Monday, October 8, 2012
Small US investor an anachronism
Financial Review
PUBLISHED: 06 Oct 2012
While the Dow and the S&P indices were stealing all the headlines
over the last decade, a quiet revolution was occurring in the market
that’s gained little attention.
Call it the institutionalisation of the stockmarket. In the past decade the number of retail investors in the stockmarket has dropped steeply.
Company filings show the individual investor has been gradually replaced by ever larger index funds, pensions and quant funds. That has caused a fundamental shift in the balance of power in the stockmarket. And it’s something public companies are only beginning to grapple with.
For years, public companies thought they knew who their shareholders were.
Not any more. High-speed, computer-driven trading by quant funds in particular makes it harder than ever for companies to know who owns them. Often it’s merely a computer program, not a person, picking a stock to buy.
Moreover, the extensive use of derivatives blurs the boundaries of ownership. The owner listed in a share registry may have traded away any economic interest in a particular stock.
Retail investors used to be a pillar of the market, demanding and receiving attention from companies and their advisers. In recent years, though, retail investors have been disappearing from the stockmarket.
Partly that’s because there’s been a shift to mutual funds and index funds and away from individual stock ownership.
In the 1980s one-quarter of US households owned a mutual fund. By the end of the 1990s almost half of all households invested in mutual funds, according to the Investment Company Institute.
The reverse is true about direct stock ownership. In 1999, 25.5 per cent of households owned individual stocks directly. By 2011 that dropped to 20 per cent, according to ICI.
At the same time as more investors have shifted into mutual funds, there’s been a decline in the overall number of Americans who actually hold any stock at all.
Today about 46 per cent of US households have any exposure to stocks, either directly or indirectly, while in 2001 almost 60 per cent of households held stocks.
While individuals have been disappearing, institutions have emerged as the dominant owners of the stockmarket. Institutions include active investment managers, index funds, quant funds, public pension funds, hedge funds and exchange-traded funds.
According to one analysis by Goldman Sachs, in 1998 institutional investors owned 57.1 per cent of the stockmarket. By 2009 that had grown to almost three-quarters.
The composition of institutional investors has also been changing. More institutional shareholders are typically passive investors such as index or quant funds, rather than active fund managers.
There are a number of interesting implications. For starters, households these days have considerably less power to influence public companies than they did in the past.
Holding stock through a mutual fund means there’s an intermediary between the investor and the company. Will the index fund manager have the same concerns about executive compensation, for instance, or any other corporate governance issue as the investor?
As long as the stock meets the index manager’s performance requirement, mightn’t he or she be satisfied with that? But then who’s looking out to make company management better?
Then there are issues for public companies. How do companies talk to and communicate with shareholders when some of them might actually not even be human?
What’s more, the rise of derivatives and other complex securities means companies might not even know who their shareholders are. Two years ago the management of US retailer JC Penny was shocked to learn that two activist investors, Pershing Square Capital Management and Vornado Realty Trust, suddenly owned almost 27 per cent of the company after exercising derivatives positions.
The shift in the balance of power in the market puts more influence in the hands of traditionally passive shareholders. The big question is what they will do with that increased power. Could Vanguard, for instance, the pioneer of index funds, become a more active shareholder?
The CEO of Vanguard hinted earlier this year about a growing focus on corporate governance.
“We continue to be generally optimistic in our assessment of governance practices broadly,” F. William McNabb said. “Nonetheless, the tension among the roles of regulators, shareholders, company directors and executives in corporate governance matters remains a subject of much debate and we believe there is still substantial room for improvement on a number of fronts.”
How all this plays out remains to be seen as institutions adjust to their new, more powerful positions and companies adjust to their new shareholders.
One thing is clear, though. The US stockmarket is now a game of big players. The era of the little investor is long gone.
PUBLISHED: 06 Oct 2012
Anna Bernasek
Call it the institutionalisation of the stockmarket. In the past decade the number of retail investors in the stockmarket has dropped steeply.
Company filings show the individual investor has been gradually replaced by ever larger index funds, pensions and quant funds. That has caused a fundamental shift in the balance of power in the stockmarket. And it’s something public companies are only beginning to grapple with.
For years, public companies thought they knew who their shareholders were.
Not any more. High-speed, computer-driven trading by quant funds in particular makes it harder than ever for companies to know who owns them. Often it’s merely a computer program, not a person, picking a stock to buy.
Moreover, the extensive use of derivatives blurs the boundaries of ownership. The owner listed in a share registry may have traded away any economic interest in a particular stock.
Retail investors used to be a pillar of the market, demanding and receiving attention from companies and their advisers. In recent years, though, retail investors have been disappearing from the stockmarket.
Partly that’s because there’s been a shift to mutual funds and index funds and away from individual stock ownership.
In the 1980s one-quarter of US households owned a mutual fund. By the end of the 1990s almost half of all households invested in mutual funds, according to the Investment Company Institute.
The reverse is true about direct stock ownership. In 1999, 25.5 per cent of households owned individual stocks directly. By 2011 that dropped to 20 per cent, according to ICI.
At the same time as more investors have shifted into mutual funds, there’s been a decline in the overall number of Americans who actually hold any stock at all.
Today about 46 per cent of US households have any exposure to stocks, either directly or indirectly, while in 2001 almost 60 per cent of households held stocks.
While individuals have been disappearing, institutions have emerged as the dominant owners of the stockmarket. Institutions include active investment managers, index funds, quant funds, public pension funds, hedge funds and exchange-traded funds.
According to one analysis by Goldman Sachs, in 1998 institutional investors owned 57.1 per cent of the stockmarket. By 2009 that had grown to almost three-quarters.
The composition of institutional investors has also been changing. More institutional shareholders are typically passive investors such as index or quant funds, rather than active fund managers.
There are a number of interesting implications. For starters, households these days have considerably less power to influence public companies than they did in the past.
Holding stock through a mutual fund means there’s an intermediary between the investor and the company. Will the index fund manager have the same concerns about executive compensation, for instance, or any other corporate governance issue as the investor?
As long as the stock meets the index manager’s performance requirement, mightn’t he or she be satisfied with that? But then who’s looking out to make company management better?
Then there are issues for public companies. How do companies talk to and communicate with shareholders when some of them might actually not even be human?
What’s more, the rise of derivatives and other complex securities means companies might not even know who their shareholders are. Two years ago the management of US retailer JC Penny was shocked to learn that two activist investors, Pershing Square Capital Management and Vornado Realty Trust, suddenly owned almost 27 per cent of the company after exercising derivatives positions.
The shift in the balance of power in the market puts more influence in the hands of traditionally passive shareholders. The big question is what they will do with that increased power. Could Vanguard, for instance, the pioneer of index funds, become a more active shareholder?
The CEO of Vanguard hinted earlier this year about a growing focus on corporate governance.
“We continue to be generally optimistic in our assessment of governance practices broadly,” F. William McNabb said. “Nonetheless, the tension among the roles of regulators, shareholders, company directors and executives in corporate governance matters remains a subject of much debate and we believe there is still substantial room for improvement on a number of fronts.”
How all this plays out remains to be seen as institutions adjust to their new, more powerful positions and companies adjust to their new shareholders.
One thing is clear, though. The US stockmarket is now a game of big players. The era of the little investor is long gone.
A new type of tickle down economics
Around the world, economic policy in
recent years has been based on a simple belief. If you make sure that all the banks
are doing fine, the rest of the economy will eventually follow suit.
That’s what’s behind so called ‘quantative
easing’, the cornerstone of the Federal Reserve’s economic policy since the
financial crisis. And the Fed’s not alone. The Bank of England and the European
Central Bank pursued the same policy in the aftermath of the 2008 financial
panic. The Bank of Japan has done it since 2001.
The policy was born out of necessity.
With official interest rates set near zero, further interest rate cuts don’t do
anything. The theory of quantitative easing is that central banks can stimulate
the economy by printing money to buy longer maturing bonds. The holders, of
course, are primarily banks and other financial institutions.
That is supposed to help in three ways.
First, when banks themselves are in trouble it ensures that they don’t go bust.
Second, putting money in the hands of banks and institutions means they can lend
more to businesses and households.
Third, the central bank offers more
than the otherwise prevailing market rate to induce bondholders to sell. That
sends prices up and pushes down yields on those longer term bonds. If all goes
well, lower long term interest rates result and actors in the real economy see
a greater incentive to borrow and invest.
With employment in the US stalled, the
Fed has now turned to a third round of quantative easing, announcing it will
buy $40 billion a month of mortgage backed securities. Stated more clearly, the
Fed is printing money to buy real estate loans for a little more than they
would otherwise fetch.
It’s worth asking whether putting that money
into banks now is going to boost the economy.
Back in 2008, when the banks were the
source of the problem, quantative easing helped stabilize institutions on the
verge of collapse and averted what looked to be a real disaster.
The second time the Fed embarked on quantative
easing was in 2010 and 2011 when economic growth slowed to crawl speed. At that
time, the biggest effect of the Fed’s policy was on the stock market, sparking
a bull charge upwards from financial crisis lows.
But now the banks are doing very well.
The problem is a lack of hiring.
Economists think the rising stock
market may have had a slight wealth effect, helping to boost consumption at the
higher end. But the number of Americans owning stocks has been falling since
2001 when it reached a peak of nearly 60 percent. Today less than half of
households own any stocks at all, while the vast majority of stock wealth is
concentrated in a small sliver of the population. In contrast, a far greater
wealth effect could come from boosting the housing market where two-thirds of Americans
own their own home.
Whether quantative easing boosts the broad
economy or not hinges on the willingness of banks to lend. If banks get extra
funds from bond sales but don’t lend them out to companies and households, it
won’t help the economy. Companies and homebuyers may want to borrow at those
low, low rates but banks have to agree to take the risk. Big companies can
access stock markets and debt markets on their own, but small and medium firms
and individual homebuyers have few options.
So how willing are banks to lend right
now?
Since the financial crisis, banks have been
cutting their risk. They have lent readily to big companies and the most
creditworthy individuals, but not to anyone else. That leaves out the vast
majority of the population.
According to recent figures from the
Fed survey of senior loan officers, lending standards are easing but only in
the area where banks have already been lending—big companies and high quality
individuals. There’s just one problem. Those companies and individuals have
already borrowed as much as they want at historic low rates. They can’t use any
more money at the moment.
The Fed’s survey shows that there has
been no shift in lending to small and medium firms or consumers with less than
perfect credit. In fact, the Fed reported that standards have tightened on both
prime and nontraditional mortgages. It seems that a lot of people would like to
borrow but are being shut out.
Then where does that leave QE3? So far the Fed’s announcement of QE3 boosted the stock market. Major indicators like the Dow and S&P are trading near record highs. Bond traders may see a windfall as well. But unless banks change their lending standards, it won’t boost the economy.
Quantative easing is the latest in a long line of trickle down economic policies. Tax cuts for the already wealthy and for the corporate sector have not proven particularly powerful ways to stimulate the broader economy. Those policies have led to growing disparity between haves and have nots. Quantative easing looks like more of the same.
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