Chapter 10. Institutional Investors

SURVEY

The Institutional Investors company shares is interested in institutional investing because he participates in such invest­ment when he buys investment company shares. Secondly, institutional investing has an impact on prices and may influ­ence the price, which he pays for his shares. Thirdly, institu­tional investing affects and probably will affect to an even larger degree both the securities market and the economy of the nation.

Institutional investing refers to investments made by an in­dividual through an intermediary rather than directly. In addi­tion to investment companies, closed-end and open-end, these intermediaries include life insurance companies, fire and cas­ualty companies, non-insured pension funds, personal trust funds, and common stock trust funds. To be fully inclusive, it would be necessary to list the assets of savings and loan associa­tions and the savings deposits of commercial banks as well as the deposits of mutual savings banks.

A review of the growth of the value of stocks held by financial intermediaries will serve to indicate their magnitude. The value of stockholdings at any point in time reflects both the rise in stock prices that may have occurred and the more general ac­ceptance of investment in common stocks as wise policy (it is now authorized by law).

The decade of the fifties is aptly described as the decade of common stocks. For many years, trustees could not invest in common stocks unless specifically authorized to do so. Gradually, many states adopted the so-called prudent man rule, which gave trustees greater latitude and permitted them to invest not only in bonds but also in common stocks that met certain tests. In 1951, New York State life insurance companies were per­mitted to make limited investments in common stocks, a prac­tice which had been beyond the pale since the insurance scandals in the early years of this century. In 1952, mutual savings banks were granted similar authority. In fact, such banks were authorized to organize an investment company. In­stitutional Shareholders Mutual Fund, Incorporated, which in­vests in common stocks, is owned by New York State mutual savings banks.

Besides changes in the law, the long-term record of common stocks and the inflationary tendencies prevailing during the fifties induced managers of college endowment funds and pen­sion funds to invest in common stocks. A step that gained wide attention was taken in 1952, when the Teachers Insurance and Annuity Association formed the College Retirement Equities Fund and introduced the first variable annuity contract involv­ing common stock investment. Common trust funds, administer­ing small individual trusts through a cooperative pooling of the assets of the smaller trusts, were established. They have in­vested a substantial part of these funds in common stocks. Such developments influenced the investment practice of individuals and undoubtedly had a profound effect on the growth of invest­ment companies, particularly open-end funds.

It has been estimated that the value of stock holdings of finan­cial intermediaries increased from approximately $18 billion in 1949 to almost $29 billion in 1949 and rose to about $84 billion in 1956.* Securities and Exchange Commission estimates of net purchases of common and preferred stocks made by financial institutions set the amount at approximately $1.0 billion in 1951 and $3.4 billion in 1960.

* Cedric V. Fricke, "The Variable Annuity," Michigan Business Studies, Vol. xiv, No. e, 1959, p. 20. This essay leans on the investigation of Raymond W. Goldsmith, Financial Intermediaries in the National Economy, (Princeton, N.J.: Princeton University Press, 1958).

The steadily growing importance of stock purchases (both preferred and common) is shown in the following tabulation (in billions of dollars):*

* Much of this section is abstracted from the excellent survey, "Institutional Investors and the Stock Market," Monthly Review, Federal Reserve Bank of Kansas City, August 1959, p. 3; and Securities and Exchange Commission, Statistical Series, Release No. 1750, May 3, 1961.

Pension funds and investment company purchases have shown by far the most rapid increase, more particularly in re­cent years. Life insurance companies have been adding to their holdings at the rate of only about $100 million annually, and have been in no hurry to reach legal maximums. Investment in equities by fire, marine, and casualty companies has been at the rate of about $200 million annually. Savings banks are adding to their stock portfolios at about the same rate as life insurance companies, a somewhat unexpected situation.

Corporate pension funds in all likelihood will continue to be the largest institutional purchasers of common stocks, both be­cause of the growth of funds available and of the conviction that a sizable part of the funds should be invested in common stocks. At the end of 1960, corporate pension funds in the United States had assets of $28.7 billion, and the average rate of growth recently has been almost $3 billion annually. As lately as 1954, assets were only $12 billion. In 1960, 50 per cent of the net receipts of all pension funds was invested by an Institutional Investor in common stocks, substantially more than in any previous year except 1959.

As of December 31, 1960, one-third of pension fund assets was invested in common and preferred stock; but based on market value, such investments comprised almost 45 per cent of the value of fund assets. Two decades ago—even had pension funds attained a magnitude approaching their present size-only a small fraction of the total would have been in common stocks.

Purchase and sales of common stock for 1951-1960, including stock of own company, were as follows (in millions of dollars):*

* Corporate Pension Funds, 1959, Statistical Release No. 1680, SEC, May 31, 1960, p. 2.

The prospects that pension funds will be an increasingly im­portant factor in the financial economy of the United States have prompted more study of the impact of their growth. The problems of size and of the availability of a sufficient quan­tity of desirable equities raise one set of possible difficulties. Another serious problem is what one writer has called the "rapid institutionalization of the ownership of property" and the effect, in essence, of thereby "socializing the wealth of capitalism."4 Purchases of stock by individuals have not risen nearly as much as is commonly thought. The net purchases of common stock by consumers, including non-profit organizations between 1946 and 1959 totaled only about $18 billion. The rise in stock prices, however, increased the value of stockholdings by more than $300 billion. Consumers did not progressively increase their net purchases of stocks directly during the foregoing period. Typical expenditures for stocks ranged between $1 billion and $2 billion annually.6

PROJECTION

Dr. C. V. Fricke has prepared the following tabulation of stockholdings of financial intermediaries for 1956 and a projec­tion for 1965 and 1975.

The foregoing table assumes an annual rate of growth of invest­ment companies of 10.4 per cent in 1956-1965 and of 8.0 per cent in 1965-1975. Only private non-insured pension funds are projected to grow more rapidly.

4Paul P. Harbrecht, Pension Funds and Economic Power (New York: The Twentieth Century Fund, Inc., 1959); see also Adolf A. Berle, Jr., Power Without Property (New York: Harcourt, Brace and Company, 1959).
5 "The Consumers Changing Portfolio," Business Review, Federal Reserve Bank of Philadelphia, October 1960.

Personal trust departments of banks and trust companies are by far the largest holders of stock, although the ratios of their holdings to the total will tend to decline over the years. The same study concludes that variable annuities will hold stocks in the amount of $400 million by 1965 and $6.2 billion by 1975. Such projections are subject to a large margin of error, of course, but they are interesting as the judgment of a competent student.

The variable annuity is likely to be the foremost alternative to investment company shares. It is also the most recent develop­ment among the different forms of institutional investment.

In 1959, the Supreme Court of the United States awarded jurisdiction over companies publicly offering variable annuities to the SEC jointly with state regulatory agencies.

Premiums paid by holders of variable annuity contracts are invested largely or entirely in common stocks, instead of the debt securities that are the basis of ordinary annuities. From retirement to death, the holder of a variable annuity gets an income that varies with the value and income obtained from investment in equities rather than the fixed number of dollars guaranteed by other types of annuities. The fundamental ra­tionale of variable annuities is that of providing protection against the decline in the purchasing power of the dollar.

Two major life insurance companies have been in the fore­front of the battle over the granting of legislative approval for life insurance companies to sell variable annuities. Prudential Insurance Company, the second largest life insurance company, led the proponents, arguing that the built-in inflationary tend­encies in the economy and the experience of the past two dec­ades proved conclusively that recipients of a fixed sum in dollars were bound to suffer because of the rise in the cost of living. In the decade 1951-1960 alone, the Consumer Price Index of the United States Bureau of Labor Statistics rose from 111.0 to 124.6 (1947-1949 = 100). This meant an average loss in pur­chasing power of about 2.5 per cent annually (in 1950, the year of the Korean invasion, the index was only 102.8). Long-term inflationary trends also accounted for much of the advocacy of the purchase of common stocks and investment company shares in recent years.

Pitted against the sale of variable annuities by life insurance companies is the nation's largest mutual life insurance company, the Metropolitan Life Insurance Company. Its position is that under standard forms of contracts issued by life insurance com­panies the company assumes the risk. Under a variable annuity contract, however, the risk is transferred to the purchaser, a practice completely contrary to the traditional philosophy of the life insurance industry. The confidence in life insurance so care­fully nurtured over the years and so priceless an asset, it is contended, might be seriously impaired in the event of a pro­tracted decline in common stock prices.

As has been mentioned, a major departure from traditional practice was taken by the Teachers Insurance and Annuity As­sociation of America (TIAA) in setting up the College Retire­ment Equities Fund (CREF). In 1952, this was established jointly with TIAA. College professors could divert up to half of their retirement contributions into a variable annuity kind of contract. Differences between CREF and the sale of variable annuities by commercial life insurance companies to the general public through commission agents are: a clientele more highly selected as to educational attainments and, presumably, as to understanding of the contract; a continuing limitation imposed on the proportion of variable to total annuity premiums; stabil­ity of income enjoyed by faculty members of institutions of higher education; absence, because of the limited number of participants, of problems growing out of potential economic power through ownership of equities with voting rights.

A number of other groups, including the New York Stock Exchange, the Investment Bankers Association of America, The Investment Company Institute, and the National Association of Securities Dealers, argue that a variable annuity contract is, in essence, an investment company share in disguise. Further, variable annuities might grow to the point of making insurance companies such large holders of stock in leading corporations that control of these corporations would be involved, leading to conditions resembling those revealed in the famous Hughes insurance investigation in New York State in 1905-1906.

At this writing, it is too early to judge the impact of the sale of variable annuity contracts by life insurance companies. Pro­vided that the buyer knows the facts and is aware of the risk involved, variable annuities seem to have a valid place in the plans of institutional investors.