The New York Fed sought to answer the question about whether or not fire sales of mutual funds could represent a systemic risk to our financial system. They conclude that, yes, it could.
One of the main reasons they cite is the jumpiness of the investor class – what with 2008 still being fresh on everyone’s mind. The authors explain that fund investors demonstrate a higher sensitivity to performance than ever before – sellers come out quickly when funds decline – we saw this with both stock and bond funds at the end of last summer.
The NY Fed calls the resulting fire sale of mutual funds “spillover vulnerability” (emphasis mine below):
One reason for the increase in spillover vulnerability is that mutual funds—bond funds in particular—have grown substantially since 2009. However, a decomposition of spillover losses themselves—as opposed to their ratio to initial losses—shows that asset growth is not the only relevant factor…
…the increase in the flow sensitivity to performance of the system has contributed as much to the increased vulnerability as the increase in aggregate assets. In other words, investors seem to have become more skittish since the crisis and are quicker to redeem shares, and in larger amounts, for a given degree of underperformance. The third factor, “illiquidity concentration,” captures how concentrated illiquid assets are in large funds with high flow sensitivity. The higher this concentration, the higher the “contagion” from funds selling illiquid assets to other funds. This third factor is also significantly higher today than before the financial crisis.
This jumpiness explains a lot of the recent volatility, as selling begets even more selling among funds that now control an enormous amount of assets.
Having spoken at numerous investment conferences over the last year, I can tell you that this is THE hot button issue amongst professional investors. Concentration of illiquid investments at funds where shareholder performance sensitivity is high means a lot more whippy action to come until either something really bad happens or people calm the hell down. You tell me which of those things happens first…
And speaking of systemic risk, no asset management firm is more emblematic of today’s concerns than BlackRock, which runs $4.6 trillion for investors around the world.
In a new research report, Morningstar says that BlackRock is not like any other investment manager in the world.
Here’s Dan Culloton (emphasis mine, again):
There has never been a money management firm like BlackRock. In fewer than 30 years the former unit of private equity firm Blackstone has used acquisitions and operational savvy to become the largest asset manager in the world, with $4.6 trillion in assets as of Dec. 31, 2015, and style-, vehicle-, strategy-, asset-class-, and globe-spanning capabilities. Its scale, breadth, expertise, and ambitions place it at the epicenter of most financial industry trends and debates. Local and national governments, sovereign wealth funds, and other institutional investors seek its input and advice and often use its risk-management tools.
With great size and complexity, however, come great challenges and responsibilities.
BlackRock, and it’s chief Larry Fink, spend a lot of time reassuring the public and the government that they are aware of the systemic risks and know what they’re doing. Carl Icahn and many other prominent market participants and journalists aren’t so sure.
The below links are today’s must-read articles for serious investors.