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.

Demand for Long-Term Mutual Funds

Stock Funds

Bond and Hybrid Funds

Demand for Money Market Mutual Funds

Retail Money Market Mutual Funds

Institutional Money Market Mutual Funds

With $12 trillion in assets, the U.S. mutual fund industry remains the largest in the world. In 2007, investor demand for mutual funds increased significantly, with net new cash flow to all types of mutual funds reaching $883 billion, a record high. Demand for money market funds grew over the year, especially following the disruptions in the credit markets that began in August. Investors also increasingly gravitated toward taxable bond funds and international stock funds in 2007.

U.S. Mutual Fund Assets

The U.S. mutual fund market, with $12 trillion in assets under management as of year-end 2007, remains the largest in the world, accounting for 46 percent of the $26.2 trillion in mutual fund assets worldwide (Figure 2.1).

Investor demand for mutual funds is influenced by a variety of factors, not 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 for specific types of mutual funds and for mutual funds in general—from year to year and over longer periods.

Stock mutual funds accounted for 54 percent of U.S. mutual fund assets at year-end 2007 (Figure 2.1). This share has ranged from 50 to 60 percent since 1997, with the exception of 2002 when the share dropped to 42 percent largely owing to the sharp decline in the U.S. stock markets that year. In 2007, domestic stock funds—those that invest primarily in shares of U.S. corporations—held 40 percent of total industry assets; international stock funds—those that invest primarily in foreign corporations—accounted for another 14 percent. Money market funds (26 percent), bond funds (14 percent), and hybrid funds (6 percent) also held sizable portions of total U.S. mutual fund assets.

Figure 2.1

U.S. Has the World's Largest Mutual Fund Market

(percent of total assets, 2007)

Download an Excel file of this data.

Note: Components may not add to 100 percent because of rounding.
Sources: Investment Company Institute, European Fund and Asset Management Association, and other national mutual fund associations

Approximately 600 sponsors managed mutual fund assets in the United States in 2007. Competitive dynamics have prevented any single firm or group of firms from dominating the market. For example, of the largest 25 fund complexes in 1985, only 13 remained in this top group in 2007. The share of assets managed by the largest 25 firms has dropped to 71 percent in 2007 from 78 percent in 1985 (Figure 2.2). In addition, the share of assets managed by the largest five firms in 2007 is comparable to the share managed by the largest five firms in 1985.

Other measures also indicate that no one firm or group of firms dominates the mutual fund market. One such measure is the Herfindahl-Hirschman index, which weighs both the number and relative size of firms in the industry to measure competition. Index numbers below 1,000 indicate that an industry is unconcentrated. The mutual fund industry has a Herfindahl-Hirschman index number of about 440.

Figure 2.2

Share of Assets at Largest Mutual Fund Complexes

(percent of total industry assets, year-end, selected years)

	1985	1990	1995	2000	2005	2006	2007
Top 5 complexes	37	34	34	32	37	38	38
Top 10 complexes	54	53	47	46	48	49	50
Top 25 complexes	78	75	70	74	71	71	71

Download an Excel file of this data.

Developments in Mutual Fund Flows

Investor demand for mutual funds increased substantially in 2007. Net new cash flow to all mutual funds—the dollar value of new fund sales minus redemptions, combined with net exchanges—was $883 billion, up significantly from the pace of the previous two years and well above the previous record pace set in 2001 (Figure 2.3). Higher inflows to money market mutual funds and taxable bond funds accounted for much of the increase. In the first part of the year, U.S. short-term interest rates moved within a fairly tight range around 5 percent, as the Federal Reserve maintained the federal funds target rate at 5.25 percent in response to heightened concerns about inflationary pressures. Disruptions in financial markets that began in August and continued to further strain financial markets for the remainder of the year prompted the Federal Reserve to lower the target federal funds rate by 100 basis points by year-end. These actions were intended to forestall adverse effects on the broader economy from tighter credit market conditions, an intensification of the correction in the housing market, and a softening in business and consumer spending.

Abroad, many countries continued to experience economic growth exceeding that in the United States. In addition, some foreign stock markets, especially those in emerging markets, continued to outperform U.S. stocks by a wide margin.

Figure 2.3

net flows to Mutual Funds

(billions of dollars, 1993–2007)

Download an Excel file of this data.

Mutual Fund Assets by Tax Status

Mutual funds generally distribute all earnings—capital gains and ordinary dividends—each year to shareholders, and are taxed only on amounts retained. 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 year-end 2007, 7 percent of all mutual fund assets were held in tax-exempt funds and 44 percent were invested in tax-deferred accounts held by households (Figure 2.4).

For more information on tax issues affecting mutual fund shareholders, visit the Institute's website.

Figure 2.4

Half of Mutual Fund Assets are Held in Tax-Deferred Accounts and
Tax-Exempt Funds

(percent, 2007)

Download an Excel file of this data.

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 $415 billion in capital gains to shareholders in 2007 (Figure 2.5). About 60 percent of these distributions were paid to tax-deferred household accounts, and another 36 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 2007,
51 percent of stock fund share classes made a capital gain distribution, and half of these share classes distributed at least 7 percent of their assets as capital gains.

Figure 2.5

Capital Gain Distributions

(billions of dollars, 1998–2007)

Download an Excel file of this data.

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 $308 billion in dividends to fund shareholders in 2007 (Figure 2.6). Mutual fund dividends were boosted by the relatively high level of short-term interest rates and an increase in dividend payments by corporations. Bond and money market funds accounted for 67 percent of all dividend distributions in 2007. About 45 percent of all dividend distributions were paid to tax-exempt and tax-deferred household accounts. Another 42 percent were paid to taxable household accounts.

Figure 2.6

Dividend Distributions

(billions of dollars, 1998–2007)

Download an Excel file of this data.

Note: Components may not add to the total because of rounding.

Demand For Long-Term Mutual Funds

Investors added $223 billion in net new cash to stock, bond, and hybrid funds in 2007, maintaining the recent robust pace of inflows to these long-term mutual funds (Figure 2.7). Investor demand for long-term funds strengthened in early 2003 and has been fairly steady since then at an average $214 billion annual rate. Over the period 2003 to 2007, net new cash to long-term funds totaled $1.1 trillion. Moreover, during this same period, investors reinvested $509 billion in dividends.

No-load share classes of stock, bond, and hybrid mutual funds continued to receive the bulk of net new cash, attracting $177 billion of the total $223 billion in inflows in 2007 (Figure 2.7). 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. Net new cash to load funds amounted to $21 billion. Front-load and level-load shares received more than the net total of $21 billion, while back-end load shares had net outflows for the seventh consecutive year.

Figure 2.7

Net New Cash Flow to Long-Term Funds by Load Structure

(billions of dollars, 2001–2007)

	2001	2002	2003	2004	2005	2006	2007
All Long-Term Funds	$129	$121	$216	$210	$192	$227	$223
Load	45	20	48	44	29	33	21
Front Load1	24	13	33	49	47	48	28
Back-End Load2	-2	-18	-19	-38	-48	-48	-45
Level Load3	22	23	27	21	19	21	25
Other Load4	1	2	8	13	11	12	12
No-Load5	71	102	126	130	145	170	177
Retail	37	53	83	94	79	77	66
Institutional	34	50	43	36	67	93	112
Variable Annuities	13	-2	42	36	18	24	25

Download an Excel file of this data

1Front load › 1 percent. Primarily includes A shares; includes sales where front loads are waived.
2Front load = 0 percent and CDSL › 2 percent. Primarily includes B shares.
3Front load ≤ 1 percent, CDSL ≤ 2 percent, and 12b-1 › 0.25 percent. Primarily includes C shares; excludes institutional share classes.
4All other load share classes not classified as front load, back-end load, or level load. Primarily includes retirement share classes known as R shares.
5Front Load = 0 percent, CDSL = 0 percent, and 12b-1 ≤ 0.25 percent.
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

Mutual Fund Share Classes

Mutual funds are often classified according to the class of shares that fund sponsors offer to investors, primarily load or no-load classes. Load classes generally serve investors who own fund shares purchased through financial advisers; no-load fund classes usually serve investors who purchase shares without the assistance of a financial adviser or who choose to compensate the financial adviser separately. About two-thirds of all mutual funds offer two or more share classes. Funds that typically sell through financial advisers offer more than one share class to provide investors with several ways to pay for the services of financial advisers.

Load Share Classes

Load share classes—front-load, back-end-load, and level-load shares—usually include a sales load and/or a 12b-1 fee. The sales load and 12b-1 fees are used to compensate financial advisers for their services.

Front-load shares, which are predominantly Class A shares, represent the traditional means of paying for investment advice and assistance. Front-load shares generally charge a sales load at the time of the purchase, which is a percentage of the sales price or offering price. Front-load shares also often have a 12b-1 fee of about 0.25 percent. Front-load shares are sometimes used in employer-sponsored retirement plans, but fund sponsors typically waive the sales load for purchases made through such retirement plans.

Back-end-load shares, which are primarily Class B shares, typically do not have a front load. Investors using back-end-load shares pay for services provided by financial advisers through a combination of an annual 12b-1 fee and a contingent deferred sales load (CDSL). The CDSL is triggered if fund shares are redeemed before a given number of years of ownership. The CDSL decreases the longer the investor owns the shares and reaches zero typically after shares have been held six or seven years. After six to eight years, back-end-load shares usually convert to a share class with a lower 12b-1 fee. For example, Class B shares typically convert to Class A shares after a specified number of years.

Level-load shares, which include Class C shares, generally do not have a front load. Investors in this kind of share class compensate financial advisers with a combination of an annual 12b-1 fee (typically 1 percent) and a CDSL (also, often 1 percent) that shareholders pay if they sell their shares within the first year after purchase.

No-Load Share Classes

No-load share classes have no front load or CDSL, and have a 12b-1 fee of 0.25 percent or less. Originally, no-load share classes were offered by mutual fund sponsors that sold directly to investors. Now, however, investors can purchase no-load funds through employer-sponsored retirement plans, mutual fund supermarkets, discount brokerage firms, and bank trust departments. Some financial advisers who charge investors separately for their services rather than through a load or 12b-1 fee also use no-load share classes.

Stock Funds

Investors added $93 billion of net new money to stock funds in 2007, down from the $159 billion pace of the previous year (Figure 2.8). Domestic stock funds, nevertheless, experienced a net outflow of $46 billion in 2007, the first such annual outflow since 2002. Funds investing in foreign companies garnered $139 billion in new cash in 2007.

Since 2004, investors have significantly reduced their net purchases of domestic stock funds. Over the period 2005 to 2007, investors withdrew $5 billion, on net, from domestic stock funds and added a total of $392 billion in net new cash to international stock funds. This robust demand for international stock funds reflected, in part, the strong performance from year to year of many foreign stock markets, especially when compared with returns in the U.S. stock markets. From year-end 2004 to year-end 2007, total cumulative returns on U.S. equity indexes were about 30 percent, while those on world stock indexes (excluding U.S. stocks) were about 74 percent. Cumulative total returns on stocks traded on emerging markets were close to 150 percent over the same period.

Figure 2.8

Flows to Equity Funds Related to global Stock Price Performance

(1993–2007)

Download an Excel file of this data.

1The return on equities is measured as the year-over-year change in the MSCI All Country World Index.
2Net new cash flow to equity funds is plotted as a six-month moving average.
Sources: Investment Company Institute and Morgan Stanley Capital International

Investors tend to own stock 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 those of short-term assets) in a fund's portfolio scaled by average net assets—is a measure of a fund's trading activity. In 2007, the asset-weighted annual turnover rate experienced by stock fund investors edged up to 51 percent, still below the average experience of the past 35 years (Figure 2.9).

Figure 2.9

Turnover Rate1 Experienced by Stock Fund Investors2

(percent, 1973–2007)

Download an Excel file of this data.

1asset-weighted average
2Variable annuities are excluded.
Sources: Investment Company Institute; © CRSP University of Chicago, used with permission, all rights reserved (312.263.6400/www.crsp.com); and Strategic Insight Simfund

Sixty-four percent of stock fund assets were in funds with asset-weighted portfolio turnover rates under 50 percent. This reflects shareholders' tendency to own stock funds with below-average turnover and the propensity for funds with below-average turnover to attract more shareholder dollars.

Asset-Weighted Turnover Rate

To analyze the turnover rate that shareholders actually experience in their funds, it is important to identify those stock funds in which shareholders are most heavily invested. Neither a simple average nor a median takes into account where stock fund assets are concentrated. An asset-weighted average gives more weight to funds with large amounts of assets and, accordingly, indicates the average portfolio turnover actually experienced by fund shareholders.

Bond and Hybrid Funds

In 2007, investors added $109 billion to their bond fund holdings, up substantially from the $61 billion pace of net investment in the previous year. Almost all of the net new cash in 2007 was invested in bond funds prior to the disruptions in credit markets that began in August. For the remainder of the year, bond funds continued to receive net new cash, but at a substantially diminished rate.

Traditionally, cash flow into bond funds is highly correlated with the performance of bonds (Figure 2.10). The U.S. interest rate environment typically has played a prominent role in the demand for bond funds. 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 investor demand for bond funds. This relationship, however, appears to have weakened somewhat over the past few years.

Figure 2.10

Flows to Bond Funds Related to Bond Returns

(1993–2007)

Download an Excel file of this data.

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

Over the period 2004 to 2006, returns on intermediate- to long-term bonds were modest, ranging between 3 percent and 5 percent per year. Based on the historical relationship between bond returns and demand for bond funds, outflows from bond funds would have been expected to continue. However, in 2005, inflows to bond funds resumed and continued to grow rapidly in 2006.

In the first half of 2007, the pace of inflows into bond funds rose further. While some of this increase likely was the result of a decline in interest rates that pushed up returns on high-grade bond funds to around 7 percent, the amount of net investment in bond funds was as high as that last seen in 2003 when returns on bonds exceeded 10 percent.

One factor that may have contributed to bond fund inflows over the past three years is the growing popularity of funds of funds. Net inflows to funds of funds totaled $307 billion from year-end 2004 to year-end 2007 and, likely, some portion of these flows was directed to the underlying bond mutual funds (Figure 2.11).

Investor demand for hybrid funds, which invest in a combination of stocks and bonds, picked up in 2007, with investors adding $22 billion in new cash to these funds, up from only $7 billion the previous year. Over the three-year period 2005 to 2007, hybrid funds attracted a total of $54 billion in net new cash.

Funds of funds

Funds of funds are mutual funds that hold and invest in shares of other mutual funds. The most popular type of these funds is hybrid funds—about 80 percent of fund-of-fund assets are in hybrid funds of funds. Hybrid funds of funds invest their net new cash in underlying stock, bond, and hybrid mutual funds.

Assets of funds of funds have grown rapidly over the past decade. By the end of 2007, the number of funds of funds had grown to 723, and total assets reached $640 billion (Figure 2.11). About two-thirds of the increase in assets of funds of funds in the past 10 years is attributable to increasing investor interest in lifestyle and lifecycle funds. The growing popularity of these funds, especially for retirement investing, likely reflects the automatic rebalancing features of these products. Lifestyle funds, also known as risk-based funds, maintain a predetermined risk level, and lifecycle funds, also known as target date funds, allow a predetermined reallocation of risk over time. Since year-end 1997, funds of funds received a total of $432 billion in net new cash, of which nearly 70 percent was from lifestyle and lifecycle funds.

Figure 2.11

Net Assets and net new Cash Flow to Funds of Funds

(1997–2007)

	Number of Funds1	Assets1 (billions of dollars)	Net New Cash Flow2 (billions of dollars)
1997	94	$21	$3
1998	175	35	6
1999	212	48	7
2000	215	57	10
2001	213	63	9
2002	268	69	12
2003	301	123	30
2004	375	200	51
2005	475	306	79
2006	604	471	101
2007	723	640	127

Download an Excel file of this data.

1year-end
2annual

Demand for Money Market Mutual Funds

Net new cash to money market funds surged in 2007, likely reflecting the attractive yields on retail money market funds and the influence of the financial markets' turmoil and associated declines in short-term interest rates in the latter part of the year.

Retail Money Market Funds

Retail money market funds, which are principally sold to individual investors, received net new cash of $172 billion in 2007, following an inflow of $96 billion the previous year (Figure 2.12). Money fund yields followed the pattern of short-term interest rates, remaining steady in the first part of 2007 then falling off somewhat in the latter part of the year. The difference between yields on money market funds and those on bank deposits remained at just under 4 percentage points for much of the year before narrowing about 80 basis points by year-end (Figure 2.13). Nevertheless, the yield on retail money market funds by year-end 2007 remained quite favorable when compared to the historical experience of the past 15 years.

Figure 2.12

Flows to Money Market Funds reached record levels in 2007

(billions of dollars, 1993–2007)

Download an Excel file of this data.

Figure 2.13

Flows to Taxable Retail Money Market Funds Related to Interest Rate Spread

(1993–2007)

Download an Excel file of this data.

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

Institutional Money Market Funds

Institutional money market funds, used by businesses, pension funds, state and local governments, and other large investors, had inflows of $488 billion in 2007, following inflows of $151 billion the previous year (Figure 2.12). Inflows to institutional money market funds likely were boosted by two factors. First, short-term interest rates fell considerably in the last three months of 2007 as the Federal Reserve eased monetary policy. Institutional money market funds tend to receive inflows when short-term interest rates decline because the yields on these funds lag behind those available on competing products such as direct investments in commercial paper and short-term U.S. Treasury instruments.

Second, the turmoil and illiquidity in credit markets that began in August 2007 may have prompted corporate treasurers to make greater use of institutional money market funds. Some corporate treasurers—cognizant of the lack of liquidity in short-term credit markets and concerned about their ability to adequately monitor and assess credit quality—may have taken the opportunity to redirect some portion of their companies' liquid assets away from direct purchases of short-term instruments and toward institutional money market funds. At year-end 2007, U.S. nonfinancial businesses held a record 31 percent of their short-term assets in money market funds (Figure 2.14).

Figure 2.14

Money Market Mutual Funds Managed 31 Percent of U.S. Businesses' Short-Term Assets* in 2007

(percent, 1993–2007)

Download an Excel file of this data.

*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

Difficulties in the credit markets also influenced the type of money market fund institutional investors gravitated toward. Investors faced with uncertainty about the extent of exposure to certain securities, such as extendible notes or those issued by structured investment vehicles (SIVs) backed by sub-prime mortgages with deteriorating credit quality, appeared to seek out the liquidity and safety of money market funds that invest primarily in U.S. government securities. These funds, which can invest in U.S. Treasury debt solely or a combination of U.S. Treasury debt and obligations of U.S. government agencies, received a record $271 billion in net new cash flow in 2007. Over 90 percent of the new cash was invested in the second half of the year, around the time when problems in the credit markets arose (Figure 2.15). As of year-end 2007, U.S. government money market funds accounted for 34 percent of total assets of taxable institutional money market funds, up from 25 percent at year-end 2006.

For more complete data on money market funds, see Section 4 in the Data Tables and the Statistics and Research section of this site.

Figure 2.15

net assets and Net New Cash Flow to U.S. Government and General Purpose Institutional Money Market Funds

(billions of dollars, 1996–2007)

	U.S. Government		General purpose
Year	Assets1	Net New Cash Flow2	Assets1	Net New Cash Flow2
1996	$125	$14	$155	$19
1997	148	14	210	38
1998	184	27	286	69
1999	195	9	405	101
2000	215	16	513	92
2001	282	69	789	254
2002	304	5	822	13
2003	275	-32	743	-90
2004	257	-22	687	-62
2005	276	15	761	36
2006	303	24	904	118
2007:H1	329	22	983	53
2007:H2	583	249	1,123	131

Download an Excel file of this data.

1year-end
2annual