ably better than commercial bank trust departments in managing equity common trust funds (Hanczaryk Study, supra pp. 46-47, at Table 22). The study's sample of trust company common trust funds is very small, and this is the first year in which that category was separated out, so further work is needed. The matter warrants the closest attention, for if it holds up after more study, it will have important ramifications.

If money managers are to be limited in the amount they can manage, we will have more competition for savings, and thus more savings and less inflation. To assure such competition and to preserve incentives for successful money management, we should consider less rather than more regulation of sales and management compensation.

With money managers limited in the amounts they can manage, the stocks of medium-sized and smaller corporations will become appropriate investments. Today's mammoth portfolios can get no help from even a fabulous price rise in a small position, and a large position in smaller corporations cannot be assumed without threatening to dominate the corporation, or exposing the portfolio to undue risk. Also, it is too hard for a huge institution to follow many small corporations. In short, these facts mean, for example, that one of our five major bank trust departments has about 50 percent of its assets in just 50 stocks. Improving the market for smaller corporations may even aid deconcentration in industry generally.

Unless elephantiasis and concentration are stopped in institutional investing, it is hard to see how anything can ever be done about concentration in this nation, and such essentially beneficent machinery as our pension funds will ultimately prove to be taking control of the economy away from the people, in return, at best, for a placid retirement.

Chairman GRIFFITHS. Mr. Werner?

STATEMENT OF WALTER WERNER, PROFESSOR, COLUMBIA UNIVERSITY LAW SCHOOL AND GRADUATE SCHOOL OF BUSINESS ADMINISTRATION

Mr. WERNER. Thank you, Madam Chairman. My remarks will touch on some of the same points as my good friend and learned colleague, Professor Schotland, but I must confess that they will be in the form of a rather mild April shower after his very far-ranging and dynamic coverage.

Let me say that my testimony is going to stress the need for measures aimed at achieving greater understanding of the investment policies of private pension funds, not only on their beneficiaries but on both the securities markets and the economy generally. I propose, first, to discuss the basis for some of the important public policy questions posed by pension fund investment practice; second, to identify some of those questions; and, finally, to recommend measures essentially in my view, to provide a response to them.

I

For purposes of my remarks today, the significant aspects of pension fund administration, as I see them, are the following:

First, that these funds must be considered in both their private and public dimensions. Any single fund is a "bundle of assets to be employed as productively as possible on a long-range basis for the sole purpose of meeting pension commitments." But in the aggregate these funds are vast pools of assets with potential for effecting other

1

1 Old Age Income Assurance, pt. V, Financial Aspects of Pension Plans (Joint Economic Committee Print, December 1967), at p. 82.

broader goals. Now growing at a rate of $6 to $7 billion annually, the assets of these funds are approaching or passing the $100 billion mark and are said to be on their way to a level of between $200 and $400 billion in 1980. The power to direct investment of this gigantic slice of the Nation's savings is the power to help shape the direction of national economic growth. It is a large portion of the power to determine the kind of Nation that we are and are to become.

Second, that this power is now exercised by a comparatively small number of corporate managements, union leaders, and a still smaller number of professional money managers-commercial banks and trust companies, and insurance companies-to whom has been delegated the authority to make specific investment decisions.

Third, that this small group of administrator-trustees enjoys broad discretion in exercising that investment authority-even though they are subject to a variety of constraints.

Fourth, that these pension fund investment decision-makers have been subjected to increasing pressure to maximize net investment yield. For the trusteed plan, higher yield brings reduction in corporate contributions; for the Insured plan, reduction-over the long span-in premiums; and possibly for the beneficiaries of both, higher pensions.

Fifth, that this pressure has been responsible for a shift in investment policy in the direction of what is described as aggressive investment in common stocks, to use a less colorful characterization than that of Professor Schotland. Taking advantage of relaxation of legal restraints on equity investment, the funds have sharply increased the portion of their assets invested in equities. The change has been accompanied by an acceleration in the rate of stock portfolio turnover. Finally, that this trend of the pension funds toward aggressive investment in equities is a single strand in a major development in the marketplace, one affecting not private pension funds alone but all financial institutions, investors, and the public generally. It is emergence of the concept that professional money management must be measured by proof of ability to outperform other money managers on a short-term basis. I stress the time factor, for this is important. Preoccupation with day-to-day results subordinates informed judg ments concerning the future prospects of a company to judgments concerning the behavior of other market participants in trading the stock of that company. Psychology and game theory replace fundamental investment analysis as the sinews of investment policy.

We are now beginning to feel the consequences of this transformation of values and investment behavior. Some effects seem clear. It appears, for example, that the trading of financial institutions-now said to constitute more than half the trading volume of the New York Stock Exchange-does not help stabilize the markets but rather serves to create increasingly delicate, nervous markets characterized by sharp fluctuations in price. Witness the loss in a single day last week of one-third of the "value" of a listed company that the market had appraised as a billion dollar company. Whatever the immediate precipitating causes for this Yo-Yo-like drop, surely one factor contributing to this kind of erratic volatility is the new cult of instant performance embraced by institutional intermediaries.

The pattern is not unfamiliar. For the individual fund, high yield seems to be an eminently reasonable investment goal. There is a difference, again as Professor Schotland pointed out, of 19 percent, I think, between the accumulations of a dollar invested at 4 percent per annum and one invested at 5 percent. No reasonable fund administrator or money manager is, therefore, likely to be happy with a 4 percent yield when other funds are earning 5 percent. But what starts as a reasonable incentive for the individual money manager can become, and seems to be well on its way to becoming an obsession when it fuels competitive drives that restructure the investment attitudes and behavior which determine stock prices. Yet, this is precisely what seems to be happening in the markets today as the time horizon for evaluating investment performance is narrowed from years to days.

It may well be that the manner in which pension funds accumulate and disburse their assets tends to insulate them from the shockwaves generated by trading activity beamed at instant performance. But this condition is hardly a reason for encouraging or even permitting a type of investment behavior that may endanger other financial institutions and public investors generally, who are not similarly favored. Furthermore, it is clear that the quest for high yield is attended, as always, by commensurate risks. The price of failure can be a fund's liability to meet its pension commitments-a loss presumably to be borne not by administrators or money managers but by beneficiaries who share the losses and not the gains.

II

These observations point in my mind to a number of questions. Some concern the effect on the funds themselves of current fund investment policies aimed at maximizing short-term market performance. First of all, of course, what is the precise nature and extent of these policies? Who actually benefits from gains realized by a "good" performance employee beneficiaries or the corporate employers? Or who suffers because of "poor" performance? What are the potential dangers of the performance derby to the funds and their beneficiaries?

Other questions concern the effects of those investment policies on the stock markets. Those markets are more a mystery today than ever before. Learned commentators continue to employ such terms as the "liquidity" of the "continuous auction market" and speak of the markets' functions in the formation of capital and allocation of resources or as a pricing mechanism as though these terms expressed proven concepts. But the fact is that we have no acceptable theory of market performance and function. We cannot satisfactorily explain either the simpler markets of an earlier day or current markets that have been transformed by the institutionalization of trading and changes in trading patterns as well as by the new electronic technology.

Let me cite a single basic illustration. Whatever the connection may have been prior to emergence of the cult of instant performance between the market price of a company's stock and the value of the underlying enterprise, it seems clear that one effect of the new cult

has been to attenuate the relationship, or perhaps destroy it, over long periods of time. But surely this relationship is not a matter to be left for surmise and conjecture. It is the crux of understanding the function of the stock markets in the economy. We must know the answers to questions like this before we can evaluate the effects of pension fund investment policy upon those markets and the economy. Cognate questions of greatest import concern the goals of fund investment policy. Should that policy be measured only from the perspective that its sole purpose is to meet pension commitments? Granted that this is the primary goal, is it the only one? Should maximization of return be the sole determinant of a fund's investment policy?

An affirmative answer would appear to imply either a disregard for the broad economic and social effects of aggregate investment fund policy or confidence that investment by individual pension funds for maximum short-term gain will operate through the invisible hand of the marketplace to channel fund assets to desired uses. I find it hard to accept either view. At the very least, it would appear essential to examine the extent to which fund investment policy can be coordinated with other measures required to achieve full employment and growth under stable conditions as well as to meet our mammoth needs for new housing, for control of the environment, and similar social goals.

For we are increasingly recognizing the importance of marshalling the Nation's resources as necessary to improve, or even to maintain, the quality of life. A significant portion of those resources consists of the assets of private pension funds. Moreover, those assets owe their existence largely to a taxing policy that encourages creation and growth of such funds. We surely require no more basis than this as the impetus for exploring the feasibility of new investment arrangements and new investment instruments that will both assure the funds' capacity to meet and increase pension commitments and also direct the funds' assets into areas of greatest national need. I am aware of the efforts to secure voluntary participation in the housing market by fund administrators and trustees and of the agreement announced last week for a new program of this type. And I know that the insured plans have long invested a considerable portion of their assets in real estate development of various kinds. These efforts underscore the potential for public policy of fund investment policy. But in the face of the pressures for stock market performance maximization, in my view, reliance on such voluntarism seems founded more on hope than on reality.

III

The singling out of the issues discussed so briefly above is not intended to imply that pension fund investment policies do not present other problems of an equally fundamental nature. I have merely stressed the areas of deepest interest to me.

All these questions point up the need, as a prerequisite to determination of responsible public policy, to understand not only the policies of pension funds but such other matters as the competition of all financial intermediaries for savings, the impact of their in

vestment policies on the stock markets and capital markets, and the function of those markets in the economy and their role in attaining economic and social goals. In other words, this is a call for understanding the capital markets on a truly integrated and comprehensive basis.

It would be naive to lose sight of the pragmatic considerations that compel dividing this broad subject matter into segments and then acting on individual segments even while an overall study is going forward. My stress on continuing long-range comprehensive study is not intended to suggest that such study is a substitute for attacking immediate specific problems. Rather, my point is that we need both kinds of study but we get only the one. And that the price of this approach is a series of immediate responses to immediate needs that fail to take into account their effect on conditions other than the ones that called the particular responses into being.

Let me illustrate by reference to a current problem of the securities markets; the commission rate structure of the stock exchanges. It is recognized today that these commission rates exert an influence that extends far beyond the reasonableness of the fees that investors pay or that exchange members receive for their services. The rates and rate policy of the exchange also determine the kind of exchanges we are to have-for example, whether institutions such as pension funds should be members or customers of the exchanges. They also help determine whether institutions such as pension funds trade on a principal exchange, on a regional exchange, or over the counter a decision that concerns the comparative merits of a central marketplace and a number of competitive marketplaces. These commission rates and commission rate policy also help determine the access of securities professionals, and through them their customers, to the exchange markets. And so on. Resolution of these questions directly affects private pension funds and all other investors. Yet, it is clear that this resolution, as it is being slowly and painfully worked out, is being related far more closely to the interests of various groups of broker-dealers than to those of pension funds and other institutional intermediaries. The result is, of course, a natural byproduct of the fragmentation of regulation in the capital markets. Problems such as these are not met by piling study upon study of the individual problem or crisis. We have seen too much of that already. By the time that a particular study group is organized and has completed its project, the needs that gave rise to it are likely to have changed. That is why I look forward to the report of the SEC group studying the institutional investor with a keen anticipation that is tempered by appreciation of the limitations within which any such crash program necessarily operate. The same observation applies to any study of the capital markets that attempts to deliver a meaningful report within a brief period of time.

Why, then, in face of this skepticism concerning ad hoc piecemea! studies, propose to establish a group that will conduct continuing, long-range study of the capital markets? No study, short or longrange, is going to supply definitive answers to problems like those of either pension fund investment policies or stock exchange commission rates. But the kind of continuing study resources I am proposing should at least provide concerned governmental agencies with