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A Big Break For Big Caps?


Economic Trends

A Big Break for Big Caps?

Institutions find them less hassle

The companies that make up the Standard & Poor's 500-stock index have dominated the long bull run of the 1990s: The S&P 500 has risen about 247% since the start of 1990, vs. 160% for S&P's index of 600 small-cap stocks. The conventional view is that the rise of global opportunities and massive restructuring have made big companies far more attractive to investors than small ones.

Two Harvard University economists have a simpler explanation: Institutional investors increasingly dominate the market, and big institutions like big-company stocks. In a National Bureau of Economic Research paper, Andrew P. Metrick of Harvard and Paul A. Gompers of the Harvard business school point out that firms that manage $100 million or more in securities controlled 51% of the capitalization of U.S. stock markets at the end of 1996, nearly double their 27.6% share in 1980 (chart). The rise has been powered by the growing popularity of mutual funds, whose holdings tripled, from 8.2% to 25.3%; and investment advisers, including those that manage most pension funds, up from 21.2% to 37.2%.

Institutions need to move lots of money, preferably without holding more than 5% of any company's stock--the level at which a shareholder is treated as an insider. It's easier to focus on big stocks. But the researchers predict that institutions' share of the market will stop growing eventually, so small stocks could outperform large caps--as they did from 1927 to 1980.BY MIKE MCNAMEEReturn to top

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How Chile Iced Hot Money

Investors no longer park overnight

Chile's controls on short-term investments from abroad are hailed as a model for small countries that want to avoid getting caught up in the next global financial crisis. A new study by Sebastian Edwards of the University of California at Los Angeles says that controls--coupled with Chile's flexible exchange rate--did help Santiago avoid financial "contagion" in the wake of Mexico's 1995 financial crisis.

Under the controls, foreign investors were required to put 30% of their funds in a non-interest-paying account with the Chilean central bank for one year. The goal: to keep out the foreign capital that might be attracted by Chile's high interest rates while the central bank fought inflation. In fact, Edwards says, Chile's rates were so high--averaging 13% from 1992 through June 1998--that foreigners swallowed the penalty and invested anyway. But the controls shifted the mix of investment toward longer-term funds, whose returns were less affected by the one-year withholding. As a result, unlike Argentina, which had to raise rates to 25% to retain capital after Mexico's near-default, Chile's rates were unaffected. And Chile made so much progress against inflation--which fell from 15% in 1992 to 3% in early 1998--that it lifted the controls in 1997.BY MIKE MCNAMEEReturn to top

Death, Taxes, and the Rich

Why don't they give while alive?

Judging from the political furor over estate taxes--"death taxes," in the lingo of opponents--wealthy Americans might be expected to go well out of their way to minimize the tax bite on their heirs. But a new study shows that the rich largely overlook the simplest way to reduce estate taxes: Giving away their property while they're alive.

Fewer than half of the elderly wealthy who could be subject to the estate tax make even $10,000 a year in overall gifts to family members, says economist James M. Poterba of the Massachusetts Institute of Technology (chart). And even many of those givers neglect to take full advantage of tax-free gifts, which can total $10,000 a year to each child or grandchild.

Grants of more than $10,000 per recipient per year are subject to a gift tax. But even at the 55% top rate, making a gift is cheaper than leaving funds in an estate. Take a benefactor who has exhausted the $10,000 annual exemption per recipient and has $100,000 more to give. He or she can give $64,500 of it and use the rest to pay the gift tax, while the same $100,000 in an estate would net the heirs only $45,000.

Why don't the wealthy take advantage of these breaks? "The low-wealth wealthy are afraid they'll need their resources for health care," says Poterba. Rules that let heirs escape capital-gains taxes on inherited assets also create an incentive to hang on to appreciated property. But even among the superrich, he says, "there's just a reluctance to give up control of assets--even if the transfer would lead to substantial tax savings."BY MIKE MCNAMEEReturn to top


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