Chapter Two

US-Registered Investment Companies

Registered investment companies are an important segment of the asset management business in the United States. US-registered investment companies play a major role in the US economy and financial markets, and a growing role in global financial markets. These funds managed more than $21 trillion in total net assets at year-end 2018, largely on behalf of more than 100 million US retail investors. The industry has experienced robust growth over the past quarter century from asset appreciation and strong demand from households due to rising household wealth, the aging US population, and the evolution of employer-based retirement systems. US funds supplied investment capital in securities markets around the world and were significant investors in the US stock and municipal securities markets.

Investment Company Assets in 2018

Total net assets in US-registered investment companies* declined by $1.1 trillion in 2018, to a year-end level of $21.4 trillion (Figure 2.1). With $21.1 trillion in assets, mutual funds and exchange-traded funds (ETFs) accounted for the vast majority.

* The terms investment companies and US investment companies are used at times throughout this book in place of US-registered investment companies. US-registered investment companies are open-end mutual funds, closed-end funds, exchange-traded funds, and unit investment trusts.

Figure 2.1

Investment Company Total Net Assets by Type

Billions of dollars, year-end

 Mutual fundsClosed-end funds1ETFs2UITsTotal3
1999 6,834 157 34 92 7,116
2000 6,956 150 66 74 7,245
2001 6,969 145 83 49 7,246
2002 6,380 161 102 36 6,680
2003 7,399 216 151 36 7,801
2004 8,093 255 228 37 8,614
2005 8,889 276 301 41 9,507
2006 10,395 299 423 50 11,167
2007 11,995 316 608 53 12,973
2008 9,619 185 531 29 10,364
2009 11,109 224 777 38 12,149
2010 11,831 239 992 51 13,113
2011 11,630 244 1,048 60 12,982
2012 13,054 265 1,337 72 14,728
2013 15,049 282 1,675 87 17,092
2014 15,877 292 1,975 101 18,244
2015 15,658 263 2,101 94 18,116
2016 16,353 265 2,524 85 19,227
2017 18,764 277 3,401 85 22,527
2018 17,707 250 3,371 70 21,398

1 Closed-end fund data include preferred share classes.

2 ETF data prior to 2001 were provided by Strategic Insight Simfund.

3 Total investment company assets include mutual fund holdings of closed-end funds and ETFs.

Sources: Investment Company Institute and Strategic Insight Simfund

The majority of US mutual fund and ETF net assets at year-end 2018 were in long-term funds, with equity funds constituting 56 percent (Figure 2.2). Domestic equity funds (those that invest primarily in shares of US corporations) held 41 percent of net assets and world equity funds (those that invest significantly in shares of non-US corporations) accounted for 15 percent. Bond funds held 22 percent of US mutual fund and ETF net assets. Money market funds, hybrid funds, and other funds—such as those that invest primarily in commodities—held the remainder (21 percent).

Mutual funds recorded $191 billion in net outflows in 2018 (Figure 3.4). While long-term mutual funds saw net outflows of $350 billion, money market funds received $159 billion of net inflows. Mutual fund shareholders reinvested $305 billion in income dividends and $495 billion in capital gains distributions that mutual funds paid out during the year. Investors continued to show strong demand for ETFs with net share issuance (which includes reinvested dividends) totaling $311 billion in 2018 (Figure 4.8). Unit investment trusts (UITs) experienced net new deposits of $49 billion, about the same as the previous year, and closed-end funds issued a net $597 million in new shares (Figure 5.3).

Figure 2.2

The Majority of US Mutual Fund and ETF Total Net Assets Were in Equity Funds

Percentage of total net assets, year-end 2018

   

* This category includes ETFs—both registered and not registered under the Investment Company Act of 1940—that invest primarily in commodities, currencies, and futures.

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Monthly Trends in Mutual Fund Investing

Americans’ Continued Reliance on Investment Companies

Households make up the largest group of investors in funds, and registered investment companies managed 21 percent of household financial assets at year-end 2018 (Figure 2.3).

Figure 2.3

Share of Household Financial Assets Held in Investment Companies

Percentage of household financial assets, year-end

   

Note: Household financial assets held in registered investment companies include household holdings of mutual funds, ETFs, closed-end funds, and UITs. Mutual funds held in employer-sponsored DC plans, IRAs, and variable annuities are included.

Sources: Investment Company Institute and Federal Reserve Board

The growth of individual retirement accounts (IRAs) and defined contribution (DC) plans, particularly 401(k) plans, explains some of the increased household reliance on investment companies in the past three decades. IRAs made up 10 percent of household financial assets at year-end 2018, up from 3 percent in 1988, while DC plans have risen from 5 percent of household financial assets to 9 percent over the same period (with 401(k) plans accounting for 6 percent of household financial assets at year-end 2018). Mutual funds made up a significant portion of DC plan assets (56 percent) and IRA assets (45 percent) at year-end 2018 (Figure 2.4). In addition, the share of DC plan assets held in mutual funds has grown significantly over the past two decades, from 37 percent at year-end 1998 to 56 percent at year-end 2018. Mutual funds also managed $1.2 trillion in variable annuities outside retirement accounts, as well as $8.4 trillion of other assets outside retirement accounts.

Figure 2.4

Mutual Funds in Household Retirement Accounts

Percentage of retirement assets in mutual funds by type of retirement vehicle

   

* This category includes private-sector employer-sponsored DC plans (including 401(k) plans), 403(b) plans,
457 plans, and the Federal Employees Retirement System (FERS) Thrift Savings Plan (TSP).

Sources: Investment Company Institute, Federal Reserve Board, Department of Labor, National Association of Government Defined Contribution Administrators, American Council of Life Insurers, and Internal Revenue Service Statistics of Income Division. See Investment Company Institute, “The US Retirement Market, Fourth Quarter 2018.”

Businesses and other institutional investors also rely on funds. For instance, institutions can use money market funds to manage some of their cash and other short-term assets. At year‑end 2018, nonfinancial businesses held $616 billion (18 percent) of their short-term assets in money market funds (Figure 2.5). Institutional investors also have contributed to growing demand for ETFs. Investment managers—including mutual funds, pension funds, hedge funds, and insurance companies—use ETFs to invest in markets, to manage liquidity and investor flows, or to hedge their exposures.

Figure 2.5

Money Market Funds Managed 18 Percent of US Nonfinancial Businesses’ Short‑Term Assets in 2018

Percentage of short-term assets, year-end

   

Note: US nonfinancial businesses’ short-term assets consist of foreign deposits, checkable deposits and currency, time and savings deposits, money market funds, repurchase agreements, and commercial paper.

Sources: Investment Company Institute and Federal Reserve Board

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Money Market Fund Resource Center

Role of Investment Companies in Financial Markets

Investment companies have been among the largest investors in the domestic financial markets for much of the past 20 years. And in recent years, they have held a fairly stable share of the securities outstanding across a variety of asset classes. At year-end 2018, investment companies held approximately 30 percent of the shares of US-issued equities outstanding, little changed from 31 percent in 2015 (Figure 2.6). Investment companies also held 20 percent of bonds issued by US corporations and foreign bonds held by US residents at year-end 2018. The percentage of corporate bonds outstanding held by investment companies has also changed little since 2015, with mutual funds holding a significantly larger share relative to other registered investment companies.

Investment companies also held 13 percent of the US Treasury and government agency securities outstanding at year-end 2018, a share that has remained fairly stable over the past few years (Figure 2.6). As a whole, investment companies have been one of the largest groups of investors in US municipal securities, holding 25 percent of the municipal securities outstanding at year-end 2018.

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Corporate and Investment Grade Bond Funds: What’s in a Name?

Figure 2.6

Investment Companies Channel Investment to Stock, Bond, and Money Markets

Percentage of total market securities held by investment companies, year-end

   

1 The percentage of total US Treasury and government agency securities held by other registered investment companies was less than 0.5 percent in each year.

2 Other registered investment companies held no commercial paper..

Sources: Investment Company Institute, Federal Reserve Board, and World Federation of Exchanges

Historically, mutual funds have been one of the largest investors in the US commercial paper market—an important source of short-term funding for major corporations around the world. Mutual fund demand for commercial paper arose primarily from prime money market funds. In 2016, however, assets of prime money market funds fell 70 percent (nearly $900 billion) as these funds adapted to the 2014 SEC rule amendments that required the money market fund industry to make substantial changes by October 2016. Consequently, prime money market funds sharply reduced their holdings of commercial paper. From year-end 2015 to year-end 2016, mutual funds’ share of the commercial paper market fell from 40 percent to 19 percent (Figure 2.6). By year-end 2017, mutual funds had increased their share of the commercial paper market to 25 percent, and their share was little changed (24 percent) at year-end 2018.

Growth in Index Funds

Index funds are designed to track the performance of a market index. To do this, the fund manager purchases all of the securities in the index, or a representative sample of them, so that the performance of the fund tracks the value of the index. This approach to portfolio management is the primary reason that index funds—which can be formed as either mutual funds or ETFs—tend to have below-average expense ratios.

Index mutual funds were first offered in the 1970s, followed by index ETFs in the 1990s. By year-end 2018, total net assets in these funds grew to $6.6 trillion. Along with this growth, index funds have become a larger share of overall fund assets. At year-end 2018, index mutual funds and index ETFs together accounted for 36 percent of assets in long-term funds, up from 18 percent at year-end 2008 (Figure 2.7). Nevertheless, actively managed funds were the majority of fund assets (64 percent) in 2018.

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Pointing Fingers at Index Funds Won’t Explain Market Volatility

Figure 2.7

Index Funds Have Grown as a Share of the Fund Market

Percentage of total net assets, year-end

   

* This category includes a small number of actively managed ETFs.

Note: The ETF category excludes non–1940 Act ETFs. The mutual fund category excludes money market funds.

Much of the growth in index funds over the past decade has been concentrated in funds that invest in domestic equities. During this time frame, 42 percent of inflows into index funds went to domestic equity funds, and domestic equity index funds accounted for 62 percent of index fund assets at year-end 2018. Despite their recent rapid growth, index domestic equity mutual funds and ETFs remain a relatively small part of US stock markets, holding only 13 percent of the value of US stocks at year-end 2018 (Figure 2.8). Actively managed domestic equity mutual funds and ETFs held another 15 percent, while other investors—including hedge funds, pension funds, life insurance companies, and individuals—held the remaining 71 percent.

Figure 2.8

Index Fund Share of US Stock Market Is Small

Percentage of US stock market capitalization, year-end

   

Note: In 2008 and 2009, data for index ETFs include a small number of actively managed ETFs.

Sources: Investment Company Institute and World Federation of Exchanges

Types of Intermediaries and Number of Investment Companies

A variety of financial services companies offer registered funds in the United States. At year- end 2018, 81 percent of investment company complexes were independent fund advisers (Figure 2.9), and these firms managed 70 percent of investment company assets. Other types of investment company complexes in the US market include non-US fund advisers, insurance companies, banks, thrifts, and brokerage firms.

Figure 2.9

More Than 80 Percent of Fund Complexes Were Independent Fund Advisers

Percentage of investment company complexes by type of intermediary, year-end 2018

   

In 2018, 846 fund sponsors from around the world competed in the US market to provide investment management services to fund investors (Figure 2.10). The decline in the number of fund sponsors since year-end 2015 may be due to a variety of business decisions, including larger fund sponsors acquiring smaller ones, fund sponsors liquidating funds and leaving the business, or larger sponsors selling their advisory businesses. Prior to 2015, the number of fund sponsors had been increasing as the economy and financial markets recovered from the 2007–2009 financial crisis. As a whole, from 2010 through 2018, 588 sponsors entered the market while 426 left, for a net increase of 162.

Figure 2.10

Number of Fund Sponsors

 

   

Many recent entrants to the fund industry have adopted solutions in which the fund’s sponsor arranges for a third party to provide certain services (e.g., audit, trustee, some legal) through a turnkey setup. This allows the sponsor to focus more on managing portfolios and gathering assets. Through an arrangement known as a series trust, the third party provides services to a number of independent fund sponsors under a single complex that serves as an “umbrella.” This can be cost-efficient because the costs of operating funds are spread across the combined assets of a number of funds in the series trust.

The increased availability of other investment products has led to changes in how investors are allocating their portfolios. The percentage of mutual fund companies retaining assets and attracting net new investments generally has been lower in recent years. In 2018, 26 percent of fund complexes saw inflows to their long-term mutual funds; 75 percent of ETF sponsors had positive net share issuance (Figure 2.11).

Figure 2.11

Positive Net New Cash Flow to Long-Term Mutual Funds and Positive Net Share Issuance of ETFs

Percentage of fund complexes

   

* Data for ETF net share issuance include reinvested dividends.

In the past decade, the percentage of fund complexes attracting new money into their long-term mutual funds has decreased, while the concentration of mutual fund and ETF assets managed by the largest fund complexes has increased. The share of assets managed by the five largest firms rose from 35 percent in 2005 to 51 percent in 2018, and the share managed by the 10 largest firms increased from 46 percent to 61 percent (Figure 2.12). Some of the increase in market share occurred at the expense of the middle tier of firms—those ranked from 11 to 25—whose market share fell from 21 percent in 2005 to 18 percent in 2018.

Figure 2.12

Share of Mutual Fund and ETF Assets at the Largest Fund Complexes

Percentage of total net assets of mutual funds and ETFs, year-end

 200520102015201620172018
Largest 5 complexes 36 42 45 47 50 51
Largest 10 complexes 47 55 56 58 60 61
Largest 25 complexes 69 74 75 76 77 79

Note: Data include only mutual funds and ETFs registered under the Investment Company Act of 1940.

At least two factors have contributed to the rise in industry concentration. First, because the 10 largest fund complexes manage most of the assets in index mutual funds, the growing popularity of index funds has increased concentration. Actively managed domestic equity mutual funds had outflows in every year after 2005, while index domestic equity mutual funds had inflows and index domestic equity ETFs had positive net share issuance in each of these years. Second, strong inflows over the past decade to bond mutual funds (Figure 3.10), which are fewer in number and are less likely to be offered by smaller fund sponsors, helped boost the share of assets managed by large fund complexes.

Macroeconomic conditions and competitive dynamics can affect the supply of funds offered for sale. Fund sponsors create new funds to meet investor demand, and they merge or liquidate those that do not attract sufficient investor interest. A total of 582 mutual funds and ETFs opened in 2018, down from 733 in 2017, and well below the 2007–2017 annual average of 815 (Figure 2.13). The rate of mutual fund and ETF mergers and liquidations declined from 708 in 2017 to 591 in 2018.

Figure 2.13

Number of Mutual Funds and ETFs Entering and Leaving the Industry

 

   

Note: Data include mutual funds that do not report statistical information to the Investment Company Institute and mutual funds that invest primarily in other mutual funds. ETF data include ETFs that invest primarily in other ETFs.

Unit Investment Trusts

Unit investment trusts (UITs) are registered investment companies with characteristics of both mutual funds and closed-end funds. Like mutual funds, UITs issue redeemable shares (called units), and like closed-end funds, they typically issue a specific, fixed number of shares. But unlike either mutual funds or closed-end funds, UITs have a preset termination date based on the portfolio’s investments and the UIT’s investment goals. UITs investing in long-term bonds might have a preset termination date of 20 to 30 years, depending on the maturity of the bonds they hold. UITs investing in stocks might seek to capture capital appreciation in a few years or less. When a UIT terminates, proceeds from the securities are paid to unit holders or, at a unit holder’s election, reinvested in another trust.

UITs fall into two main categories: bond trusts and equity trusts. Bond trusts are either taxable or tax-free; equity trusts are either domestic or international/global. The first UIT, introduced in 1961, held tax-free bonds, and historically, most UIT total net assets were invested in bonds. Equity UITs, however, have grown in popularity over the past two decades. Assets in equity UITs have exceeded the combined assets of taxable and tax-free bond UITs in recent years and constituted 86 percent of the assets in UITs at year-end 2018 (Figure 2.14). The number of trusts outstanding has been decreasing as sponsors created fewer new trusts and existing trusts reached their preset termination dates.

Federal law requires that UITs have a largely fixed portfolio—one that is not actively managed or traded. Once the trust’s portfolio has been selected, its composition may change only in very limited circumstances. Most UITs hold a diversified portfolio, described in detail in the prospectus, with securities professionally selected to meet a stated investment goal, such as growth, income, or capital appreciation.

Investors can obtain UIT price quotes from brokerage or investment firms and investment company websites, and some but not all UITs list their prices on NASDAQ’s Mutual Fund Quotation Service. Some broker-dealers offer their own trusts or sell trusts offered by nationally recognized independent sponsors. Units of these trusts can be bought through their registered representatives. Units can also be bought from the representatives of smaller investment firms that sell trusts sponsored by third-party firms.

Though a fixed number of units of a UIT are sold in a public offering, a trust sponsor is likely to maintain a secondary market, in which investors can sell their units back to the sponsor and other investors can buy those units. Even absent a secondary market, UITs are required by law to redeem outstanding units at their net asset value (NAV), which is based on the underlying securities’ current market value.

Figure 2.14

Total Net Assets and Number of UITs

Year-end

 

The total number of investment companies has increased since 2005 (the recent low point), but it remains well below the year-end 2000 peak (Figure 2.15). This largely reflects the sharp decline in UITs in the early 2000s. The number of UITs declined to 4,917 at year-end 2018 from 5,035 at year-end 2017. The number of mutual funds increased in 2018 to a total of 9,599 funds from 9,354 at year-end 2017. The total number of closed-end funds fell to 506 at year-end 2018, the lowest level since 2001. The number of ETFs continues to grow, with 2,057 ETFs at year-end 2018, nearly three times the total number of ETFs a decade ago.

Figure 2.15

Number of Investment Companies by Type

Year-end

 Mutual funds1Closed-end fundsETFs2UITsTotal
1999 7,970 512 30 10,414 18,926
2000 8,349 482 80 10,072 18,983
2001 8,480 490 102 9,295 18,367
2002 8,490 543 113 8,303 17,449
2003 8,406 581 119 7,233 16,339
2004 8,411 618 152 6,499 15,680
2005 8,439 635 204 6,019 15,297
2006 8,704 646 359 5,907 15,616
2007 8,723 664 629 6,030 16,046
2008 8,860 644 743 5,984 16,231
2009 8,594 629 820 6,049 16,092
2010 8,523 626 950 5,971 16,070
2011 8,662 634 1,166 6,043 16,505
2012 8,742 604 1,239 5,787 16,372
2013 8,970 601 1,332 5,552 16,455
2014 9,256 570 1,451 5,381 16,658
2015 9,515 561 1,644 5,188 16,908
2016 9,505 534 1,774 5,100 16,913
2017 9,354 533 1,900 5,035 16,822
2018 9,599 506 2,057 4,917 17,079

1 Data include mutual funds that invest primarily in other mutual funds.

2 ETF data prior to 2001 were provided by Strategic Insight Simfund. ETF data include ETFs that invest primarily in other ETFs.

Sources: Investment Company Institute and Strategic Insight Simfund

Investment Company Employment

Registered investment companies typically do not have employees—instead, they contract with other businesses to provide services to the fund. Except for UITs, funds in the United States have fund boards that oversee the management of the fund and represent the interests of the fund shareholders. Fund boards must approve all major contracts between the fund and its service providers, including the advisory contract with a fund’s investment adviser, who is usually also the fund’s sponsor.

Fund sponsors and third-party service providers offer advisory, recordkeeping, administrative, custody, and other services to a growing number of funds and their investors. Fund industry employment in the United States has grown 56 percent since 1997, from 114,000 workers in 1997 to 178,000 workers in 2017 (Figure 2.16).

Figure 2.16

Investment Company Industry Employment

Estimated number of employees of fund sponsors and their service providers, thousands

   

Note: Years are those in which ICI conducted its employment survey.

Fund investment advisers are one of the prominent providers of services to funds. This group of service providers is responsible for managing the fund’s business affairs, ensuring compliance with laws and regulations, overseeing other third-party service providers the fund may rely on, and directing funds’ investments by undertaking investment research and determining which securities to buy and sell. The adviser will often undertake trading and security settlement for the fund. In March 2017, 39 percent of the industry worked in support of fund management functions such as investment research, trading and security settlement, information systems and technology, and other corporate management functions (Figure 2.17).

The second-largest group of workers (28 percent) provides services to fund shareholders and their accounts (Figure 2.17). Shareholder account servicing encompasses a wide range of activities to help investors monitor and update their accounts. These employees work in call centers and help shareholders and their financial advisers with questions about investor accounts. They also process applications for account openings and closings. Other services include retirement plan transaction processing, retirement plan participant education, participant enrollment, and plan compliance.

Distribution and sales force personnel together accounted for 24 percent of the workforce (Figure 2.17). Employees in these areas may work in marketing, product development and design, or investor communications, and can include sales support staff, registered representatives, and fund supermarket representatives.

Fund administration, which includes financial and portfolio accounting and regulatory compliance duties, accounted for 10 percent of industry employment (Figure 2.17). Employees performing those services are often affiliated with a fund’s investment adviser. Fund administration encompasses the middle- and back-office functions necessary to operate the fund, and includes clerical and fund accounting services, data processing, recordkeeping, internal audits, and compliance and risk management functions.

Figure 2.17

Investment Company Industry Employment by Job Function

Percentage of employees of fund sponsors and their service providers, March 2017

   

Typically, employees with administration duties are responsible for regulatory and compliance requirements, such as preparing and filing regulatory reports, overseeing fund service providers, preparing and submitting reports to regulators and tax authorities, and producing shareholder reports such as prospectuses and financial statements of the funds. Administration services also help to maintain compliance procedures and internal controls, subject to approval by a fund’s board and chief compliance officer.

For many industries, employment tends to be concentrated in locations where the industry began. The same is true for investment companies: those located in Massachusetts and New York, early hubs of investment company operations, employ 23 percent of fund industry workers (Figure 2.18). As the industry has grown, other states—including California, Pennsylvania, and Texas—have become major centers of fund industry employment. Fund companies in these three states employed more than one-quarter of US fund industry employees as of March 2017.

Figure 2.18

Investment Company Industry Employment by State

Estimated number of employees of fund sponsors and their service providers by state, March 2017