Money Market Funds
Operations and Technology
Across the Universe: Seeing the Whole Picture in the Systemic Risk Debate
By Paul Schott Stevens
July 30, 2014
Astrophysicists have discovered that they can’t account for the composition and behavior of the universe without including “dark matter”—matter that can’t be observed directly. New calculations show that only around 15 percent of the matter in the cosmos can be observed through today’s telescopes or other electromagnetic instruments.
There’s a parallel situation in finance. One segment of the financial universe—also around 15 percent—is more easily observed and readily measured than the rest of it, and thus tends to draw more attention. It’s sometimes even viewed as an indicator for the capital markets as a whole.
This observable financial “matter” is the regulated fund industry—U.S. mutual funds, exchange-traded funds, closed-end funds, and unit investment trusts, as well as similar funds offered in other jurisdictions. It’s not that the rest of the financial universe can’t be observed; it’s just that these other players are harder to measure and thus often overlooked, despite their dominant role in markets. Even regulators have exhibited this tendency—as seen in the Financial Stability Board’s consultation on investment funds, which effectively singled out 14 U.S.-regulated funds as the focus of systemic risk discussion in asset management.
A Small Share of Assets, a Smaller Share of Trading
Globally, long-term mutual funds held just 14.5 percent of the market value of stocks and bonds at year-end 2012, a share that hasn’t varied significantly since 2005 (Figure 1). The other 85 percent is held by mostly institutional entities—including central banks, sovereign wealth funds, endowments and trusts, defined benefit pension plans, banks, insurance companies, hedge funds, and broker-dealers—as well as some retail investors with individual stocks and bonds.
Long-Term Mutual Fund Share of Worldwide Stock and Bond Markets
Trillions of U.S. dollars; year-end, 2005–2012
1Worldwide mutual fund total net assets include open-end fund assets, and for non-U.S. countries may also include exchange-traded fund (ETF) assets.
Note: Funds of funds are not included except for France, Italy, and Luxembourg.
Sources: International Investment Funds Association and International Monetary Fund
What about the markets in the United States? The story holds true there as well—as Figure 2 shows, U.S. domestic equity mutual funds (U.S.-registered mutual funds that invest primarily in U.S. equities) held 23.8 percent of U.S. stock market capitalization at year-end 2013, and U.S. bond mutual funds held just 8.8 percent of all outstanding U.S. debt securities.
U.S. Mutual Fund Share of U.S. Stock and Bond Markets
Trillions of U.S. dollars; year-end, 2005–2013
1Domestic equity mutual fund total net assets include assets of U.S.-registered open-end mutual funds whose investment objectives are to invest primarily in U.S. equities.
2Bond mutual fund total net assets include assets of U.S.-registered open-end mutual funds whose investment objectives are to invest primarily in debt securities.
Note: Data exclude assets in ETFs and money market funds. Components may not add to the totals because of rounding.
Sources: Investment Company Institute, Federal Reserve Board, and World Federation of Exchanges
If mutual funds’ share of assets in U.S. capital markets is not particularly large, their share of trading volume is even smaller (Figure 3). U.S. domestic equity mutual funds accounted for only 10.4 percent of trading in the U.S. stock market in 2013, while U.S. mutual funds made up an estimated 5.6 percent of trading in the U.S. bond market.
U.S. Mutual Fund Share of U.S. Stock and Bond Market Trading
Trillions of U.S. dollars; annual, 2005–2013
1U.S. domestic equity mutual fund trades include gross portfolio purchases and sales of common stock by U.S.-registered open-end mutual funds whose investment objectives are to invest primarily in U.S. equities.
2U.S. long-term mutual fund trades include gross portfolio purchases and sales of debt securities.
3Transactions with counterparties other than inter-dealer brokers.
Note: Data exclude portfolio purchases and sales of ETFs and money market funds. Components may not add to the totals because of rounding.
Sources: Investment Company Institute, Federal Reserve Board of New York, and World Federation of Exchanges
Beyond Mutual Funds—and into the Dark Matter
Scientists have grudgingly accepted the concept of dark matter (and similarly unobservable dark energy) because they can’t explain the development and movements of stars and galaxies without it. Similarly, it’s impossible to understand the functioning and risks of capital markets without looking beyond the easily observed regulated fund sector and considering the players who account for the vast majority of holdings and trading. Focusing primarily on mutual funds would be akin to looking for lost car keys under a streetlight simply because “the light is better there.”
There’s a better approach that recognizes the role played by all capital markets participants, lighted and dark. Regulators charged with reducing systemic risk should take an activity-based approach—focusing on activities and practices that occur across the entire universe of financial markets—rather than singling out particular sectors or firms for designation as “systemically important.” Under an activity-based approach, regulators address any risks that they perceive with solutions that apply to all players in the markets and that relate directly to the identified activities.
For activities involving the capital markets, regulators with relevant experience and expertise—such as the U.S. Securities and Exchange Commission (SEC)—should drive the process, identifying issues and considering appropriate solutions. Under this process, regulators would adhere to standard rulemaking procedures, including public meetings (with advance notice and reporting after), opportunities for the public to comment on proposals, and requirements to apply rigorous cost-benefit analysis.
Regulators’ rulemaking authority was substantial before the financial crisis, and was further strengthened by the Dodd-Frank Act. SEC Chair Mary Jo White confirmed at an April 2014 congressional hearing that the commission has all the authority it needs to regulate the asset management industry adequately. Supervision of asset managers by banking regulators—whose approach is to address concerns about capital markets through bank-like regulations—is neither necessary nor constructive.
Just One Part of the Markets
U.S. mutual funds are highly transparent and easy to track because of regulatory disclosure and because a number of organizations—including ICI—gather and publish data on fund assets, flows, portfolio holdings, returns, and much more. These funds have opened up the capital markets for more than 95 million Americans and created an investment culture that lets workers and savers reap the benefits of owning shares in businesses across the world. But the downside to success and transparency may be attention out of proportion to potential risks.
Capital markets have long played a critical role in helping economies grow. Numerous types of players—and innumerable types of activities—have a place in these markets, and mutual funds are just one type. Any search for systemic risk must take that diversity into account.
Paul Schott Stevens has served as president and CEO of the Investment Company Institute since 2004.
Industry Leaders Address Evolving Industry Challenges and Opportunities
By Miriam Bridges
June 9, 2014
In conversations exploring outcome-oriented investing, the globalization of the fund industry, and the next generation of retirement plans, industry leaders offered their perspectives on serving investors in an evolving world during several insightful sessions at ICI’s annual General Membership Meeting, held in Washington May 20–22.
Now Off the Hill, Senator Snowe Still Brimming with Ideas, Advice
By Rob Elson
June 5, 2014
U.S. policy is ripe for reform in a number of key areas, but changes to ease the polarized political environment must come first, former U.S. senator Olympia Snowe (R-ME) told the crowd during the final session of ICI’s 56th annual General Membership Meeting (GMM), held May 20–22 in Washington, DC.
Industry Leaders Reflect on Serving Investors in an Evolving World
By Tina Kilroy
June 4, 2014
Speaking on the Leadership Panel held Wednesday, May 21, at ICI’s General Membership Meeting (GMM), fund industry leaders agreed that challenges as well as opportunities abound for their businesses in today’s complex world.
SEC Chair White Stresses Need for FSOC to Consult Sources for Necessary Expertise
By Rachel McTague
May 22, 2014
Securities and Exchange Commission (SEC) Chair Mary Jo White today called for the U.S. Financial Stability Oversight Council (FSOC) to use outside expertise to the degree necessary in its process of designating systemically important financial institutions (SIFIs). She asserted that it is “enormously important for FSOC, before it makes any decision of any kind, to make sure it has the necessary expertise on any of those issues.”
GMM Policy Forum: BlackRock’s Larry Fink Speaks with ICI’s Paul Stevens
By Todd Bernhardt
May 21, 2014
The fund industry needs to stop focusing on the moment and start focusing on outcomes when advising investors on their resources, said Laurence D. Fink, chairman and CEO of BlackRock, at ICI’s Annual Policy Forum, part of the Institute’s 56th General Membership Meeting (GMM).
America’s Retirement System Is Strong
By Sarah Holden
December 18, 2013
One year ago, ICI released its landmark study, The Success of the U.S. Retirement System, a compilation of research from a wide range of sources, which found that the country’s retirement system is fostering economic security in retirement for Americans across all income levels.
ICI’s Guide to Avoiding a Common 401(k) Tax Trap
By Mike McNamee
December 9, 2013
A tax trap for retirement savings is catching many smart people unaware. If allowed to go unchecked, it could harm the retirement savings of millions of Americans. A columnist for the Washington Post was just the latest in a long list of victims.
Revenue Estimates of Restricting Tax Deferral: It Ain’t Necessarily So
By Peter Brady
September 20, 2013
Fifth in a series of posts about retirement plans and the policy proposals surrounding them.
In previous Viewpoints posts, I explained that retirement contributions are neither tax deductions nor tax exclusions, but rather are tax deferrals. I also explained why, in my opinion, the two most prominent proposals to restrict qualified deferred compensation are flawed (post three and post four).
Tax Reforms Should Not Favor DB Plans over DC Plans
By Peter Brady
September 19, 2013
Fourth in a series of posts about retirement plans and the policy proposals surrounding them.
In The Tax Benefits and Revenue Costs of Tax Deferral and in two previous Viewpoints posts (post one and post two), I explained the benefits that workers get from deferring tax on compensation set aside for retirement.
A ‘Modest’ Proposal That Isn’t: Limiting the Up-Front Benefits of Retirement Contributions
By Peter Brady
September 18, 2013
Third in a series of posts about retirement plans and the policy proposals surrounding them.
Marginal Tax Rates and the Benefits of Tax Deferral
By Peter Brady
September 17, 2013
Second in a series of posts about retirement plans and the policy proposals surrounding them.
In a previous Viewpoints post, I discussed the difference between tax deferral—the tax treatment applied to retirement savings—and tax deductions and exclusions, such as the mortgage interest deduction or the exclusion of employer-paid health insurance premiums from income. The difference is often overlooked or misunderstood, leading to inaccurate analysis and harmful policy proposals.
Retirement Plan Contributions Are Tax-Deferred—Not Tax-Free
By Peter Brady
September 16, 2013
First in a series of posts about retirement plans and the policy proposals surrounding them.
In today’s fiscal and political climate, taxes are never far from politicians’ minds. Whether to achieve comprehensive tax reform or to raise revenue to meet budget deficits, members of Congress are now considering changes to a range of tax code provisions—including those governing retirement policy. Any comprehensive effort to address fiscal policy or tax reform should examine every option, but some discussions of retirement policy have been misguided. The tax treatment of retirement savings—tax deferral— too often has been lumped together with tax deductions (such as the deduction from income of mortgage interest expense) and tax exclusions (such as the exclusion from income of employer-provided health insurance premiums).