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Mutual Funds and the U.S. Equity Market

Agency securities. Agency securities are the obligations of federal gov- ernment agencies or government-sponsored enterprises. Generally, agency debt offers a slight yield premium over T-bills. Turn back to Chapter 6 for more on agency securities. Commercial paper. Commercial paper, or CP, is issued by corporations (including banks) to finance short-term cash needs. While smaller corpo- rations usually depend on bank loans for this type of funding, larger cor- porations with good credit ratings can access the CP market and often do so. By raising money from investors directly rather than from a bank, these companies can lower their borrowing costs | Mutual Funds and the U.S. Equity Market Eric M. Engen and Andreas Lehnert of the Board s Division of Research and Statistics prepared this article with the assistance of Richard Kehoe. Mutual funds have become an important intermediary between households and financial markets particularly the equity market. By providing liquid lowcost shares in a diversified portfolio of financial assets selected by professional money managers mutual funds have enabled an increasing number of households to enter financial markets. Indeed about half of all U.S. households currently own shares in a mutual fund. Since 1990 total mutual fund assets have increased nearly sevenfold and the assets of mutual funds that invest in stocks have grown even more expanding nearly twentyfold. Over the same period mutual fund assets have come to account for a larger share of household wealth. Moreover a greater proportion of U.S. households now own stock in large part because of their investments in mutual funds. Much of this growth has come in households retirement assets as developments in pension plans and other taxpreferred retirement accounts have increasingly made it possible for households to control more of their retirement asset portfolios and households have tended to invest a significant portion of their retirement assets in mutual funds. As the popularity of mutual funds as an investment vehicle has grown so too has their importance in financial markets. Mutual funds currently hold about one-fifth of publicly traded U.S. corporate equities. Thus the investment behavior of mutual fund shareholders could in theory influence equity market prices. For example if fund shareholders were to request large redemptions from their accounts when faced with a sharp decline in equity prices mutual fund managers might be forced to sell some of the funds equity holdings in the slumping market exacerbating the decline. In recent years however mutual fund shareholders as a group have not tended to flee .