Just when mutual-fund managers thought the systemic-risk talk was over, the New York Fed has stoked the fire. Sort of.
In a post published Thursday on the New York Federal Reserve’s Liberty Street Economics blog, economists argued that mutual funds are at risk of fire-sales and runs.
On Friday, however, the economists, on the same blog, took a closer look at a recent event “similar to a run” and concluded it had not had a large impact on bond market liquidity.
The event? The meltdown of a credit fund run by Third Avenue Management LLC.
The authors of the post argue that the heavy outflows, which ultimately led the firm to suspend redemptions, impacted less liquid bonds but “in terms of magnitudes, the liquidity reactions were not particularly large.”
On Friday the authors also looked at a hypothetical situation in which half of a given fund’s investors cash out, forcing a fund to liquidate half of its assets. The post focused on high-yield funds and concluded that while there were some “spillovers” and losses to other fixed income and equity funds, in their example the impact was “relatively small and nonsystemic”.
They said under other circumstances including larger price movements “the fire-sale consequences of run events for funds might be significantly more severe.”
In their Thursday post, the authors assumed a “permanent, unexpected parallel shift of the yield curve of 100 basis points” in a market-wide stress test and argued that a wave of redemptions could trigger heavy selling that pushes down market prices and ripples through the financial system.
“Mutual funds can, in fact, be subject to a ‘run’—despite the fact that they have no significant leverage and a floating [net asset value],” they wrote. “In addition, the test shows that such a run can produce significant negative spillovers in asset markets through forced liquidations.”
They pointed to the growth of mutual funds, especially fixed-income funds, since the financial crisis and argued that investors have become more jittery and likely to pull money when performance suffers.
This is the very accusation money managers have spent the last few years batting away. Regulators in the U.S. and overseas have been studying whether asset managers and the funds they manage pose systemic risks and should be subject to additional regulation.
For now, policymakers have focused on certain products and activities. In the U.S., the Securities and Exchange Commission is in the process of crafting a new set of rules on subjects like mutual fund liquidity management and derivatives use.
“Mutual funds hold a small percent of the world’s capital markets. Holders are tens of millions of people with widely diversified time horizons. They don’t move as a mass, ” said John Hollyer, head of Vanguard’s global investment risk management group. He added that many mutual funds are used for longer-term college and retirement savings.
Mr. Hollyer said the Thursday NY Fed post seemed not to jive with others it has generated. A post late last year, for example, argued that corporate bond market liquidity is “ample”.
“It’s a bit of a non sequitur in relation to the other work that’s going on,” he said. “The concept of a first mover advantage is really rooted in the banking system.”
BlackRock in its latest paper on bond market liquidity argued that much of the recent debate on bond market liquidity has not taken into account the “diversity of asset owners” such as pension funds, central banks, and insurers with different investment horizons that could step in.
They added that “the prevailing dialogue is focused on approximately $5 trillion (debt securities held by open-end mutual funds and ETFs) out of approximately $39 trillion of debt securities” included in Fed data.
“This is a theoretical exercise not grounded in data,” said Sean Collins, senior director at the Investment Company Institute, adding that the post is instead based on assumptions built into the economists’ model.