Lecture 20: Professional Money Managers and their Influence

What this lecture covers

This lecture surveys the institutions that manage most of the world's wealth: mutual funds, pension funds, trusts, endowments, and family offices and foundations. Professor Shiller opens with a breakdown of U.S. household assets and liabilities from Federal Reserve data, showing how much wealth is now managed by professionals rather than held directly by families, and argues this reflects a broader historical shift from family-based to institution-based risk management.

The lecture then examines the legal duties of institutional investors, notably the "prudent person rule," and works through the history and mechanics of several institution types in turn. It follows the course's earlier lectures on regulation and banking, and sets up the closing weeks of the course.

Key ideas

• Institutionalization of wealth: roughly half of measured U.S. household assets are managed by institutions such as pension funds, mutual funds, banks and insurers, up sharply from a century ago.
• Human capital and national wealth: capitalizing national income suggests total wealth far exceeds measured financial and real assets, putting institutional investors' role in perspective.
• Fiduciary duty and the prudent person rule: investment managers must act as a "prudent person" would, a legal standard from ERISA (1974) that has proven hard to define and has shifted over time toward more aggressive investing.
• Dodd-Frank and prudential standards: the 2010 Dodd-Frank Act shifts oversight of institutional risk-taking toward government regulators through bodies like the Financial Stability Oversight Council.
• Mutual funds vs. UCITS: U.S. mutual funds, modeled on the 1920s Massachusetts Investment Trust, differ from Europe's UCITS funds mainly in how capital gains are taxed.
• Trusts: legal arrangements, including "spendthrift trusts," that let people manage money on behalf of others, including after their own death.
• Defined benefit vs. defined contribution pensions: older plans promised a fixed retirement benefit; since the 1980s, most companies shifted the investment risk to employees through defined contribution plans like the 401(k).
• Endowment investing history: examples like Yale's 1825 collapse and more recent mismanagement cases show how endowment investing has professionalized, aided by the "prudent person" flexibility used by managers like David Swensen.

Walkthrough

Assets and liabilities of U.S. households and nonprofit organizations (0:00)

Using Federal Reserve balance sheet data, Shiller breaks down roughly $70 trillion in U.S. household assets, including real estate, pension funds, equities and deposits, and around $14 trillion in liabilities such as mortgages and consumer credit. He shows that close to half of these assets are institutionally managed, and adds a rough estimate of national and world wealth by capitalizing income.

Human capital and modern societal changes (11:30)

Shiller argues that as families take on smaller direct roles in caring for elderly relatives or managing health care, professional institutions such as pension funds and insurers increasingly perform these risk-management functions instead.

The fiduciary duty of investment managers (17:04)

The lecture defines fiduciary duty and the ERISA-era "prudent person rule," explaining how its vague standard shifted from conservative bond investing toward more aggressive strategies over time, and how the 2010 Dodd-Frank Act shifts oversight of institutional risk-taking toward government regulators.

Financial advisors, financial planners, and mortgage brokers (28:23)

Shiller distinguishes financial advisors, who must be licensed through FINRA, from less-regulated financial planners and mortgage brokers, noting that weak oversight of these roles contributed to poor advice during the housing boom.

Comparison of mutual funds between the U.S. and Europe (33:53)

Covering the origins of the mutual fund in the 1920s Massachusetts Investment Trust and the 1940 Investment Company Act, the lecture compares U.S. mutual funds with Europe's UCITS funds, noting that the key practical difference is how capital gains taxes are triggered.

Trusts: providing the opportunity to care for your children (37:58)

Trusts let an institution manage money on behalf of someone else, illustrated through the example of providing for a disabled child after a parent's death, and the "spendthrift trust," which protects assets from being spent too freely or claimed in a divorce.

Pension funds and defined contribution plans (43:14)

The lecture traces pension history from the 1875 American Express plan through union pension failures, the 1950 General Motors fully funded plan, the 1963 Studebaker collapse that prompted ERISA and the Pension Benefit Guaranty Corporation, and the shift since the 1980s from defined benefit to defined contribution plans like the 401(k).

History of endowment investing (58:23)

Shiller recounts early endowment mismanagement, including Yale's 1825 loss of its entire endowment in a single bank investment, and more recent losses at Boston University and the University of Bridgeport, contrasting these with the professionalized approach associated with Yale's David Swensen.

Family offices and family foundations (1:02:34)

The lecture closes by describing family offices, which manage very wealthy families' portfolios, and family foundations, charitable vehicles that offer tax advantages and have grown to roughly 36,000 in the United States, illustrated by the philanthropic activities of Microsoft co-founder Paul Allen.

Before you watch

• Review the earlier lecture on regulation of investment banking for context on the Dodd-Frank Act and the Financial Stability Oversight Council.
• Knowledge of basic present value concepts helps follow the wealth capitalization calculations near the start of the lecture.

Check your understanding

1. What share of U.S. household assets does the lecture attribute to institutional investors, and how has this changed over the past century?
2. What is the "prudent person rule," and why does Shiller argue it has been difficult to apply consistently?
3. What is the main practical difference between a U.S. mutual fund and a European UCITS fund?
4. How does a defined contribution pension plan shift risk compared with a defined benefit plan?
5. What lesson does Shiller draw from Yale's 1825 loss of its entire endowment in the Eagle Bank of New Haven?