ranging from “guaranteed investment contracts” to government bond funds to do-
mestic corporate bond and stock funds to international stock and bond funds. Un-
der most plans, the employees can, within certain limits, shift their investments
from category to category. Thus, if someone thinks the stock market is currently
overvalued, he or she can tell the mutual fund to move the money from a stock
fund to a money market fund. Similarly, employees may choose to gradually shift
from 100 percent stock to a mix of stocks and bonds as they grow older.
These changes in the structure of pension plans have had two extremely impor-
tant effects. First, individuals must now make the primary investment decisions for
their pension plans. Because such decisions can mean the difference between a
comfortable retirement and living on the street, it is important that people covered
by defined contribution plans understand the fundamentals of investing. Second,
whereas defined benefit plan managers typically invest in individual stocks and
bonds, most individuals invest 401(k) money through mutual funds. Since 401(k)
defined contribution plans are growing rapidly, the result is rapid growth in the
mutual fund industry. This, in turn, has implications for the security markets, and
for businesses that need to attract capital.
Financial institutions have historically been heavily regulated, with the primary
purpose of this regulation being to ensure the safety of the institutions and thus to
protect investors. However, these regulations—which have taken the form of prohibi-
tions on nationwide branch banking, restrictions on the types of assets the institutions
can buy, ceilings on the interest rates they can pay, and limitations on the types of ser-
vices they can provide—tended to impede the free flow of capital and thus hurt the
20 CHAPTER 1 An Overview of Corporate Finance and the Financial Environment
Mutual Fund Mania
Americans love mutual funds. Just over ten years ago, Amer-
icans had invested about $810 billion in mutual funds, which
is not exactly chicken feed. Today, however, they have more
than $5 trillion in mutual funds!
Not only has the amount of money invested in mutual
funds skyrocketed, but the variety of funds is astounding.
Thirty years ago there were just a few types of mutual funds.
You could buy a growth fund (composed of stocks that paid
low dividends but that had been growing rapidly), income
funds (primarily composed of stocks that paid high divi-
dends), or a bond fund. Now you can buy funds that special-
ize in virtually any type of asset. There are funds that own
stocks only from a particular industry, a particular continent,
or a particular country, and money market funds that invest
only in Treasury bills and other short-term securities. There
are funds that have municipal bonds from only one state.
You can buy socially conscious funds that refuse to own
stocks of companies that pollute, sell tobacco products, or
have work forces that are not culturally diverse. You can buy
“market neutral funds,” which sell some stocks short, invest
in other stocks, and promise to do well no matter which way
the market goes. There is the Undiscovered Managers Be-
havioral fund that picks stocks by psychoanalyzing Wall
Street analysts. And then there is the Tombstone fund that
owns stocks only from the funeral industry.
How many funds are there? One urban myth is that there
are more funds than stocks. But that includes bond funds,
money market funds, and funds that invest in non-U.S.
stocks. It also includes “flavors” of the same fund. For exam-
ple, some funds allow you to buy different “share classes” of
a single fund, with each share class having different fee
structures. So even though there are at least 10,000 different
funds of all types, there are only about 2,000 U.S. equity
mutual funds. Still, that’s a lot of funds, since there are only
about 8,000 regularly traded U.S. stocks.
Sources:“The Many New Faces of Mutual Funds,” Fortune, July 6, 1998,
217–218; “Street Myths,” Fortune, May 24, 1999, 320.
18 An Overview of Corporate Finance and the Financial Environment
