Dedicated EM exposure has surged by over 55% since 2007, with assets concentrated on few managers. A new BIS article points out that trading flows are correlated due to the widespread use of benchmarks. Moreover, EM asset prices and final investor flows have been pro-cyclical and mutually reinforcing. These patterns seem conducive to recurrent market dislocations.
Bank of England’s Andrew Haldane has summarized the rise and risks of asset management in a recent speech. As demographics and economic development propel the industry to ever higher assets under management, self-reinforcing correlated dynamics become a greater systemic concern. Market conventions, accounting practices, regulatory changes and structural changes in the industry all contribute to this risk.
A new IMF policy paper defines global liquidity as the ease of funding in global financial markets. The concept is useful for understanding the commonality in global financial conditions, with four large financial centers dominating the world’s institutional funding. In the 2000s banks have been the main conduit of financial shock propagation, but asset managers may play a greater role in the 2010s (see also posts here, here and here).
A paper by Feroli, Kashyap, Schoneholtz and Shin illustrates how unlevered funds can become a source of asset price momentum due to peer pressure and redemptions. Regulatory reforms that impair bank intermediation could compound negative escalatory dynamics. This raises the risk of dislocations in fixed income markets if and when extraordinary monetary accommodation is being withdrawn.
Herding is a deliberate decision to imitate the actions of others. In financial markets with private information herding can be efficient for an individual asset manager, but increases the risks that the market as a whole is inefficient and fragile, particularly in the case of “information cascades”. A paper of Michael McAleer and Kim Randalj provides empirical evidence of herding in a range of futures markets.
Sovereign wealth funds now hold assets worth roughly 4% of global GDP, and are governed by politically-mandated investment objectives. A new IMF paper gives an overview of size, types, investments and governance structures of these institutions.
A new IMF paper suggests that so-called “long-term institutional investors” have largely turned pro-cyclical in recent crises. This feature may be structural and reflect (a) underestimation of liquidity needs in boom times, (b) failure of traditional risk management systems to appreciate tail risk, (c) asset managers’ short-term performance targets, (d) links between short-term performance disclosures and asset outflows, and (e) regulations and conventions that encourage herding.
‘Reach for yield’ describes regulated investors’ preference for high-risk assets within the confines of a rule-based risk metric (such as credit ratings or VaR). Bo Becker and Victoria Ivashina provide evidence that U.S. insurance companies act on this principle and show that ”conditional on ratings, insurance portfolios are systematically biased toward higher yield bonds”. ‘Reach for yield’ would be a form of regulatory arbitrage, a source of inefficiency, and a reward for “unaccounted risk” of securities and issuers.
Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.
