Investors, NEC

SIC 6799

Industry report:

This classification covers establishments primarily engaged in investing, not elsewhere classified. Businesses covered in this industry include investment clubs, commodity contract pool operators and trading companies, and venture capital companies.

In 2010, investors in the United States were still reeling from the major upheaval that occurred during the subprime mortgage crisis of the late 2000s, begun in 2001 when the Federal Reserve cut interest rates in an effort to stimulate the economy. The number of houses sold and the prices of houses rose dramatically in 2002. Many of these mortgages were packaged and sold as bundled securities to investors on Wall Street. The resulting profitability of mortgages encouraged banks to loosen lending standards and grant mortgages to even more consumers, including those with little or questionable credit. In addition, exporting much of the risk of mortgages to investors freed up capital for banks, and they started to offer very low adjustable rate mortgages (ARMs), which allowed consumers that may not be able to afford to buy a home to purchase one with a low mortgage payment. However, in 2006, the housing market stalled, and interest rates started to rise as the price of houses fell. Many of the ARMs granted earlier started to be reset at higher rates, resulting in large increases in many Americans' house payment. Thousands of Americans were not able to make this higher payment and defaulted on their loans. In turn, the investment packages that had been purchased by the security industry lost their value, and investors lost billions of dollars. On September 21, 2008, Goldman Sachs and Morgan Stanley, the only two remaining unregulated investment banks, converted to bank holding companies, effectively ending the era of investment banking on Wall Street.

Still, investors not elsewhere classified continued to engage in miscellaneous activities and markets, including investment clubs, commodities markets, futures exchanges, the managed futures industry, and venture capital endeavors.

Investment Clubs.
An investment club is a group of individuals who meet regularly, usually once or twice a month, and pool their money, time, knowledge, and efforts to discuss and invest in securities. The investment club is a method whereby individuals are able to gain experience and acquire knowledge about stocks, financial statements, and securities markets. It is a proven means of learning and profiting by doing with others what an individual cannot accomplish alone. The primary goals of an investment club are to educate the individual members to make a profit on the money invested and to encourage social harmony among the members for greater productivity. Investment clubs also serve a vital national function in that they create many new investors trained in successful investment techniques, and in so doing, provide a substantial and regular flow of capital for the needs of growing industries.

BetterInvesting (formerly the National Association of Investment Clubs) is a nonprofit organization owned by its membership whose purpose is to encourage the creation of investment clubs with a goal of becoming successful operations. Founded in 1951, BetterInvesting had grown to a level by the mid-2000s wherein the total new monthly money invested through its membership investment exceeded $131 million.

An investment club must file tax returns like any other business. When the club adopts a partnership format, the individual members pay taxes on dividends and realized capital gains even though the members leave their money in the club for many years. The partnership must also file the partnership information return form, which informs the Internal Revenue Service of the financial distributions made to individual partners. The investment club may request an exemption from filing this form by writing to the U.S. Treasury Department. If an exemption is granted, the partners must still file their share of club income on their personal tax forms. If the club is a corporation, it must pay taxes on its earnings, with no tax liability accruing to the members until a distribution is made. In 2000, investment club members were required to file a Form 1065, U.S. Partnership Return of Income, and a Schedule K-1, Partners Share of Income, Credits, and Deductions, on individual tax returns. While the club does not have to pay federal income taxes, it must report portfolio results to the IRS and include each member's share of the account.

In 2010 BetterInvesting had over 90,000 members. Figures from the mid-2000s showed that the average member household income was $114,100, and over 72 percent of members held a college or post-graduate degree. The average age of an investment club was four years with an average of 11 members. The median member age was 56 years old, and about 54 percent of investment clubs were women only; 38 percent were men and women; and 8 percent were men only. The average club member invested $84 per month through the investment club, and the average investment club portfolio was valued at $86,700.

Commodities Markets.
While stocks, bonds, and mutual funds are the most common investment vehicles for individual investors, they are by no means the only ones. Two other types of investments, futures and options, became increasingly popular for the individual investor in the 2000s. In the futures market, investors trade futures contracts, which are agreements for the future delivery of designated quantities of given products for specified prices. Until 1972, this market was linked exclusively with commodities such as soybeans, cocoa, silver, or pork bellies. Since that time, the fastest growing part of the futures market has been that of futures contracts on financial instruments, such as treasury bonds or stock indexes. While traditional commodities still trade actively, the divergence between the two branches widened increasingly in the late twentieth and early twenty-first centuries. In 2004, for instance, there were 949.5 million contacts traded concerning financial instruments, while there were only 38.9 million grain contracts traded. Energy and wood products accounted for 104.5 million trades in 2004, and currencies produced 43.4 million trades. In all, commodities futures totaled nearly 1.23 billion trades during 2004, up from 477.8 million in 2000. Average month-end open interest in contracts totaled $17.6 million in 2004, up from $8.9 million in 2000.

In many ways futures trading was simpler than securities trading in the 2000s. For example, there are fewer than 100 actively traded American commodities, compared to several thousand common stocks. Margins, short sales, and tax considerations were far less complicated than securities trading. Accordingly, a futures trader chose investment opportunities from a very small sample and trades were affected with generally more simple mechanics than those associated with securities. It was also considerably easier to follow news and market developments that might have an impact upon a given commodity, such as wheat prices, than to follow the complex details that surround an individual stock, including dividends, earnings, competition, interest rates, the overall market, and other national and international factors.

A futures contract is a standardized exchange-traded contract calling for the delivery of a specified amount of a specified commodity in a specified month in a specified location. Unlike a securities transaction, no transfer of property is involved unless and until delivery actually occurs. In fact, analysts estimate that fewer than 5 percent of all contracts actually result in delivery of the actual commodity. Money does not change hands between the buyer and seller of a futures contract, although each is required to post a margin deposit to ensure responsibility for the entire contract in the delivery month. Unlike an options contract, if a futures contract is held through the last trading day in the delivery month, the holder of the contract must accept delivery and the seller must deliver. Also, futures contracts never result in a delivery prior to the appointed month, whereas an option on a security may normally be exercised and delivery demanded at any time from the trade date to the expiration date.

While most futures contracts used to be agricultural in nature, by the late 2000s they were traded for a variety of items, including interest rates, stock indexes, manufactured and processed products, nonstorable commodities, precious metals, and foreign currency. Proposals for new kinds of contracts are made consistently.

Futures Exchanges.
There are 11 futures exchanges in the United States. Trading is conducted by open outcry in "pits" or "rings." The former term is commonly used in Chicago, which is by far the world's leading commodities market. While trading futures bear a number of similarities to stock trading, there are notable differences. For example, futures exchanges put a limit on the maximum daily price changes, a practice not undertaken by stock exchanges. Futures trading is regulated by the Commodity Futures Trading Commission (CFTC), an independent federal regulatory commission established by Congress in 1974. The CFTC regulates the industry and the industry's employees. The Commission was set up to prevent abuse, neglect, fraud, and to promote competition.

Based in Washington, D.C., in the mid-2000s the CFTC regulated the activities of 50,747 sales people, 8,699 floor brokers, 1,522 floor traders, 1,871 commodity pool operators, 2,677 commodity trading advisors, 215 futures commission merchants, and 1,703 introducing brokers.

The leading U.S. commodity exchanges and their trading volume for 2004 included the Chicago Mercantile Exchange, with 607.3 million contracts; the Chicago Board of Trade, which posted 457.2 million contracts; the New York Mercantile Exchange and Commodity Exchange, with 127.1 million contracts; the New York Board of Trade, New York Cotton Exchange, New York Futures Exchange, the Coffee, Sugar and Cocoa Exchange, and the Cantor Exchange, with 21.2 million contracts; EUREX US, with 3.3 million contracts; the Kansas City Board of Trade, with 2.91 million contracts; the Minneapolis Grain Exchange, with 2.8 million contracts; One Chicago, with 1.96 million contracts; BrokerTech Futures Exchange, with 71,400 contracts; CBOE Futures Exchange, with 62,000 contracts; Nasdaq Liffe Exchange, with 339,000 contracts; and Merchants Exchange of St. Louis, with 205 contracts. These commodity exchanges remained the top operators in the late 2000s and early 2010s.

The trend in the 2000s was toward globalization, rapid growth in trade volume, and a shift away from the open-cry system to all-electronic trading, which does not limit traders to a specific location. During fiscal year 2004 the CFTC designated two new electronic exchanges. In February 2004, the CFTC authorized the U.S. Futures Exchange LLC as a contract market. HedgeStreet, a derivatives clearing organization that conducts all trades over the Internet, also came into existence in 2004. In addition, the Chicago Mercantile Exchange operated its electronic trading on GLOBEX, and the Chicago Board of Trade employed its electronic activities through LIFFE CONNECT technology. The BrokerTech Futures Exchange dissolved in 2003, and in 2004 the CFTC approved the merger of the Coffee, Sugar, and Cocoa Exchange with the New York Cotton Exchange into the New York Board of Trade.

Managed Futures Industry.
The traditional way to play the commodities market has been to open an account with a broker who trades the account. Brokers are compensated with trading commissions and have no financial interest in the outcome of a trading transaction. Discount brokers execute trades at a lower cost than full-service brokers but do not generally offer trading advice or other services to the individual investor. As a result, a host of advisory services, quotation and data services, and trading systems emerged to provide the investor with the information and ability to trade commodities.

Trading for one's own account is a risky proposition, and a significant proportion of investors and traders lose money trading commodities. Fixed costs, including quote screens, commissions, and office equipment, are high and so is the risk. Rather than opening an account with a broker and dabbling in commodities, many individuals are allowing professional managers to trade futures for them. Managed futures offer individuals several choices including individual managed accounts, private futures funds, and public futures funds. Many new programs that were launched throughout the 1990s enticed investors to trade their own commodities from home. With personal computer ownership and usage at an all-time high, it was more conceivable that individuals would begin to become their own brokers.

Hiring an advisor to manage an individual trading account is similar to using a broker. The key difference is that the commodity trading advisor (CTA) is not usually compensated on commissions. Rather, advisors most often participate in the profits of the money they manage through management fees and profit incentive fees. Management fees are charged as a percentage of the equity in the account. Profit incentive fees vary per CTA but are calculated as a percentage of new trading profits. If the advisor does not make money trading the investor's money, then no fees are charged. At the end of 2004, there were 2,677 CTAs, according to the CFTC.

CTAs organize client trading in either individual client accounts or in a single, pooled account from which all client money is traded. A CTA who does the latter is a commodity pool operator (CPO). From 1980 to 1996, the number of CPOs registered with the Commodity Futures Trading Commission grew from 1,055 to 1,350. By 2000, the CFTC was regulating 1,534 CPOs. At the end of 2004 CPOs totaled 1,871.

Venture Capital.
Venture capital is a private source of financing for high-risk business endeavors. It is one financing alternative among many sources of capital that are available to growing companies. Venture capital is generally invested in equity ownership of a company or new venture. The investment is usually in the form of stock, but could also be the form of convertible debt, which is a loan that becomes a stock holding at some point. Offsetting the high risk the investor takes is the promise of a very high return on investment.

Between 1992 and 1994, 417 venture-backed companies went public. In 1993, venture capital-backed companies raised $4.2 billion, up 19 percent from 1992. The number of venture capital entities, however, dwindled at the end of the twentieth century. During the third quarter of 1998, for instance, only 19 companies principally funded with venture capital went public, raising $1.13 billion, bringing the total number of initial public offerings (IPOs) to 68. Their offering size was $3.38 billion. During the same period in 1997, however, 98 companies raised $3.35 billion. The average offering size, though, increased from $34.2 million in 1997 to $49.7 million in 1998. During this time, the software and services industries had the most number of IPOs. The telephone and data communications industry came in second. The lead underwriter for this time period was BankBoston.

Venture capitalists were underwriting over 5,000 new companies per year during the peak of the dot-com, technology, and telecommunications. During 1997 venture capitalists' average annual returns increased by 67.5 percent. However, the boom was followed by a bust, and in 2000, average annual returns fell to -8.7 percent. "If you were a [venture capitalist] between 1994 and 1997, you couldn't help but make money. But by 2000, you were underwater," Howard Anderson noted in Technology Review in June 2005.

By the mid-2000s venture capital was slowly regaining ground. According to a MoneyTree survey, in 2003 venture capital investments fell to $18.9 billion but in 2004 rose to $21 billion, which represented the first increase since 2000. Technology companies garnered $11.3 billion in funding. Although software investments were up nearly 20 percent to $4.9 billion in 2004, communications and semiconductor investments dropped by 17 percent to $2.5 billion. Silicon Valley received the most investment dollars, followed by the Boston area.

Venture capital increased in 2010, fueled by merger and acquisition activity, according to the National Venture Capital Association. President Mark Heesen commented, "In 2010 we moved from abysmal to viable in the venture-backed IPO market." The top industries receiving venture capital investments in 2010 were biotechnology, industrial/energy, software, medical devices and equipment, and IT services.

Current Conditions

In response to the meltdown in the financial services industry in the United States in the late 2000s, the government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The act, which constituted a complete overhaul of all U.S. financial systems and a major increase in regulation and oversight, was expected to affect many aspects of the investment industry. One of the hundreds of provisions of the law was for the CFTC to more accurately define "swap dealer" and "swap trading." According to the Bloomberg News Agency, "During the three decades that swap-trading grew into a $583 trillion market, almost 40 times bigger than the U.S. economy, no one legally defined the terms." The 6 January 2011 article went on to say, "Largely unregulated swaps helped fuel the 2008 credit crisis. Dodd-Frank aims to improve transparency by moving some swaps to central clearinghouses and onto trading platforms such as exchanges and so-called swap execution facilities." Such changes were pressing issues for the investing industry as the 2010s began.

© COPYRIGHT 2018 The Gale Group, Inc. This material is published under license from the publisher through the Gale Group, Farmington Hills, Michigan. All inquiries regarding rights should be directed to the Gale Group. For permission to reuse this article, contact the Copyright Clearance Center.

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