Earlier this month the Securities and Exchange Commission added a new dimension to mutual funds: They can now be used as marginable securities. Thus, investors who own shares in a mutual fund, including a money-market fund, can use them as collateral to buy stocks and bonds on margin. When buying on margin, an investor puts up 50 percent of the value of the security purchased and borrows the rest of the money from the broker. Usually, stocks or bonds on deposit with the broker are used as collateral for the loan.
The SEC decision will affect any fully paid-for mutual fund shares issued by an open-ended investment company or unit trust. Variable annuities, sold by insurance companies, are included in this order as well. Closed-end mutual funds have been marginable for some time.
Alan Shaw, an analyst with Smith Barney, Harris Upham & Co., estimates that the total amount of securities now eligible as a new marginable base is some $ 150 billion. He figures some $80 billion rests in money-market mutual funds, while some $20 billion worth of unit investment trusts have been sold. The rest is made up of stock- and bond-oriented mutual funds and, to a lesser extent, variable annuities. Mr. Shaw notes that "somewhere out [in time], this pool may begin to be tapped." He figures that mutual funds will also benefit from the ruling with increased interest in share purchases, possibly translating into greater stock demand.
Mutual fund managers, however, are not so certain that the new rule will have any immediate effect. Monte Gordon, director of research at the billion-dollar Dreyfus Fund group, says that "this is not a cataclysmic or earthshaking event." Specifically, Mr. Gordon does not think investors will turn aggressively to buying stocks on margin as a result of the ruling. People who buy mutual funds, he notes, don't usually buy stocks on margin.
Frank Parrish, portfolio manager of the Puritan Fund, part of the Fidelity Group, says Fidelity has not yet seen any great surge of interest in using mutual fund shares as collateral. "The effect of the rule," he says, "will be gradual rather than dramatic, and even when it happens it may not mean that much." Naturally, he says, "the ruling will be built into the literature of mutual funds as an advantage."
Banks and loan companies have been allowed to use mutual fund shares as collateral for loans in the past. Fidelity currently has such a company. However, its brokerage subsidiary has not been able to use Fidelity mutual fund shares as collateral for margin and now will be able to.
One possible snag, says Mr. Parrish, is that mutual funds must supply investors with a certificate to be used as collateral. Some money market funds do not issue certificates.
The Investment Company Institute has also petitioned the SEC to allow investors to buy mutual fund shares on margin. Since mutual fund shares are defined by the SEC as "new issues," because new investments in the funds involve the issuance of new shares, they are subject to credit restrictions. Although the SEC has decided against allowing this in the past, in its latest ruling it said it might reconsider its ruling.
To Mr. Shaw, if the SEC were to allow this development, the action "would only be bullish for the funds." He notes that over the past four months, net purchases of funds have exceeded redemptions. But mutual fund managers have yet to put this cash to work aggressively, since the ratio of cash to fund assets is historically quite high. Thus, any new surge in buying mutual fund shares could also propel stocks. Mr. Gordon likewise thinsk this could be a positive development, particularly for investors who trade no-load mutual funds like stocks.