GLOBAL - Investors should be wary of economic policies striving for macroeconomic stability, the IMF has argued, as such approaches, while increasing an investor's interest in countries, risk producing asset price bubbles.
In a paper examining how long-term investors have changed their asset allocation in the wake of the financial crisis and falling interest rates, the inter-governmental organisation raises the question of whether changes to asset allocation in recent years have played a role in increasing investors' vulnerability to market shocks and says that institutional investors are increasingly unlikely to shoulder the continued and sustained investment risk.
It says: "Initiatives like Solvency II and Basel III aim to make individual financial institutions safer, but may make institutional investors more like other short-term investors.
"As a result, they would be less likely to act as the 'deep pockets' of financial markets that support riskier, long-term investment and are willing to hold such illiquid assets through market downturns."
The IMF said this would jeopardise institutional investors' role as a source of financial stability.
It also argued that, in an effort to guarantee returns in a low interest rate environment, investors were taking on additional risk in alternative assets, as well as in other "smaller, potentially less liquid markets".
"The question, from the perspective of financial stability, is whether any such changes in investor behaviour, especially by real-money investors, could be making financial institutions, markets or economies more vulnerable to unexpected shocks," it says.
The paper argues that countries witnessing a stable macroeconomic climate will see increased interest from investors, but that this could have negative repercussions.
"The additional investment flows attracted by macroeconomic stability and strong growth prospects could have potentially destabilising effects over the longer run, including asset price bubbles and credit booms," the paper says.
"Monitoring and possible management of these flows should therefore be part of the larger framework of growth-enhancing policies."
The organisation concludes that the global financial crisis has altered investment strategies in a "structural and lasting way", although it concedes its findings have so far been based on "anecdotal" evidence.