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Equity prices in industrial countries have risen strongly in the 1990s, with the increase in Japanese prices being somewhat less pronounced. The US equity market has clearly been the star performer of the 1990s. Although the rise in United States markets since early 1996 has been matched or exceeded by that in other advanced equity markets, US markets have outperformed most other advanced equity markets since the beginning of the decade, in some cases by a factor of two or more. Remarkably, in the period 1992-1996, the Dow Jones Industrial Average doubled in value, while historically the index has doubled every 17 years. Moreover, over the same period, US equity market capitalization increased from 72% of GDP to 107% of GDP. The Japanese market has not performed as strongly as markets in some of the other main industrial countries. Japan's Nikkei 225 index declined 2.5% in 1996. (See International Monetary Fund (IMF), International Capital Markets – Figures on Stock Market Indices, 1990-May 1997 http://www.imf.org)
Markets in ten European countries ended 1996 at all-time highs. Some of the momentum in European equity markets has been attributed to improved prospects for the export sectors in these economies that is associated with the depreciation of most continental European currencies against the dollar. Also favorable has been the trend toward low interest rates, which have an important impact on the discounted value of future corporate earnings. (See IMF, International Capital Markets: Figures on Stock Market Indices, 1990-May 1997)
Market capitalization and listed companies
| In 1996, over 60 developing countries had stock markets, compared with half of that number in 1985. Their capitalization increased more than tenfold over the period 1985-1995, from $171 billion to $1.9 trillion. Liquidity has increased even faster – turnover rose from 26% to 85% of emerging market capitalization between 1985 and 1994. Meanwhile, the number of domestic companies listed on emerging market exchanges more than doubled, from 8,916 in 1985 to 19,397 in 1995. (International Finance Corporation (IFC), Investment Funds in Emerging Markets, 1996) |  |
The net increase in the market capitalization of emerging stock markets in 1996 – up 16% over the end of 1995 – was generally in line with the increase in listings, new issues by already-listed companies, and share price increases registered during the year. Despite the net increase in new listings over 1995 figures, fewer companies are estimated to have raised capital via stock offerings in 1996 than in 1995 (2,385 vs. 2,700), and the estimated aggregate amount of capital raised fell to $35.8 billion from its 1995 level of $43.8 billion. This decline is due almost entirely to decreases in new issue activity in Korea and India during 1996. (IFC, Key Trends in Emerging Stock Markets)
The number of companies listed in the 27 constituent markets of the IFC Global (IFCG) Composite Index rose 7.5%, due largely to a dramatic increase of listings in the People's Republic of China (up 67% in 1996, to 540 companies) and in Malaysia (up 17%, to 621 firms). Some markets saw a decline in the number of listed companies, and typically for good reasons. The Czech Republic, Egypt and Peru are among the countries that de-listed shares of companies that had not traded for years or that did not comply with listing requirements. The trend towards overall increases in the number of listings is also illustrated by the small gains in Korea (5% more listings) and Thailand (9% more) – despite the generally poor market conditions these countries experienced throughout 1996.
The trading of shares within emerging markets rebounded strongly in 1996, up 49% in value terms from 1995 to almost $1.5 trillion. Though this is still below the 1994 record of $1.6 trillion in "home market" trading, it is remarkable for a number of reasons.
The IFC Investable (IFCI) Composite Index, consisting of 1,224 stocks in 26 markets, is the broadest index available. It is designed to measure returns on emerging-market stocks that are legally and practically open to foreign portfolio investment, and is a widely used benchmark for international portfolio management purposes. The IFCI Composite gained 6.7% in 1996.
On a regional basis, the largest gain was in Latin America – the IFCI Latin America Index rose 14% in 1996. This was followed by an 8.9% gain in the IFCI Asia Index, and a loss of about 5.2% in the IFCI Europe/Mideast/Africa Index.
While share price performance in most emerging markets was positive, individual performance among emerging markets in 1996 was as diverse as the markets themselves. As in many years past, emerging markets could be found both at the top and bottom of the list of world stock market performance.
For instance, emerging markets swept the top 15 spots for annual performance measured in dollar terms, from a list of 76 world stock markets. Among developed markets, only Spain and Sweden made the top 20 on this list, which included 54 markets from developing countries and 22 from developed countries. The top five performers for 1996 were Bangladesh (up 196%), Russia (156%), Venezuela (132%), Hungary (95%), and China (89%). It is noteworthy that many of the largest gains came from smaller, less-known emerging markets not contained in any composite indexes, although the relatively large Taiwanese market took the 18th spot on the list, with a 36% increase.
The worst performers were also concentrated in emerging markets. A total of 21 world equity markets dropped in price in 1996, of which 19 were emerging markets. The market in Bulgaria was nearly wiped out, as stock prices continued to post losses in dollar terms after trading was suspended beginning in September in light of a radical currency devaluation. As a consequence, the IFCG Bulgaria Index lost nearly 83% over the course of 1996, making it the world's worst performing stock market in 1996. Large emerging markets such as Korea, Thailand, and South Africa also suffered heavy losses, with their IFCI indexes falling 39%, 38%, and 19% for the year respectively, in reaction to domestic economic problems.
A mutual fund is an open-end investment company that pools money from shareholders and invests in a diversified portfolio of securities. Unlike closed-end funds, which issue a fixed number of shares, open-end mutual funds are obliged to redeem shares at the request of the shareholder. When a shareholder redeems shares, he or she receives their net asset value, which equals the value of the fund’s net assets divided by the number of shares outstanding. An investment manager determines the composition of the fund’s investment portfolio in accordance with the fund’s return objectives and risk criteria.
There are three basic types of mutual funds: stock (or equity) funds, bond and income funds, and money market funds. Money market funds are referred to as short-term funds, because they invest in securities that generally mature in about one year or less. Stock funds and bond and income funds, on the other hand, are known as long-term funds.
An investor in a mutual fund is a shareholder, buying shares of the fund. Each share represents proportionate ownership in the fund’s underlying securities. The securities are selected by a professional investment adviser to meet a specified financial goal, such as growth or income. The Investment Company Institute classifies mutual funds into 21 broad categories, according to their basic investment objective (See the categories).
Mutual funds have been on the financial landscape for longer than most investors realize. In fact, the industry traces its roots back to 19th-century Europe, in particular to Great Britain. The Foreign and Colonial Government Trust, formed in London in 1868, resembled a mutual fund. It promised the "investor of modest means the same advantages as the large capitalist… by spreading the investment over a number of different stocks." Most of the early British investment companies and their American counterparts resembled today’s closed-end funds. They sold a fixed number of shares, the price of which was determined by supply and demand. (As a source for this section, see: Investment Company Institute (ICI), Mutual Funds Fact Book 1997.)
The first modern mutual fund was the Massachusetts Investors Trust, which was introduced in March 1924 and began with a modest portfolio of 45 stocks and $50,000 in assets. This was the first so-called open-end mutual fund. It introduced concepts that would revolutionize investment companies and investing: a continuous offering of new shares and redeemable shares that could be sold anytime based on the current value of the fund’s assets.
The early mutual fund
industry was, however, overtaken by events – namely, the 1929 stock market crash and
the Great Depression. Mutual funds began to grow in popularity in the 1940s and 1950s. In
1940, there were fewer than 80 funds in United States, with total assets of $500 million.
Twenty years later, there were 160 funds and $17 billion in assets. However, truly
significant amounts of money did not start flowing into the funds until the mid-1980s.
The complexion and size of the mutual fund industry dramatically changed as new products and services were added. The first international stock mutual fund was introduced in 1940; today there are scores of international and global stock and bond funds. Before the 1970s, most mutual funds were stock funds, with a few balanced funds that included bonds in their portfolios. By 1972, there were 46 bond and income funds in United States, and another 20 years later, there were 1629.
Innovations in investment and retirement vehicles have also swept the industry. In 1971, the first money market mutual funds were established, which offered cheque-writing capability and higher interest rates than bank savings accounts. The mutual fund industry also began to introduce even more diverse stock, bond, and money market funds. Today’s mutual funds run the gamut – from aggressive growth funds, to global bond funds, to single-state tax-exempt money market funds, to "niche" funds that may specialize in one segment of the securities market.
| The number of mutual funds worldwide has grown rapidly in the 1990s, and mutual fund assets have increased even more rapidly. At the end of 1996, there were 34,552 mutual funds, with $6,404 billion in assets. The number of funds decreased somewhat in the first half of 1997, but the value of total assets increased. At the end of June 1997, the number of funds was 33,431 and the value of their assets was $6,696 billion. (ICI, Mutual Fund Fact Book 1997 and International Mutual Funds Survey) |  |
| Most of the mutual funds are based in the United States, Japan and
France. (See ICI table on the number of open-end investment
companies, 1991-1996) The distribution of fund assets is even more uneven. More than half of the worldwide total in mutual fund assets belongs to US mutual funds, even though only one-sixth of the total number of funds are based there. Large size is typical of US funds. To illustrate, United States mutual fund assets increased from $2.8 trillion in 1995 to $3.5 trillion in 1996, while total Japanese mutual fund assets decreased from $470 billion to $420 billion. (See ICI table on the assets of open-end investment companies, 1991-1996 and Fortune Magazine's list of United States mutual funds http://www.fortune.com) |
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| See also Fortune Magazine's lists on top funds in each fund category:
aggressive growth funds, balanced funds, convertible bond funds, corporate high yield
funds, corporate general funds, equity income funds, global/world stock funds, government
general funds, government mortage funds, government Treasury funds, growth funds, growth
and income funds, international stock funds, municipal national funds, small company
funds, world funds (http://www.fortune.com) The United States mutual fund assets increased from $2,820 billion in 1995 to $3,539 billion in 1996, whereas the Japanese mutual fund assets decreased from $470 billion to $420 billion. |
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| Of the total $3.5 trillion invested in US mutual funds, $1.75 trillion
was invested in stock funds, $886 billion in bond and income funds, and $901 billion in
money market funds. An increasing proportion of US mutual fund assets is being invested outside the United States. There are at least three types of mutual funds that may invest abroad: international mutual funds, global mutual funds and emerging market mutual funds (See types of mutual funds) At the end of 1996, the assets of international and global equity and bond funds were $321 billion, up from $230 billion at year-end 1995. In 1986, assets of US international and global mutual funds were just $16 billion. (ICI, Mutual Fund Fact Book 1997.) |
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Securities in emerging markets are becoming an increasingly popular option for mutual fund investors. The following are considered emerging markets: all countries in Latin America and the Caribbean; all markets in Asia except Australia, Hong Kong, Japan, New Zealand, and Singapore; all countries in Africa and the Middle East except Israel; all former Eastern Bloc countries, Russia and the Commonwealth of Independent States; and Greece, Portugal and Turkey.
International and global US mutual funds invested about 10% of their assets in emerging markets as of mid-year 1996 (ICI, Mutual Fund Fact Book 1997). According to the IFC, in 1995 over $100 billion was being managed in about one thousand international emerging market funds (IFC, Investment Funds in Emerging Markets, 1996). In February 1996, assets of US emerging-market equity funds amounted to $25 billion. However, the proportion of emerging market funds in total mutual fund assets is still quite modest. (ICI, United States Emerging Market Funds: Hot Money or Stable Source of Investment Capital)
For the period January 1991 through February 1996, net flows of new cash from shareholders to emerging market equity funds accounted for much of the asset growth of these funds. Virtually all asset growth for this five-year period came from net inflows into these funds, rather than from asset appreciation – even though the total return on emerging market funds was a healthy 16% per annum. At times, new cash flows to these funds ran counter to movements in share prices in the markets concerned, and thus helped to maintain the level of investment in these funds while offering stability to these markets. (ICI, United States Emerging Market Funds: Hot Money or Stable Source of Investment Capital)
| Assets of mutual funds have | Total assets of major United States financial intermediaries, 1986, 1995 |
| grown much more rapidly than the assets of commercial banks or thrift institutions. While in 1986 the share of mutual funds in total assets of major United States financial intermediaries was only 9%, by 1995 it had reached 16%. Besides mutual funds, pension plans and insurance companies have also increased their share. |  |
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At the end of 1996, the United States had 6,293 mutual funds with combined assets of $3.54 trillion. Mutual funds were second to commercial banks in asset size. At the end of the fourth quarter of 1996, the latest period for which figures are available from the Federal Reserve Board, the assets of commercial banks totaled $4.71 trillion.
Assets of other major financial institutions in the same period include: private pension funds at $3.03 trillion; life insurance companies at $2.24 trillion; state and local government pension plans, $1.74 trillion; and savings institutions at $1.04 trillion. (ICI, Assets of United States mutual funds and other financial institutions)
As large as the recent flows have been, mutual funds still hold relatively small portions of the markets in which they invest. At the end of 1995, they held 16% of the capitalization of the municipal bond market, 12% of the corporate equity market, 7% of the corporate and foreign bond market, and 5% of the United States Treasury and agency securities market. (FRBNY, Economic Policy Review, July 1997.)
| In the United States, households own the
majority of the mutual fund industry’s $3.54 trillion in assets. As of year-end 1996,
they held $2.63 trillion of mutual fund assets, while fiduciaries – banks and
individuals serving as trustees, guardians, or administrators – and other
institutional investors held the remaining $913 billion. In 1996, United States households purchased a net $543 billion in financial assets, including mutual funds; this was up 8.7%, from $499.6 billion in 1995. The increase in net purchases of financial assets was partly financed through higher household savings, which rose 8.3% to $274.0 billion. In addition, a pickup in household borrowing in 1996 indirectly helped finance the increase in household purchases of financial assets. |
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| Households have | Major United States household financial assets, 1986, 1995 | |
| directed a significantly higher proportion of their financial assets to securities in recent years. The share of deposits has decreased correspondingly. In 1986, 31% of assets were placed directly in corporate equities and other securities, or in mutual funds. By 1995, this share had risen to 43%. The proportion of mutual fund shares in total assets, meanwhile, rose from 4% to 7%. This upward trend continued in 1996. |  |
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Mutual funds are the investment vehicle of choice for many individual retirement plans. Consequently, the retirement market plays an increasingly important role in fund industry growth. At year-end 1995, an estimated 35.7% of mutual fund assets, or about $1 trillion, was held by retirement plans. This was up from 33% or $716 billion in 1994, and 25% or $411 billion in 1992. In 1996, inflows to long-term funds from private pension plans doubled, especially from defined-contribution plans.
Research of the Investment Company Institute conducted in 1995 found that the average mutual fund investor is of the middle class, is 44 years old, has financial assets of $50,000, and is likely to be married and employed. The typical mutual fund investor purchased his or her first fund shares in 1990 or earlier (68%). Among these seasoned fund investors, 57% also own individual stocks, and 75% have Individual Retirement Accounts.
Fund investors have long-term goals. Retirement is cited by 84% as one of their investment goals, and 26% cite saving for their children’s or grandchildren’s college education. The typical mutual fund investor has assets in more than one type of fund. For instance, investors in equity mutual funds typically hold three different funds, and more than half also hold bond and income funds.
The growth in mutual fund assets worldwide is part of the overall growth in both the size and maturity of many foreign capital markets. There are several reasons why this growth has occurred. First, the securities markets of many developed countries have benefited in recent years from favourable economic conditions. For example, Canada and Western Europe have experienced low interest and inflation rates, which have enhanced the attractiveness of their capital markets for investors worldwide. (As a source for this section, see: ICI, Mutual Fund Fact Book 1997.)
Securities markets in some emerging markets have prospered because of new investment opportunities arising from economic reform, privatization, lowered trade barriers, and rapid economic growth. For example, the emerging markets of Malaysia, Mexico, "Taiwan, China", and Korea are now among the 15 largest equity markets in the world.
At the same time, demand for capital has risen – especially in emerging markets. For mutual funds, emerging markets mean possibilities to diversify risks and benefit from higher returns. Domestic firms benefit from funds through improved access to equity capital, and in the case of venture capital funds, through management input (strategic and financial planning, marketing, etc.). The infusion of foreign capital into local equities markets has improved liquidity and raised price-to-earnings ratios, thus reducing the cost to firms of issuing new capital.
Among investors, mutual funds are popular because throughout the world they share many of the same basic needs and goals – a comfortable retirement, higher education for their children, and improved family living standards. Investors are turning to mutual funds for diversification and as a way to participate in growing securities markets. Professionally managed funds are a viable alternative for investing directly in securities. In addition, as many countries begin to face the prospect of aging populations, they are considering the need for increased private savings to meet retirement needs.
Countries such as Chile have enacted new pension systems that place greater emphasis on the role of private investment in retirement savings. Mutual funds are often used as funding vehicles for such systems.
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