Last month’s Global Financial Stability Review (GFSR), the International Monetary Fund’s (IMF) twice-yearly study of financial markets, warned that record-low interest rates are increasingly pushing institutional investors to buy risky illiquid assets.
At the same time, corporate debt burdens are rising. The GFSR emphasised the role of institutional investors, whose desperate search for yield could lead to serious consequences.
“Similarities in investment funds’ portfolios could magnify a market sell-off, pension funds’ illiquid investments could constrain their ability to play a role in stabilizing markets as they have done in the past, and cross-border investments by life insurers could facilitate spillovers across markets,” says the IMF.
The debate over systemic risk in the asset management industry has intensified. Global bodies such as the Financial Stability Board (FSB), the International Organization of Securities Commissions (IOSCO) and the European Systemic Risk Board (ESRB) are concerned about systemic risk in the industry and have made recommendations for minimising it.
Meanwhile, the industry is far from reaching a consensus on whether systemic risk is significant. Critics of the regulators’ views argue that asset managers are agents rather than principals, as opposed to banks which, during the global financial crisis of 2008-09 moved to protect their own balance sheets. Another argument is that investors in funds are in for the long term and therefore have less urgency to sell assets during times of market stress. They should also be clear about the liquidity terms offered by funds.
None of those arguments are particularly strong. There are plenty of large ‘hybrid’ managers, which invest on behalf of clients as well as themselves. Many open-ended funds and exchange-traded funds (ETF) investing in illiquid assets offer daily redemptions. This may give investors a false sense of security that could amplify shocks if investors try to liquidate their positions simultaneously.
Furthermore, institutional investors may generally have a long-term approach, but there are many, such as defined benefit pension funds, that need liquidity and must comply with regulation around risk and solvency.
The central bank shift back towards dovish policies raises the urgency of the debate. Investors are forced to take risks and corporates are hungry for cheap debt financing, at a time when economic activity faces a slowdown. The financial system is facing its greatest challenge since the 2008 financial crisis.
Carlo Svaluto Moreolo, Senior Staff Writer