Plain Vanilla Investment Funds Can Pose Risks

SUMMARY

Even simple investment funds such as mutual funds can pose financial stability risks, and regulators need to know more about them through hands-on supervision, and better data and oversight, according to new research from the International Monetary Fund.

 
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  • Asset management industry plays rising role in financial system
  • Role has benefits, risks for financial stability
  • More “hands on” supervision needed, with better data, oversight
  • Asset management firms help investors diversify their assets easily. The industry can also be a “spare tire” for financing the real economy when banks are distressed. Compared to banks, investment funds offered by asset managers are less likely to default because end investors bear losses and gains from the funds’ assets.

    In the latest research for the Global Financial Stability Report, the IMF said the debate about possible risks related to the industry had intensified. Risks from some segments of the industry—leveraged hedge funds and money market funds—are already widely recognized. However, there is an ongoing discussion about the risks from less leveraged, “plain-vanilla” investment products, such as simple mutual funds and exchange-traded funds investing in bonds and equities.

    “The new attention to possible risks related to asset management is motivated by the growth of the industry, its larger focus on less liquid bonds, and by concerns that in some advanced economies, many funds have increasingly been buying similar assets, while banks have withdrawn from market making,” said Gaston Gelos, Chief of the Global Financial Stability Analysis Division at the IMF.

    Size and scope

    The industry manages over $75 trillion assets globally, exceeding 100 percent of world GDP, the IMF said. In particular, bond funds have grown significantly, investing in less-liquid assets such as emerging market bonds and high-yield corporate bonds. This has increased the mismatch between the liquidity of funds’ assets and liabilities, because many funds allow investors to redeem on a daily basis.

    Large redemptions from these funds – possibly triggered by an external event, such as a faster-than-anticipated rise in interest rates in the United States - may have a widespread market impact, especially if banks are unable or unwilling to step in to provide liquidity in such a situation.

    In its latest Global Financial Stability Report, the IMF provides a detailed analysis of various risk-creating features of the industry and suggests how to revamp oversight of the sector.

    Understanding the risks

    The analysis highlights that it is important to distinguish conceptually risks that are introduced by the presence of funds from those that would exist even in their absence; that is if...

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