The Chief Economist of the Bank of England, Andrew Haldane, recently gave an address entitled “The age of asset management?” which explored the relationship of the asset management industry and financial stability. A major theme of the speech was that the asset management industry has grown and will continue to grow, bringing about what the author of the speech termed “the age of asset management.”
Haldane readily acknowledges that asset managers have an agency relationship with their investors, and thus do not bear credit, market or liquidity risks on behalf of their customers, as do banks. However, citing the Office of Financial Research report issued in 2013, the author posits that a large fund selling assets may “aggravate frictions in financial markets.” While the author notes that “history is not littered with examples of failing funds wreaking havoc in financial markets,” in the future, “Black Swan risk in asset management may be real and rising.”
A primary method by which he believes asset managers may channel financial risk is by amplifying “procyclical swings in asset prices and investor flows.” This occurs when, for example, funds with strong performance show stronger inflows, or when large pension funds in a declining market “sell risky assets and purchase bonds to better match their assets and liabilities.” Such behavior, the speech asserts, encourages a “pro-cylical spiral.” The author criticizes pension funds in particular for this behavior, noting that “patient capital,” that is, long-term investments, should not make these sorts of portfolio allocations (even though the author notes that in 2008 the decisions “made sense”). He asserts that long-term investors should instead “purchase risk” when it is “cheap.”
The speech then turns to appropriate regulatory policy measures to apply to asset managers. The author notes that “we are in the intellectual foothills when understanding the transmission channels through which asset managers could generate systemic risk.” Consequently, he warns against “ruling out future sightings of asset management Black Swans.”
The speech notes that leverage or capital-based tools are inappropriate for asset managers, as asset managers are “essentially unlevered.” However, the speech suggests that “minimum liquid asset requirements, restrictions or gates on liability redemptions may be more suitable.” The author advocates “fresh thinking on new policy tools to moderate” asset managers’ impact on financial market risk. The author notes that an area of concern is “the portfolio choices of long-term savings institutions,” because these investors have become “restless just at the time the economy requires patience.”
Our report on industry comments on the Office of Financial Research report of 2013 can be found here.
Our webinar on the OFR report can be found here (member log-in required).