Looking at the hard economic impact of the Great Depression (1929-1932) and the Great Recession (2007-2009), leads us to the eminent role played by banks in both. It then comes as little surprise that the banking sector captures all the attention. However, what remains to be looked into, and perhaps more worrying in today’s environment, is the role of prolonged periods of uptrend and low-vol on the asset management industry. This is where the risk builds…as everybody gets overly comfortable and ultimately concentrates in the same investments.
In 2014, the Financial Stability Board (FSB), an international body that makes recommendations to G20 nations on financial risks, published a consultation paper asking whether fund managers might need to be designated as “global systemically important financial institution” or G-SIFI, a step that would involve greater regulation and oversight. It did not result in much, as the industry lobbied in protest, emphasizing the difference between the levered balance sheet of a bank and the business of funds.
The reason for asking the question is evident: (i) sheer size, as the AM industry ballooned in the last few years, to now represent over 15trn for just the top 5 US players!, (ii) funds have partially substituted banks in certain market-making activities, as banks dialed back their participation in response to tighter regulation and (iii) , funds can indeed do damage: think of LTCM in 1998, the fatal bailout of two Real Estate funds by Bear Stearns in 2007, the money market funds ‘breaking the buck’ in 2008 amongst others.
But it is not just sheer size that matters for asset managers. What may worry more is the positive feedback loops discussed above and the resulting concentration of bets in one single global pot, life-dependent on infinite momentum/trend and ever-falling volatility. Positive feedback loops are the link for the sheer size of the AM industry to become systemically relevant. Today more than ever, they morph market risks in systemic risks.
Volatility will not forever be low, the trend will not forever go: how bad a damage when it stops? As macro prudential policy is not the art of “whether or not it will happen” but of “what happens if”, it is hard not to see this as a blind spot for policymakers nowadays.
Generally speaking, large positive net flows lead to higher prices. But the presence of these flows is only possible due to the way ETFs are constructed. As explained here:
ETF shares are created when an “authorized participant” deposits a daily “creation basket” (or cash) with the ETF.
ETF shares may be redeemed through the reverse of the creation process. That is, an authorized participant presents the specified number of ETF shares to the ETF in exchange for a “redemption basket” of securities, cash, or both, which typically mirrors the creation basket.
This creation and redemption creates traceable flows, but this process is not repeated in other instruments such as Bitcoin. There are some Bitcoin ETFs planned, but even when we have flow data for them, the flow data does not always correlate to price.
Companies in the S&P 500 are on pace to spend $500 billion this year on share buybacks, or about $125 billion a quarter, according to data from INTL FCStone. That is the least since 2012 and down from a quarterly average of $142 billion between 2014 and 2016.
Buyback activity among top-rated nonfinancial debt issuers, many of which have regularly borrowed money to finance share repurchases, declined for the third straight quarter in the July-to-September period, according to Bank of America Merrill Lynch. Meanwhile, mergers and acquisitions among that group of companies had their biggest quarter of the year, analysts at the bank said.
Factors including high stock price, historically high share valuations and uncertainty over the future shape of the tax code mean that “companies may be less likely to favor buybacks over other uses of cash in 2018,” analysts at Goldman Sachs Group Inc. said in a report this week.