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Letter from the US: No panic as investors stay the course

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Some 59% of US defined contribution (DC) plans’ assets and 47% of Individual Retirement Accounts (IRAs) are invested in mutual funds, with a total of $8.8trn (€7.5trn). Overall, the US mutual fund industry manages about $22trn on behalf of more than 100m investors. 

“More than four out of five fund investors are looking toward long-term goals such as retirement, according to our research,” said William ‘Ted’ Truscott, CEO of Columbia Threadneedle Investments and chairman of the Investment Company Institute (ICI) during an address to its annual membership meeting in Washington, DC in May. 

He added: “They recognise investment risk: that’s why they have stayed the course through market downturns and volatility since the bear market of 1973-74 until the financial crisis from October 2007 to February 2009.

“So don’t worry about mutual fund investors’ role in the next financial crisis: they don’t panic and run to liquidate their investments, they don’t intensify the crisis,” he said. “See, for example, what happened on 5 February when the DJIA [Dow Jones Industrial Average] dropped 1,175 points and only 0.23% of sales came from mutual funds.”   

Talking about preventing the next financial crisis, the new mutual fund liquidity rules should probably be reconsidered, said Securities and Exchange Commissioner Michael Piwowar at the ICI conference. The rules were approved by the Securities and Exchange Commission (SEC), a financial regulator, in October 2016 and should be implemented by December 2018. 

The rules require US mutual funds with assets of more than $1bn to classify their portfolio holdings into four liquidity buckets, according to how fast they can liquidate the assets. Their aim was to avoid a repeat of the kind of problems that surfaced with the collapse of the Third Avenue Focused Credit Fund in December 2015. 

“But that case was pretty unique,” said Piwowar. “I had an ‘ah ah’ moment when a fund manager told me that during a recent liquidity crisis he was able to sell liquid assets and buy non-liquid ones at a bargain price. That trading helped stabilise the market, but it wouldn’t have been possible if the liquidity rules were already in place. So I think that fund managers need more flexibility.”

Another rule regarding both the mutual fund and the retirement industries that was approved as an outcome of the Dodd-Frank Wall Street Reform is the fiduciary rule. The version that was written by the Department of Labor (DOL) and that was supposed to be effective last year, is in practice ‘dead’. It has come under the responsibility of the SEC after being abandoned by the justice system.

“The DOL’s fiduciary rule was a terrible, horrible, no good, very bad rule… It set up an unworkable, impossible set of standards for people to comply with”

Michael Piwowar

The ICI approves the shift. The DOL’s fiduciary rule was “a terrible, horrible, no good, very bad rule”, said Piwowar (who will no longer be with the SEC in August, after the end of his five-year term as commissioner). “It was marketed as a way to increase investor protections around discussions of retirement accounts. What it really was, was a politicised tool from the beginning to enable trial lawyers. It set up an unworkable, impossible set of standards for people to comply with.” 

During the conference, the economist Sean Collins, leader of the ICI’s research department and Sarah Holden, ICI senior director of retirement and investor research, outlined to IPE some of the trends affecting the mutual fund and the pension fund industry. “Demography plays an important role,” Holden said. “On one hand, baby boomers who are approaching retirement age are switching from stock to bond funds in their 401(k) plans because they look for a less risky source of income. On the other hand, the millennials are the largest generation now. They start investing at a very young age and they mostly choose equities for their 401(k)s.” 

In fact, according to ICI Research, at the end of 2015 (the latest available data), 75% of 401(k) participants in their 20s held more than 80% of their accounts in equities, while only 21% of participants in their sixties held such high equity allocation.

The trend in favour of low-cost index funds and exchange-traded funds (ETFs) is gaining momentum. In 2007 they accounted for only 15% of $9.5trn (€8.2trn)total net assets, and in 10 years they grew to 35% of $19.2trn total net assets (at the end of 2017 almost $3trn were managed in money market funds). 

But that does not mean that active managers are destined to disappear. “To survive, managers can focus on certain areas of the market, choosing to become boutique companies, specialising, for example, on emerging markets,” said Collins. “Besides, they can save money outsourcing the back office and other operations such as audit and some legal services to a third party through a turnkey setup.” The third party provides services to a number of independent fund sponsors under a single complex that serves as an ‘umbrella’ and that is cost-efficient. In any case, 65% of the fund market is still controlled by active managers. “Active management will always be necessary,” he said, “for investors who have to pick index funds of ETFs for their portfolios.” 

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    Asset class: All/Large Cap Equities.
    Asset region: Global Developed Markets.
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    Closing date: 2018-09-25.

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