Schumpeter, Minsky, and the FCA: Exploring the links between financial regulation, growth, and stability London, 9-10 June 2017
Global Financial Stability Analysis Division Monetary and Capital Markets Department
Asset Management and Financial Stability: Recent Insights Luis Brandão-Marques International Monetary Fund The views expressed herein are those of the author and should not be attributed to the IMF, its Executive Board, or its management. 2
Motivation • Rapid growth of asset management industry and increasing role in credit intermediation and securities markets. – Smaller role of banks. – Interaction with monetary policy.
• Financial intermediation through asset management firms has many benefits—diversification, alternative to banks—even from financial stability point of view. • However, concerns over liquidity mismatches, run risk, leverage, and complexity (also for other intermediaries). 3
Outline Overview of analytical work featured in recent GFSR issues: • Asset management and sources of systemic risk. • Asset management and market functioning. • Asset management and monetary policy. • Asset management and financial sector policies. 4
ASSET MANAGEMENT AND SOURCES OF SYSTEMIC RISK 5
Leverage and complexity are known risks
Known issues… • Hedge funds—leverage, insolvency, complexity • MMMF—constant net asset value NAV (= money-like liability), link to bank funding
…do not apply to other MF, ETF • Low leverage • Variable NAV • Low insolvency risk: liabilities are “shares”—return and losses absorbed fully by investors
6
But even plain-vanilla funds present risks Incentive problems
Information gap between managers and investors • Benchmark
based evaluation →Excessive risk taking + Herding • Brand name effects
Fire sales, contagion, amplification
First-mover advantage Run risk
•Liquidity mismatches •Managers sell liquid assets first •Pricing rules pass liquidation cost to second movers 7
Does mutual fund investment matter for asset price dynamics? –Yes • Does aggregate mutual fund flows affect aggregate price index? GFSR April 2015 (Chapter 3): – Yes—for smaller, less liquid markets (EM assets, HY US corp. bonds) – Not much for US equity, US broad bond funds
• Concentrated holding by mutual fund—bad for bond spreads during 2008 crisis and 2013 – The share held by the 5 largest mutual fund investors for each bond 8
What drives run risk? • Drivers of fund flows –Market factors (VIX, benchmark), and fund’s own performance matter • Chasing past returns • Flight to quality
–Some brand name effects • Limited macro impact so far 9
What can mitigate run risk? Fees are effective in dampening redemptions • Redemption fees reduce net outflows for EM funds but not for US bond funds. Chart: difference between average flows during 9/2008-12/2008 and 5/2013-9/2013.
Change of average fund flows before and during stress episodes, in percent of total net assets
GFSR April 2015 (Chapter 3):
3. Redemptions during Stress Times, by Redemption Fee Levels
5
Funds with low redemption fees Funds with high redemption fees
0 -5 -10 -15 -20 -25 -30 -35 2008 Equity Funds 2013 EM Bond Funds Stress episodes
2013 EM Equity Funds
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… but fees have been declining 4. Trend of Mutal Fund Fees (Simple average, in percent)
• Competitive pressures and transparency requirements have driven down fees.
4.5
• Difficult for investment funds to raise fees on their own.
1.5
Purchase Fee
Redemption Fee
4.0 3.5 3.0 2.5 2.0 1.0 0.5 0.0
Dec-01 Jan-03 Feb-04 Mar-05 Apr-06 May-07 Jun-08 Jul-09 Aug-10 Sep-11 Oct-12 Nov-13 Feb-02 Mar-03 Apr-04 May-05 Jun-06 Jul-07 Aug-08 Sep-09 Oct-10 Nov-11 Dec-12 Jan-14
GFSR April 2015 (Chapter 3):
Bonds
Equity 11
Does asset managers amplify risks? (1) Incentives for excessive risk taking • Investor pour money into funds with strong recent performance.
US Mutual Funds: "Convex" fund flow-performance relationship Monthly fund flows, percent of total net assets
GFSR April 2015 (Chapter 3):
1.2 1.0 0.8 0.6
Bond fund
Equity fund
0.4 0.2 0.0 -0.2 -0.4 -0.6 -2.0 -1.7 -1.4 -1.1 -0.8 -0.5 -0.2 0.1 0.4 0.7 1.0 1.3 1.6 1.9 2.2 2.5 Fund's monthly excess return over benchmark, in percent
12
Does asset managers amplify risks? (2) Herding GFSR April 2015, Chapter 3: • Herding among US funds increased (measure by Lakonishok et al. 1992). • Retail funds show more herding:
More difficult for retail investors to monitor fund manager performance?
1. Average Measure of Herding by Security Type (Mean across securities, four-quarter average) End 2009
20% 18%
Mid 2014
More herding
16% 14% 12% 10% 8% 6% 4% 2% 0% S&P 500
U.S. equity
HG bond
HY bond
EM equity
EM debt
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Asset managers can have large market impact
0.6
More concentration
0.5 0.4 0.3 0.2 0.1
37.4
17.0
14.0
12.1
10.6
9.1
7.9
7.1
6.4
5.7
5.1
4.4
3.8
3.2
2.6
2.0
1.4
0.9
0.5
0.0
0.1
• Bond prices decline more in stress periods when ownership by mutual funds is higher or concentrated.
0.7
Change in credit spreads, %
• Mutual fund flows affect asset returns in smaller, less liquid markets.
Bonds Issued by Emerging Market and Developing Economies, 2013:Q1 and 2013:Q2
Concentration
GFSR April 2015, Chapter 3
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Investment focus matters for systemic risk… GFSR April 2015, Chapter 3: 1. Average Contribution to Systemic Risk, by • Contribution to systemic Investment Focus (in percent) 4.5 risk measured by ∆Covar 4.0 (Adrian & Brunnermeier 3.5 2011). 3.0 • Specification:
• Depends more on investment focus than on size.
2.5 2.0 1.5 1.0 0.5 0.0
AE Sovereign bonds
AE Corp. bonds
EM Bonds
AE Equity
EM Equity
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ASSET MANAGEMENT AND MARKET FUNCTIONING 16
Changes in market landscape GFSR October 2015, Chapter 2: • Reduction in the role of banks as market makers. • Increased presence of central banks in securities markets through asset purchases/quantitative easing. • Increased presence of asset managers.
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Asset managers, as part of the investor base, affect market liquidity and of its resilience Macroeconomic Environment
Risk Appetite
Monetary Policy
Market Making
Day-to-Day Liquidity
Liquidity
Technology
Search Costs
Liquidity Resilience
Regulation
Investor Base
Banks’ reduced balance sheet space affects market liquidity GFSR October 2015, Chapter 2
• Banks reduced presence in market making. • Specification: • Reduction in banks’ balance sheet space associated with lower market liquidity. 19
Asset managers and the resilience of market liquidity: GFSR October 2015, Chapter 2: • Higher holdings by mutual funds and higher concentration of ownership associated with less-resilient market liquidity. 20
ASSET MANAGEMENT AND MONETARY POLICY
21
Monetary Transmission has Strengthened • Based on a VAR of log real GDP, log GDP deflator, log NEER, and monetary policy rate. • Robust to alternative specifications and monetary policy measures (U.S.). GFSR October 2016, Chapter 2
quarters
22
Possible reasons for changes in transmission • Changes in the conduct of monetary policy and expectations. • Increased economic and financial integration. • Changes in the way financial markets work.
The focus of this section (GFSR October 2016, Chapter 2) 23
Channels of Monetary Policy Transmission Emphasis on two mechanisms: • Frictions affecting the supply of credit; • Risk-taking channel. 24
Empirical Strategy • Aggregate analysis of monetary policy changes—stylized facts: – Exploratory analysis: PVAR with four variables: Y, P, NEER, and i. – Detailed analysis: VAR country-by-country including total assets owned by financial sector (banks, insurance and pension, and OFI).
• Firm-level analysis—improve identification: – Microanalysis of the behavior of financial firms: • Mutual fund allocations: changes in response to monetary policy changes. 25
Transmission Seems Stronger When Nonbanks More Important But differences are small. GFSR October 2016, Chapter 2.
26
Aggregate Analysis—UK vs. USA GFSR October 2016, Chapter 2: • Responses of OFI similar to banks, but often more intense. • Different composition of OFI across countries. quarters
27
Mutual Funds Increase Risk Taking in Response to Monetary Expansion GFSR October 2016, Chapter 2: • Following a 1 p.p. increase in U.S. shadow monetary policy rate (Wu and Xia 2016), mutual funds increase allocation to: – High-yield bonds by 4 p.p. – Long-term bonds by 9 ½ p.p. • Evidence of risk-taking channel? 28
ASSET MANAGEMENT AND FINANCIAL SECTOR POLICIES 29
Recommendations from previous GFSRs • More “hands-on” microprudential supervision of risks – Regulators’ own risk analysis, stress testing – Better data (derivatives, securities lending)
• Incorporate macroprudential views (focus on systemic risk)
30
Recommendations • Improve liquidity requirements – Better definition of “liquid assets”
• Reduce first mover advantage – (Minimum) redemption fees for funds investing in illiquid assets – Adjust technical aspects of fund share pricing rules
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Thank you
Global Financial Stability Analysis Division Monetary and Capital Markets Department
Appendix • All material sourced from: – GFSR April 2015, Chapter 3 – GFSR October 2015, Chapter 2 – GFSR October 2016, Chapter 2
• Check chapters for original data sources.
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