Latin American Capital Markets

INSTITUTIONAL INVESTORS AND CAPITAL MARKET DEVELOPMENT 133Box 5-2 I Growth of the Institutional Investor in the United States/ 900-40. Equities play a minor role in corporate financing. Few pension plans exist, and thosethat do invest primarily in unmarketable "book reserves" of sponsoring corporations. In the1920s, restrictions against corporations owning stock of other corporations are lifted, and thetransfer of funds from individuals to institutions begins.The modern mutual fund is created to providesmall investors access to the period's boom market, and pension funds begin to invest inequities and government bonds. Institutional equity holdings remain insignificant and contributelittle to market liquidity due to the lack of new issues and institutional buy-and-hold policies(U.S. SEC 1971)./ 940-70. Institutions become a major force in U.S. markets, as young, less wealthy individualsfavor life insurance and pension fund investments. Savers become more yield conscious and movecash out of bank accounts and away from conservative, long-term investments and into mutualfunds. Pension funds hold the majority of institutionally held equity, decreasing investments in governmentbonds, but continuing to trade infrequently, avoid private placements, and concentrateholdings in large, well-known NYSE-listed stocks. Insurance companies, limited to investments inbonds, mortgages, and other fixed-income assets by state law, develop separate accounts free ofstate restrictions and begin to increase their equity holdings (U.S. SEC 1971)./ 970-90. Pension funds and mutual funds reach new heights, while individual direct stock holdingsfall (relatively). Rising interest rates and a rising stock market lead corporations to issue moreequity. Money market mutual funds explode as interest rates rise while payments on bank depositsremain capped by regulation. Index funds first appear as the growing stock market outpacesactively invested fund returns. Institutions increase their use of derivatives products suchas index options and futures.Through relaxed investment restrictions, pension funds increase financingof smaller riskier ventures through high-yield securities, venture funds, and private equityfunding. Institutions continue to hold large, primarily well-known equities, leaving financing of newand small enterprises unfulfilled (U.S. SEC 1992; Gremillion 2000; ICI 2001)./ 990-200 /. Mutual fund assets increase sevenfold, reaching $7 trillion. Mutual fund growth is dueto investment by households attracted by equity funds' high returns and relatively low minimuminvestment. Mutual funds also become an important component of household retirement accounts.Investment by other institutional investors, particularly retirement plans, and fund performancealso contribute to mutual fund asset growth. International funds, increased business use ofmoney market funds for cash management, and the growing importance of defined-contributionpension plans also contribute to overall mutual fund demand (ICI 2001).pelled to evaluate the sufficiency of their pension resources. In the United States, thedemand for private pension plans first occurred when families could not meet theneeds of older people who had suddenly fallen into poverty during the Great Depression(Munnell 1982). Beginning in the 1970s, an aging population coupled with decreasing birth rates strained the social security system, and the demand for privatepension investments increased. In other OECD countries, aging populations haveCopyright © by the Inter-American Development Bank. All rights reserved.For more information visit our website: www.iadb.org/pub