Tài chính doanh nghiệp - Lecture 16: Institutional investing

Lecture 16: Institutional InvestingMigration of Capital:Main Street to Wall StreetTrend 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 $BillionsPension funds $10348Corporate equities $7447Equity in noncorporate business $4848Deposits $4456Mutual funds $3274Personal trusts $1124Life insurance $821Corporate & foreign bonds & other $2887Total $35205Private Pension Funds’ Assets2000-III in $BillionsCorporate equities $2451Mutual fund shares $918Assets held at insurance companies (GICs, variable annuities etc.) $506US Government securities $457Corp & foreign bonds $287Other $511Total $5129State & Local Employees’ Retirement Funds 2000-III in $BCorporate equities $1953US government securities $383Corporate & foreign bonds $324Other $324Total $3054Commercial Banks’Assets 2000-III in $billionsLoans $3803US Government Securities $913Vault cash $35Reserves at Federal Reserve $17Corporate equities $12OtherTotal $6344S&Ls’ & Savings Banks’ Assets 2000-III in $billionsMortgages $722US Government securities $148Equities $24Reserves at Federal Reserve $1Other $308Total $1203Credit Unions’ Assets2000-III in $billionsConsumer credit $181Home mortgages $125US Government securities $75Other $54Total $435Mutual FundsCorporate equities $3622US Government securities $393Corporate & foreign bonds $368Municipal securities $228Other $205Total $4816Mutual Fund HistoryIn 1920s, many investment companies bilked small investorsMassachusetts Investment Trust (MIT) in 1920s had only one class of investors, published portfolio, redeemed on demandBecame model for mutual fund industryInvestment Company InstituteStructure of Mutual FundAssets of mutual fund are held in commonPurchases and redemptions are made at prices as of 4pm market close on that dayOther people’s purchases and redemptions affect youRecent Mutual Fund ScandalsLate trading: mutual funds accept orders at 4pm prices even though orders were made after 4pmMarket 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 FundsFirst Exchange Trade Fund: Standard & Poors Depositary Receipts (SPDRs, Spiders), AMEX 1993SPDRs hold portfolio of S&P indexManagement fee: 12 basis pointsAutomatic creation and redemptionQQQs, I-SharesMacro 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 $BillionsMutual funds $418Corporate Equities $358US Government securities $67Money Market $56Other $198Total $1097Trusts Not Always InstitutionalCommon 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 $BillionsCredit market instruments (bonds, corp & gov’t, mortgages, policy loans) $1928Corporate equities $1028Other $44Total $3000Rest of World Assets in US2000-III in $BillionsUS Government securities $1703US corporate equities $1691Foreign & direct investments $1310US Corporate bonds $953Other $1320Total $6977Pension FundsFirst 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 History1875 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 1901First large industrial pension fundAndrew Carnegie: The Gospel of Wealth, Carnegie Institute of Technology, Carnegie Endowment for PeaceBy 1929, 329 industrial firms had pension plans, and these covered 10% of labor force.Pension benefits were not a contractual right.Union Pension FundsPatternmakers 1900Granitecutters & Cigarmakers 1905Locomotive 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 extinctionFailures 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 standardPlans were viewed as incentive for long-term company loyalty, which few achieved.Reflects general slowness for financial innovation. General Motors Pension Plan 1950In labor negotiations, GM Chairman Charles Wilson proposed fully funded plan managed by financial professionals.Proposed investing in the stock market, rather than fixed incomes, but no more than 5% in any one stock. Diversification.Wilson made stunning proposal that funding not be invested in GM stock.Studebaker Pension Default, 1963UAW accused of acquiescing in underfunding of pension plan so that it could obtain a false “victory” in prior negotiations with management.After default, UAW negotiated full benefits for senior workers, little or nothing for others.Scandal led to Employee Retirement Income Security Act (ERISA) 1974.Employment Retirement Income Security Act (ERISA) 1974Act was in response to abuses in earlier defined benefit pensionsProhibits pay-as-you-go pension plans, defined benefit plans must be fully funded.Funds must be adequate:sound actuarial principles.Created Pension Benefits Guarantee Corp.Prudent person standard for managersMinimum vesting standards. An employee for ten years has complete vestingPrudent Person RuleERISA: Investments must be made with “the care, skill prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims.”Problems with Prudent Person RuleLegislates conventional wisdom.Decisions cannot be based on individual judgment.Pension Funds TypesDefined Benefit: Traditional, old-line manufacturing, supported by labor unions. Now in decline. Not usually indexed.Defined Contribution: Employee contributes to own account. 401(k) plans begun in 1981 in US. In defined contribution, individuals choose allocations across broad asset classes.O’Barr & Conley StudyO’Barr & Conley (Fortune & Folly, 1992) “questions [about pension strategy] elicited lengthy narratives about such cultural issues as history, politics, and relationships, but little talk about economics or finance.” (p. 75)Fund executives “rarely rise above their personal perspectives to articulate a corporate vision.” “too busy living through an event to stop and analyze it.” (p. 76) O’Barr & Conley Cont.Creation myths prominent. The great founderDisplacing responsibility. Outside managers used to shift possible blame.Blaming the lawNonprofit OrganizationsNon distribution constraint. Effectively, there are no owners. Tax exempt. Board of trustees appoints own successors.900,000 tax-exempt nonprofits in the US120,000 non-profit charities in the UKMany other countriesNonprofits contribute 4% of US national incomeEconomics of NonprofitsDonations are usually only a minor source of income.Nonprofit hospitals compete alongside for-profit hospitals, look similar.Endowments and FoundationsNot completely tax freeGrantmaking foundations must give away 5% of wealth each year, or else lose tax-exempt status. (Does not apply to operating foundations.)Two-tier excise tax on income, 1% if they maintain or increase giving, 2% otherwise.Fragility & Importance of University EndowmentsYale University and Eagle Bank 1825 Yale lost virtually its entire endowment in this bank.Boston University John Silber and Seragen $90 million in one company, lost 90%.University of Bridgeport & Reverend Sung Myung Moon Unification Church 1992Yale University’s IndependenceYale initially supported by Colony of Connecticut. Yale mostly supported by CT1755 CT refused annual grant to Yale over religious controversy.1792 CT made legislators fellows of Yale Corporation. Elected officials govern Yale1871 CT terminates all support for YaleEndowment Investing Strategy DifferencesEndowments have very long-term focus, so can invest in illiquid assetsNo risk of clients pulling money after poor performanceEndowments can earn liquidity premiumUniversity endowments have higher purpose, can generate loyal support.“Illiquidity’s Attractions” (Swensen)Less info available on illiquid assets, so universities better able to find nuggets.High market cap stocks are too well known. Microsoft mentioned 19,899 times in 1998 in the Wall Street Journal alone.Illiquid investments accord with “value investing,” which is inherently a long-term strategy