Institutional Investors

by E. Philip Davis and Benn Steil

• ISBN13: 9780262541756
• ISBN10: 0262541750
• Format: Paperback
• Copyright: 2004-03-01
• Publisher: Mit Pr

Summary

One of the most important recent developments in financial markets is the institutionalization of saving associated with the growth of pension funds, life insurance companies, and mutual funds. An increasing proportion of household saving is now managed by professional portfolio managers instead of being directly invested in the securities markets or held in the form of bank deposits. With the aging of the population and its adverse impact on public pension systems, the shift of individual savings to institutional investors is likely to become even more marked in the coming years. This book provides a comprehensive economic assessment of institutional investment. It charts the development and performance of the asset management industry and analyzes the implications of rising institutionalized saving for the development of the securities trading industry, the financial sector as a whole, and the wider economy. The book draws extensively on international experience, particularly in the United States, Western Europe, and Japan.

Author Biography

Linda J. Wachner is Chair in Foreign Economic Policy at the Council on Foreign Relations.

Table of Contents

Acknowledgments	p. xix
About the Authors	p. xxi
Introduction and Executive Summary	p. xxiii
The Development and Performance of Institutional Investors	p. 1
The Development of Institutional Investors	p. 3
Introduction	p. 3
Size of Institutions and Financial Systems	p. 3
Summary Ratios and Institutional Investment	p. 4
Estimates of the Size of Institutional Investors	p. 9
Characteristics of Institutions and Their Role in the Financial Sector	p. 12
General Features Common to All Institutional Investors	p. 12
The Main Types of Institutional Investor	p. 14
Risk Bearing and Regulation	p. 18
Institutional Investors and the Functions of the Financial Sector	p. 21
Institutions and Financial Development	p. 25
Development of Corporate Financing	p. 25
Three Phases of Financial Development and the Role of Banks	p. 27
Preconditions for Financial Development	p. 28
Supply and Demand Factors Underlying the Growth of Institutional Investors	p. 29
Household and Institutional Balance Sheet Composition	p. 29
Supply-Side Factors Favoring Growth of Institutional Investors	p. 34
Structural Aspects	p. 34
Recent Developments	p. 38
Demand Factors	p. 41
Past Demographic Factors and Institutional Saving	p. 42
Future Demographic Changes	p. 44
Pressures on Pension Systems in the Wake of Population Aging	p. 45
Saving Projections in the Light of Demographic Shifts	p. 48
Nondemographic Aspects	p. 49
Conclusions	p. 50
Investment Behavior and Performance of Institutional Investors	p. 51
Introduction	p. 51
Asset Management Objectives and Constraints	p. 52
The Risk-Return Trade-Off	p. 52
Steps in Institutional Investment	p. 53
The Role of Liabilities	p. 55
Alternative Approaches to Asset Allocation	p. 56
The Role of Conventions	p. 57
Investment Techniques: Active and Passive Management	p. 58
Style Analysis	p. 61
Investment Considerations for the Main Types of Institutional Investor	p. 63
Mutual Funds	p. 64
Life Insurers	p. 65
Pension Funds	p. 66
Defined Contribution Pension Funds	p. 68
Defined Benefit Pension Funds	p. 69
The Role of Individual Investors in Determining Institutional Behavior	p. 72
Topics in Investment	p. 74
Issues in Equity Investment	p. 74
International Investment	p. 75
Arguments Favoring International Investment	p. 75
Reasons for Home Asset Preference	p. 77
Derivatives	p. 79
Performance Measurement	p. 80
Asset Manager Performance at a Micro Level	p. 81
Asset Manager Performance: Mutual Funds	p. 82
Asset Manager Performance: Pension Funds	p. 87
Asset Manager Returns at a Macro Level: A Case Study of Pension Fund Sectors	p. 94
Influences on the Portfolio	p. 95
Returns and Risks on the Portfolio	p. 103
Conclusions	p. 108
The Industry of Asset Management: Present and Future	p. 111
The Industrial Structure and Dynamics of Asset Management	p. 113
Introduction	p. 113
What Is Asset Management?	p. 114
Aspects of the Industrial Economics of Financial Institutions	p. 115
The Structure-Conduct-Performance Model	p. 116
Contestable Markets	p. 118
Discretion and Managerial Approaches	p. 119
Strategic Competition	p. 120
Summary	p. 121
Generic Aspects of the Asset Management Industry	p. 122
Wholesale Asset Management	p. 123
Generic Asset Management	p. 123
Specialized Asset Management	p. 124
Balanced Management	p. 126
General Features of Wholesale Management	p. 127
Retail Asset Management	p. 128
The U.S. Asset Management Sector	p. 131
Wholesale Asset Management in the United States	p. 132
Overview	p. 132
Structural Aspects	p. 135
Conduct and Performance	p. 139
Summary	p. 141
Retail Asset Management in the United States	p. 142
Overview	p. 142
Structural Aspects	p. 144
Conduct and Performance	p. 149
Summary	p. 151
The U.K. Asset Management Sector	p. 151
Wholesale Asset Management in the United Kingdom	p. 153
Overview	p. 153
Structural Aspects	p. 155
Conduct and Performance	p. 157
Summary	p. 160
Retail Asset Management in the United Kingdom	p. 162
Overview	p. 162
Structural Aspects	p. 162
Conduct and Performance	p. 164
Summary	p. 165
The Continental European Asset Management Sectors	p. 165
Wholesale Asset Management in Continental Europe	p. 167
Overview	p. 167
Structural Aspects	p. 168
Conduct and Performance	p. 169
Summary	p. 171
Retail Asset Management in Continental Europe	p. 172
Overview	p. 172
Structural Aspects	p. 173
Conduct and Performance	p. 176
Summary	p. 177
The Evolution of Wholesale Asset Management in Japan	p. 177
The Historical Situation	p. 177
Recent Changes	p. 179
The Mutual Fund Sector	p. 180
Conclusions	p. 181
Influences on the Future of the Asset Management Industry	p. 183
Introduction	p. 183
Challenges in the U.S. Market	p. 183
Wholesale Asset Management	p. 183
Retail Asset Management	p. 185
Social Security Privatization	p. 188
The Future of U.K. Asset Management	p. 189
Europe: European Monetary Union and Institutional Investors	p. 192
Ongoing Forces for Change	p. 192
EMU and Pension Provision	p. 195
Improved Conditions for Institutional Investment under EMU	p. 196
Pressures on Banks' Traditional Business	p. 198
The Scope of Potential Change in Financing	p. 199
Globalization of the Industry?	p. 200
Questionnaire Answers Relating to the Structure and Dynamics of Asset Management Sectors	p. 205
Sample Characteristics	p. 206
Elements of Competition in the Market	p. 209
Barriers to Entry in Domestic Markets	p. 212
Barriers to Entry in Foreign Markets	p. 214
Expectations Regarding Industry Structure	p. 215
Economies of Scale	p. 216
Influences on the Asset Management Sector over the Next Five Years	p. 218
Conclusions	p. 221
Institutional Investment, the Financial Sector, and the Economy	p. 223
Implications of the Growth of Institutional Investors for the Financial Sectors	p. 225
Introduction	p. 225
Implications for Capital Markets	p. 226
Institutional Investors and the Growth of Capital Markets	p. 226
Patterns of Institutional and Capital Market Developments	p. 226
Experience in Chile	p. 229
Estimates of the Relationship of Institutionalization to Capital Market Development	p. 232
Institutional Investors and Securities Market Structure	p. 236
General Considerations	p. 236
Institutional Investors and Equity Market Structure	p. 237
Institutional Investors and Debt Market Structure	p. 239
Derivatives and Other New Markets	p. 240
Implications for Banks	p. 243
Trends in Banking	p. 243
Competition on the Liabilities Side	p. 246
Competition on the Asset Side	p. 247
Bank's Responses to Disintermediation	p. 250
The Future of Banking	p. 252
Institutionalization and Financial Stability	p. 255
Institutions and Securities Market Turbulence: General Considerations	p. 255
Asset Price Volatility	p. 257
Herding by Institutional Investors	p. 259
Capital Market Instability	p. 265
Overview	p. 265
Herding and Price Volatility	p. 267
Market Liquidity Risk	p. 268
Why Are Market Liquidity Crises of Concern?	p. 270
Institutional Investors and Liquidity in the Russia/LTCM Episode	p. 271
Institutional Behavior and Emerging Markets	p. 274
U.S. Mutual Funds and Financial Stability	p. 278
The Threatened Insolvency of Japanese Institutional Investors	p. 282
Conclusions	p. 284
Implications of the Growth of Institutional Investors for the Nonfinancial Sectors	p. 287
Introduction	p. 287
Macroeconomic Implications of Institutionalization	p. 288
Institutions and Saving	p. 288
Institutions and Financing Patterns	p. 292
International Capital Flows	p. 295
Trends in Portfolio Investment	p. 295
International Investment and Portfolio Strategies	p. 298
Causes of Increased International Investment	p. 299
Macroeconomic Implications	p. 300
Corporate Finance Issues	p. 302
Corporate Financing Patterns and Debt Finance	p. 302
Corporate Governance and Institutional Investors in the United States	p. 305
Agency Costs and Equity Finance	p. 305
Four Paradigms of Corporate Governance	p. 308
The Corporate Governance Movement in the United States	p. 311
Effectiveness of Shareholder Activism	p. 315
Corporate Governance in Europe and Japan: A Revolution in Corporate Financing?	p. 317
Institutional Investors and Bank-Based Systems of Corporate Finance	p. 317
Barriers to Change	p. 319
EMU and Corporate Governance	p. 320
Risks in the Transition	p. 322
Summary	p. 323
Short-Termism	p. 323
Small Firm Finance	p. 325
The Public Sector and Policy Issues	p. 330
Government Finance	p. 330
Financial Regulation	p. 333
Monetary Stability	p. 337
Financial Stability	p. 340
Conclusions	p. 343
Institutional Trading	p. 345
Automation, Trading Costs, and the Structure of the Securities Trading Industry	p. 347
Introduction	p. 347
Automation and Network Effects	p. 350
Networks in the Context of Automated Trading and Market Structure Development	p. 352
Entry and Cost	p. 352
Entry and Strategic Pricing	p. 356
Adapters and Incompatible Networks	p. 357
Remote Cross-Border Trading	p. 357
Mergers and Alliances	p. 358
Automation and Cross-Subsidization of Trading	p. 361
Cross-Subsidization of Large Trades by Small Trades	p. 362
Cross-Subsidization of On-Exchange by Off-Exchange Trades	p. 364
Cross-Subsidization of Retail Trades by Institutional Trades	p. 364
Automation and Exchange Governance	p. 365
Market Quality Comparisons	p. 369
Bid-Offer Spreads	p. 371
Depth of Market	p. 372
Informational Efficiency	p. 372
Adverse Selection	p. 373
Transmission of Information to Prices	p. 374
Volatility	p. 374
What Have We Learned about Relative Market Quality?	p. 376
Transaction Costs, Intermediation, and Market Structure	p. 378
The Data	p. 379
The Definition of Transaction Costs	p. 382
Average Trading Costs	p. 383
A Benchmark Correction for Trade Difficulty	p. 386
Execution Costs Relative to Benchmark Costs	p. 388
Trade Characteristics and Total Trading Costs	p. 390
Conclusions	p. 393
Institutional Trading Costs: The Impact of Market Structure and Trading Practices	p. 399
Introduction	p. 399
The Significance of Trading Costs: The Implementation Shortfall	p. 400
Measuring and Decomposing Trading Costs	p. 400
Explicit Costs	p. 400
Implicit Costs	p. 401
Bid-Offer Spreads	p. 401
Market Impact	p. 403
Opportunity Costs	p. 405
Trading Costs and Investment Style	p. 407
Trading Costs and Order Handling	p. 408
Managing Information Leakage	p. 408
Managing Commissions	p. 410
VWAP Trading	p. 417
Trading Costs and Market Structures	p. 419
Auction versus Dealer Markets	p. 419
Intermediated versus Nonintermediated Markets	p. 421
ECN Trading	p. 423
Alphabet Soup	p. 423
Institutional ECN Use	p. 424
The Future of ECNs	p. 428
The Future of Institutional Trading	p. 429
Trading Systems	p. 430
The Major Players	p. 431
Trade Intermediation	p. 432
Public Policy	p. 432
Glossary	p. 437
References	p. 457
Name Index	p. 489
Subject Index	p. 497
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