A Letter From ICI’s
Chief
Economist
ICI Research: Staff
and
Publications
SECTION ONE:
Overview of U.S.-Registered
Investment Companies
SECTION TWO:
Recent Mutual Fund
Trends
SECTION THREE:
Exchange-Traded Funds
SECTION FOUR:
Closed-End Funds
SECTION FIVE:
Mutual Fund Fees and
Expenses
SECTION SIX:
Mutual Fund Owners:
Who Are They and
Where Do They
Purchase Fund Shares?
SECTION SEVEN:
The Role of Mutual Funds
in Retirement and
Education Savings
APPENDIX A:
How Mutual Funds and
Investment Companies
Operate
This section describes recent U.S. mutual fund developments and examines the market factors that affect the demand for stock, bond, hybrid, and money market funds. Developments in Mutual Fund Flows Demand for Long-Term Mutual Funds Demand for Money Market Mutual Funds |
The U.S. mutual fund market, with a record $8.9 trillion in assets under
management as of year-end 2005, is the largest in the world, accounting
for half of the $17.8 trillion in mutual fund assets worldwide. Investor
demand for mutual funds is influenced by a variety of factors, not
the least of which is funds’ ability to assist investors in achieving
a wide variety of investment objectives. In particular, U.S. households’ growing
reliance on stock, bond, and hybrid mutual funds reflects investor
desire to meet long-term personal financial objectives such as preparing
for retirement. Furthermore, U.S. households, businesses, and other
institutional investors use money market mutual funds as cash management
tools because they provide a
high degree of liquidity and competitive, short-term yields. Investors’ reactions
to U.S. and worldwide economic and financial conditions also play an
important role in determining demand from year to year for mutual funds
in general and for specific types of funds.
U.S. Mutual Fund Assets
Stock mutual funds accounted for a little more than half of U.S. mutual fund assets in 2005. This share has ranged from 50 to 60 percent since 1997, with the exception of 2002 when the share dropped to around 42 percent largely owing to the sharp decline in the U.S. stock markets that year. Domestic stock funds—those that invest primarily in shares of U.S. corporations—held 45 percent of total industry assets; international stock funds—those that invest primarily in foreign corporations—accounted for another 10 percent. Money market funds (23 percent), bond funds (15 percent), and hybrid funds (6 percent) also held sizeable portions of total U.S. mutual fund assets.
U.S. Has the World’s Largest Mutual Fund Market
(percent of total assets, 2005)
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*Components may not add to 100 percent because
of rounding.
Sources: Investment Company Institute, European Fund and Asset Management Association,
and other national fund associations
More than 500 fund sponsors managed mutual fund assets in the United States in 2005. Many firms have entered and exited the fund industry since the mid-1980s, when the modern mutual fund market began to take form. For example, of the top 25 firms in 1985, only 16 remained in the top group in 2005. This ongoing competitive dynamic has prevented any single firm or group of firms from dominating the market. In addition, the share of assets managed by the largest firms in 2005 is comparable to the share managed by the largest firms in 1985.
Share of Assets at Largest Mutual Fund Complexes
(percent of total industry assets, selected years)
| 1985 | 1990 | 1995 | 2000 | 2005 | |
| Top 5 Complexes | 37 | 34 | 34 | 32 | 37 |
| Top 10 Complexes | 54 | 53 | 47 | 46 | 48 |
| Top 25 Complexes | 78 | 75 | 70 | 74 | 71 |
Download an Excel file of this data.
Alternative measures of market concentration—including the Herfindahl-Hirschman index, which weighs both the number and relative size of firms in the industry to measure competition—also indicates that no one firm or group of firms dominate the mutual fund market. The Herfindahl-Hirschman measure considers industries with index numbers below 1,000 to be unconcentrated industries. The mutual fund industry has a Herfindahl-Hirschman measure of around 400.
Developments in Mutual Fund Flows
As measured by net new cash flow—the dollar value of new fund sales minus redemptions, combined with net exchanges—investor demand for mutual funds picked up in 2005. Net new cash flow to all mutual funds was $255 billion, up from the pace of the previous three years. Inflows to international stock funds and money market mutual funds accounted for much of the increase. Abroad, many countries experienced economic growth in excess of that seen in the United States. In addition, foreign stock markets, especially those in emerging markets, outperformed U.S. stocks by a wide margin. U.S. short-term interest rates rose to around 4 percent by year-end, as the Federal Reserve steadily tightened monetary policy in response to strong underlying growth in productivity and heightened concerns about inflationary pressures.
For detailed data on inflows to stock, bond, and hybrid funds, see Section 3 in the Data Tables.
Inflows to Mutual Funds
(billions of dollars, 1990–2005)
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Mutual Fund Assets by Tax Status
Unlike most corporations, a mutual fund generally distributes all of its earnings—capital gains and ordinary dividends—each year to shareholders and is taxed only on amounts it retains. Fund investors are ultimately responsible for paying tax on a fund’s earnings, whether they receive the distributions in cash or reinvest them in additional fund shares. Investors often attempt to lessen the impact of taxes on their investments by investing in tax-exempt funds and tax-deferred retirement accounts. As of 2005, 7 percent of all mutual fund assets were held in tax-exempt funds and 47 percent were invested in tax-deferred accounts held by households.
For more information on tax issues affecting mutual fund shareholders, visit the Institute’s website.
More Than Half of Mutual Fund Assets Held in Tax-Deferred Accounts
and Tax-Exempt Funds
(percent, 2005)
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Mutual Fund Capital Gain Distributions
Capital gain distributions represent a fund’s net gains, if any, from the sale of securities held in its portfolio. When gains from these sales exceed losses, they are distributed to fund shareholders.
Mutual funds distributed $129 billion in capital gains to shareholders in 2005. About 56 percent of these distributions were paid to tax-deferred household accounts, and another 38 percent were paid to taxable household accounts. Stock, bond, and hybrid funds can distribute capital gains, but stock funds typically account for the bulk of the distributions. In 2005, 35 percent of stock fund share classes made a capital gain distribution, and these share classes distributed an average of nearly 6 percent of their assets as capital gains.
Capital Gain Distributions
(billions of dollars, 1996–2005)
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Note: Components may not add to the total because of rounding.
Mutual Fund Dividend Distributions
Dividend distributions represent income—primarily from the interest
and dividends earned by the securities in a fund’s portfolio—after
expenses are paid by the fund.
Mutual funds distributed $166 billion in dividends to fund shareholders
in 2005. Mutual fund dividends were boosted by higher short-term interest
rates and an increase in dividend payments by corporations. Bond and
money market funds accounted for 65 percent of all dividend distributions
in 2005. About 49 percent of all dividend distributions were paid to
tax-exempt and tax-deferred household accounts. Another 39 percent were
paid to taxable household accounts.
Dividend Distributions
(billions of dollars, 1996–2005)
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Note: Components may not add to the total because of rounding.
Demand For Long-Term Mutual Funds
Investors added $192 billion in net new cash to stock, bond, and hybrid funds in 2005, down slightly from a year earlier, but still maintaining the recent robust pace of inflows to long-term funds. Investor demand for these funds, which slowed largely in response to the decline in the stock market from mid-2000 to the end of 2002, began to strengthen in early 2003. Between 2003 and 2005, net new cash to long-term funds totaled $618 billion. Moreover, during this same period, investors reinvested an additional $239 billion in dividend distributions back into the funds.
No-load share classes of stock, bond, and hybrid mutual funds continued to receive the bulk of net new cash, attracting $154 billion of the total $192 billion in inflows in 2005. Mutual fund sales to investors in employer-sponsored retirement plans account for a large portion of no-load fund sales. Also, no-load inflows likely were boosted by sales of funds of funds which often invest in underlying no-load funds. In 2005, funds of funds received $79 billion in net new cash, of which 25 percent was from sales of funds of funds with loads. Net new cash to load funds amounted to $20 billion. Class A and class C shares received more than all of the $20 billion, while class B shares had net outflows for the fifth consecutive year.
Stock Funds
Investors added $136 billion of net new money to stock funds in 2005, somewhat below the pace of the previous two years, but still a sizeable amount. Domestic stock funds attracted $31 billion in new cash—down considerably from 2004—owing largely to the more limited gains in U.S. equity markets in 2005. Funds investing in foreign companies garnered a record $105 billion in new cash. The strong demand for these funds reflected, in part, the outstanding performance of many foreign stock markets during 2005, especially when compared with returns in the U.S. stock markets. Total returns on U.S. equity indexes ranged from 5 percent to about 7.5 percent, while those on world stock indexes (excluding U.S. stocks) were about 15 percent. Total returns on stocks traded on emerging markets were close to 35 percent.
Net New Cash Flow to No-Load Funds Continues to Grow
(billions of dollars, 2000–2005)
| 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | |
| All Long-Term Funds | 229 | 129 | 121 | 216 | 210 | 192 |
| Load | 70 | 46 | 20 | 51 | 48 | 20 |
| A Shares | 32 | 32 | 20 | 39 | 60 | 68 |
| B Shares | 26 | -1 | -16 | -18 | -35 | -65 |
| C Shares | 27 | 22 | 24 | 29 | 22 | 25 |
| Other Load | -14 | -7 | -7 | 1 | 1 | -8 |
| No-Load | 109 | 70 | 102 | 123 | 126 | 154 |
| Retail | 80 | 37 | 53 | 78 | 84 | 86 |
| Institutional | 29 | 33 | 49 | 45 | 42 | 69 |
| Variable Annuities | 51 | 13 | -2 | 42 | 36 | 18 |
Download an Excel file of this data
Note: Components may not add to the total
because of rounding.
Sources: Investment Company Institute; Lipper; ValueLine Publishing,
Inc.; CDA/Wiesenberger Investment Companies Service; ©
CRSP University of Chicago, used with permission, all rights reserved
(312.263.6400/www.crsp.com); and Strategic Insight Simfund
Flows to Equity Funds Related to Stock Market Performance
(2000–2005)
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Sources: Investment Company Institute and Morgan Stanley Capital International
Investors tend to own mutual funds with relatively low fees, expenses, and turnover rates. Mutual fund assets are heavily concentrated in funds with below-median expenses and below-average turnover. The turnover rate—the lesser of purchases or sales (excluding short-term assets) scaled by average net assets—is a measure of a fund’s trading activity. In 2005, the asset-weighted annual turnover rate experienced by stock fund investors edged up to 47 percent, but remained low when compared with the historical experience of the past 35 years.
Two-thirds of stock fund assets were in funds with asset-weighted portfolio turnover rates under 50 percent. This reflects shareholders’ tendency to own funds with below-average turnover and the propensity for funds with below-average turnover to attract more shareholder dollars.
Turnover Rate1 Experienced by Stock Fund Investors Remains Low2
(percent, 1971–2005)
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1asset-weighted average
2excludes variable annuities
Sources: Investment Company Institute; © CRSP University of Chicago,
used with permission, all rights reserved (312.263.6400/
www.crsp.com); and Strategic Insight Simfund
Bond and Hybrid Funds
Investors added $31 billion to their bond fund holdings in 2005, following modest outflows the previous year. Cash flow into bond funds is highly correlated with the performance of bonds. Traditionally, the U.S. interest rate environment plays a prominent role in the demand for bond funds from year to year. Movements in short- and long-term interest rates can significantly alter the returns offered by these types of funds and, in turn, influence retail and institutional investors’ demand for bond funds.
Falling interest rates between 2001 and 2003 led to significant returns for bond funds, spurring investor demand. In contrast, interest rates on intermediate- to long-term bonds moved in a narrow range over 2004 and 2005, eliminating the boost to bond fund returns from rising bond prices. As a result, money moved out of bond funds in 2004 and—based on the historical relationship between bond prices and demand for bond funds—one would have expected outflows to continue in 2005. A factor that may have contributed to the $31 billion in bond fund inflows in 2005 is the growing popularity of lifecycle and lifestyle funds. Net inflows to these funds—which often invest their net new cash in shares of other mutual funds—more than doubled in 2005 to $49 billion. Likely some portion of these flows was directed to bond mutual funds.
Flows to Bond Funds Related to Bond Returns
(percent, 1990–2005)
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1The total return on bonds is measured as the year-over-year
change in the Citigroup Broad Investment Grade Bond Index.
2Net new cash flow to bond funds is plotted as a three-month
moving average of net new cash flow as a percentage of previous
month-end assets. The data exclude flows to high-yield bond funds.
Sources: Investment Company Institute and Citigroup
Total annual flows to hybrid funds were $25 billion in 2005, down somewhat from the pace in 2004, but still substantial by historical standards. Over the past few years, investors increasingly have turned to this investment class by purchasing shares of hybrid funds of funds. These hybrid funds of funds invest in other mutual funds and the net new cash is reported as flows into the underlying funds. In 2005, hybrid funds of funds received $71 billion in net new cash with some part of these flows going towards underlying hybrid mutual funds.
Demand for Money Market Mutual Funds
Net new cash flow to money market funds turned positive for the first year since 2001, likely reflecting rising short-term interest rates in 2005.
Retail Money Market Mutual Funds
Retail money market funds, which are principally sold to individual investors, received net new cash of $2 billion in 2005, after net outflows totaling $319 billion over the period from 2002 to 2004. Money fund yields ramped up steadily during 2005 and outpaced any increases in yields on bank deposits. This relationship between rising short-term interest rates, the widening money market fund yield premium relative to bank deposits, and slowing outflows that eventually turn to inflows is a pattern that has been observed over the past 20 years.
Flows to Taxable Retail Money Market Funds Related to Interest Rate Spread
(percent, 1990–2005)
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1Net new cash flow is a percent of previous month-end taxable
retail money market fund assets and is shown as a
six-month moving average.
2The interest rate spread is the difference between the
taxable retail money market fund yield and the average interest rate
on money market
deposit accounts.
Sources: Investment Company Institute, iMoneyNet, and Bank Rate Monitor
Nevertheless, households have continued to invest in bank deposits more heavily than expected based on this historical relationship. In 2005, they added about $400 billion to their holdings of time and savings deposits, despite the wide premium offered on money market funds. Changes in brokerage firms’ cash management policies for their retail accounts likely have contributed to the increased use of bank deposits by households. In recent years, brokerage firms increasingly have relied less on money market funds and more on bank money market deposit accounts as cash management accounts for their retail clients.
Flows to Money Market Funds Turn Positive in 2005
(billions of dollars, 1990–2005)
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Institutional Money Market Mutual Funds
Institutional money market funds, used by businesses, pension funds, state and local governments, and other large investors had inflows of $61 billion in 2005, after substantial outflows the previous two years. Some of this reversal may reflect the diminished need for businesses to hold checking deposits at banks. Banks are prohibited by law from paying interest on demand deposits, but many institutional customers earn credits based on an implicit interest rate on their deposits. These credits can be used to pay for banking services. When interest rates decline, businesses often increase their checking deposits to earn sufficient credits to pay for their services. Over the period from 2002 to 2004, nonfinancial businesses added about $100 billion to their checking accounts, and some of this additional cash likely came from money market funds. In 2005, conversely, rising short-term interest rates may have triggered the shift of cash flow for some businesses away from checking accounts and into money market funds. U.S. businesses held about 19 percent of their short-term assets in money market funds as of year-end 2005.
For more complete data on money market funds, see Section 4 in the Data Tables and the Statistics and Research section of this site.
Money Market Mutual Funds Managed 19 Percent of U.S. Business Short-Term Assets* in 2005
(percent, 1990–2005)
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*U.S. nonfinancial business short-term assets
consist of foreign deposits, checkable deposits, time and savings deposits,
money market funds, repurchase agreements, and commercial paper.
Sources: Investment Company Institute and Federal Reserve Board
