LOS ANGELES — Mutual funds have allowed millions of investors of modest means to invest safely by buying a diverse portfolio of securities at low-cost. But the success of this financial tool — mutual fund assets rose from $1.1 trillion to $6.3 trillion from 1990 to 2002 — has also led to a host of regulatory loopholes that have cost small investors billions, explains Rutgers University Professor Eugene White in an article in the latest Milken Institute Review.
"As the market for funds grew and became more sophisticated, opportunities for exploiting the governance structure and liquidity rules appeared," says White. "Conflicts of interest arising from incentive structures and the diversity of fund activities led investment advisers to pay less attention to the interest of fund shareholders."
White offers his own ideas on how to reform, from more independent directors to changes in the incentives offered fund managers. "No magic bullet would prevent late trading and market-timing arbitrage," he writes. "It is clear, however, that the reform of mutual fund governance is a key to controlling such abuses."
Other highlights from the latest Review:
- G. Pascal Zachary, a senior writer for Business 2.0 magazine, examines the future of Silicon Valley as the center of global technological leadership. "The big question is not whether the Silicon Valley thrives," he writes, "but whether the region can dominate emerging fields in the way it has dominated computing, software and the Internet."
- Robert Crandall, Robert Hahn, Robert Litan and Scott Wallsten of the American Enterprise Institute-Brookings Joint Center examine the pros and cons of regulating what′s been billed as the Next Big Thing in telecommunications — telephone service over the Internet. "With the emergence of productive new technologies, the rationale for continuing to regulate local telephone service is rapidly disappearing," they write. "But there will always be pressure to regulate because the losers from new technologies have incentives to use the political process to limit their expected losses, while regulators and legislators are loath to give up the right to divvy up the spoils."
- Laurie Bassi and Daniel McMurrer of Bassi Investments examine the relationship between corporate investments in employee development and stock market performance and find a strong positive correlation between the two. Yet corporations continue to under-invest in their human capital. "Until accounting and reporting requirements are changed," they write, "efforts to create unsustainable increases in quarterly earnings will all too often take priority over investments that result in higher earnings in the long run."
- Richard Rapp, president of National Economic Research Associates, takes aim at the newest trend in fighting corporate mergers — what′s known in antitrust as "innovation market" analysis. While the idea of stopping a merger if there is a prospect that it will delay innovation sounds reasonable, "a close look suggests the idea is badly flawed in both theory and practice," he writes.
- Tim Taylor, managing editor of the American Economic Association′s Journal of Economic Perspectives, examines the "lump of labor" fallacy — the belief that jobs can only be gained or lost by capturing them or ceding them to other countries. "There′s an arcade game called Whack-a-Mole in which a plastic mole pops up and you pound its head with a mallet," he writes. "The lump-of-labor fallacy is the Whack-a-Mole of arguments about jobs: as often as you slam it, it reappears somewhere else."
- Glenn Yago, director of Capital Studies at the Milken Institute, offers a capsule history of capital market access in the United States. "The promise of democratization of capital is at the heart of the American republic," he writes. "Indeed, the key to sustainable prosperity in coming decades is expanding capital ownership, thereby aligning the interests of investors, workers and the broader public."
This issue includes an excerpt from Islam and Mammon: The Economic Predicaments of Islamism, by Timur Kuran of the University of Southern California, which offers a timely, skeptical analysis of the efforts of Islamic fundamentalists to remake economics according to the teachings of the Prophet; an edited transcript of the panel discussion between Michael Milken and winners of the Nobel Prize in economics that took place at the 2004 Milken Institute Global Conference; and demographer Bill Frey′s latest charticle.
The Milken Institute Review is distributed to some 10,000 corporate and financial executives, policymakers, academics and journalists throughout the world. Its editor is Peter Passell, former economics columnist for The New York Times.