World Assets in US 2000-III in $BillionsPension FundsMilestones in US Pension HistoryCarnegie Steel Pension 1901Union Pension FundsCollapse of Pensions after 1929Why Were Early Pension Plans So Badly Designed?General Motors Pension Plan 1950Studebaker Pension Default, 1963Employment Retirement Income Security Act (ERISA) 1974Prudent Person RuleProblems with Prudent Person RulePension Funds TypesO’Barr & Conley StudyO’Barr & Conley Cont.Nonprofit OrganizationsEconomics of NonprofitsEndowments and FoundationsFragility & Importance of University EndowmentsYale University’s IndependenceEndowment Investing Strategy Differences“Illiquidity’s Attractions” (Swensen)Lecture 16: Institutional InvestingMigration of Capital:Main Street to Wall Street•Trend over decades has been to greater institutional investing, and volume of trade on stock market now dominated by it.•Increasing tendency for institutions to participate in corporate governance, solving the control problem referred to by Berle and Means.•An epic shift of power in our society towards Wall Street.Financial Assets of US Households 2000-III in $Billions•Pension funds $10348•Corporate equities $7447•Equity in noncorporate business $4848•Deposits $4456•Mutual funds $3274•Personal trusts $1124•Life insurance $821•Corporate & foreign bonds & other $2887•Total $35205Private Pension Funds’ Assets2000-III in $Billions•Corporate equities $2451•Mutual fund shares $918•Assets held at insurance companies (GICs, variable annuities etc.) $506•US Government securities $457•Corp & foreign bonds $287•Other $511•Total $5129State & Local Employees’ Retirement Funds 2000-III in $B•Corporate equities $1953•US government securities $383•Corporate & foreign bonds $324•Other $324•Total $3054Commercial Banks’Assets 2000-III in $billions•Loans $3803•US Government Securities $913•Vault cash $35•Reserves at Federal Reserve $17•Corporate equities $12•Other•Total $6344S&Ls’ & Savings Banks’ Assets 2000-III in $billions•Mortgages $722•US Government securities $148•Equities $24•Reserves at Federal Reserve $1•Other $308•Total $1203Credit Unions’ Assets2000-III in $billions•Consumer credit $181•Home mortgages $125•US Government securities $75•Other $54•Total $435Mutual Funds•Corporate equities $3622•US Government securities $393•Corporate & foreign bonds $368•Municipal securities $228•Other $205•Total $4816Mutual Fund History•In 1920s, many investment companies bilked small investors•Massachusetts Investment Trust (MIT) in 1920s had only one class of investors, published portfolio, redeemed on demand•Became model for mutual fund industry•Investment Company InstituteStructure of Mutual Fund•Assets of mutual fund are held in common•Purchases and redemptions are made at prices as of 4pm market close on that day•Other people’s purchases and redemptions affect youRecent Mutual Fund Scandals•Late trading: mutual funds accept orders at 4pm prices even though orders were made after 4pm•Market timing: mutual fund investors wait until almost 4pm to buy in or redeem their shares in foreign funds, such as Japan fund.ETFs vs. Mutual Funds•First Exchange Trade Fund: Standard & Poors Depositary Receipts (SPDRs, Spiders), AMEX 1993•SPDRs hold portfolio of S&P index•Management fee: 12 basis points•Automatic creation and redemption•QQQs, I-Shares•Macro securities are analogous to ETFs, but are based on an index. (AMEX). Macro Securities Research LLC, Macro Financial LLCBank Personal Trusts & EstatesAssets 2000-III in $Billions•Mutual funds $418•Corporate Equities $358•US Government securities $67•Money Market $56•Other $198•Total $1097Trusts Not Always Institutional•Common law countries allow individuals to appoint friends as trustees.•Spendthrift trust increasingly common form of inheritance. Planning for divorces decades hence.Life Insurance Companies’ Assets 2000-III $Billions•Credit market instruments (bonds, corp & gov’t, mortgages, policy loans) $1928•Corporate equities $1028•Other $44•Total $3000Rest of World Assets in US2000-III in $Billions•US Government securities $1703•US corporate equities $1691•Foreign & direct investments $1310•US Corporate bonds $953•Other $1320•Total $6977Pension Funds•First pension funds in world: late 19th Century. •Retirement was not invented until then.•Increase in life expectancy in 20th Century brought large numbers of elderly people for first time in human history.Milestones in US Pension History•1875 American Express Co. (then a shipping co.) establishes first US corporate pension plan: for employees who worked there 20 years, passed age 60, and were disabled, 50% of average of last ten years’ pay. Few employees qualified.Carnegie Steel Pension 1901•First large industrial pension fund•Andrew Carnegie: The Gospel of Wealth, Carnegie Institute of Technology, Carnegie Endowment for Peace•By 1929, 329 industrial firms had pension plans, and these covered 10% of labor force.•Pension benefits were not a contractual right.Union Pension Funds•Patternmakers 1900•Granitecutters & Cigarmakers 1905•Locomotive Engineers 1912 was first to to grant contractual right to pensionCollapse of Pensions after 1929• Plans almost all unfunded, benefits paid out of profits now nonexistent. With Great Depression, benefits were cut sharply. Those funded were often invested in company stock. •Union plans failed disastrously, leading to their near extinction•Failures were impetus to Social Security Act of 1935.Why Were Early Pension Plans So Badly Designed?•Pension benefits not yet perceived as a right or standard•Plans were viewed as incentive for long-term company loyalty, which few achieved.•Reflects