Personal finance: the next stock market crash looms in fund reform
A series of investment incidents have reinforced how seemingly easy-to-trade securities can turn into petrified assets in the blink of an eye. Nervous about the next market rout, regulators wonder how to protect investors from the frozen investment fund trap without strangling the market. They need to wiggle their hips.
The problem is easy to identify and incredibly difficult to solve: how to impose sufficiently strict liquidity rules on different flavors of funds without compromising their ability to generate returns.
In theory, funds run the gamut of liquidity, from money market funds promising instant cash conversion when needed, to real estate assets filled with property that is difficult to value and unload quickly. In between are credit funds, which buy corporate bonds of varying solvency, and equity products, with stakes in both publicly traded stocks and in private companies.
However, in times of market stress, each of these asset classes experienced difficulties.
More recently, investors panicked in March 2020 as the coronavirus spread and governments locked down their savings. In the UK, investors withdrew a staggering sum 10% of cash held in sterling money market funds in just eight days in what the Bank of England has dubbed a “dash for cash”. In the United States, institutional investors took 30% of prime money market funds in two weeks.
These funds seek to outperform liquidity by purchasing short-term commercial paper and certificates of deposit which, under normal circumstances, are some of the easiest securities to buy and sell. But as investors sought to withdraw £ 25bn ($ 35bn) in just over a week from the UK, they found the market for these assets “was closed,” according to the governor of the United Kingdom. Bank of England, Andrew Bailey. Put the.
It was a scary moment. Amid the risk of a rush for funds, trading in government bonds was disrupted and market interest rates were pushed up at the most inopportune moment. Rather than absorbing shocks, the system played a role “in transmitting and amplifying stress,” said Derville Rowland, Ireland’s central bank chief financial officer last month.
Unfortunately, attempts to fix the problem risk scaring fund providers and investors alike. Bailey said last month that potential remedies include limiting money market funds to only holding government securities, restricting the percentage of non-government assets they can hold, or requiring investors to give notice before they can get their money back. He recognized, however, that such reforms would change the nature and performance profiles of funds intended to serve as cash equivalents.
Efforts to make real estate funds less likely to stop buyouts, as happened in the UK after the Brexit vote and the start of the pandemic, are also proving tricky. The Financial Conduct Authority recently delayed a decision on proposed changes to its bylaws, including a change to notice periods rather than daily redemptions.
The problem for asset managers is that the increase in money set aside to cover potential withdrawals is eroding the potential for returns, while the elimination of daily redemptions is likely to deter retail buyers. So next month, Aviva Plc plans to close real estate funds it had frozen at the start of the pandemic. The London-based insurer said it could not meet its investment goals while ensuring sufficient liquidity to meet likely redemption requests.
In Sweden, asset managers are also concerned restrictions on the frequency of repayment of funds will backfire, prompting investors to demand repayment and increasing borrowing costs for companies. The onset of the pandemic effectively halted trading in the Nordic country’s corporate bond market, prompting more than 30 credit funds to freeze withdrawals. The central bank has proposed to end daily transactions for products. This week, the Swedish market regulator suggested mutual funds should only be redeemable twice a month.
It has been two years since Bank of England Governor Mark Carney warned that investment products containing illiquid assets and promising daily withdrawals were “built on a lie.” The likely solution will involve an assortment of fund classifications, with liquidity becoming a key differentiating feature, making it imperative Fund managers are perfectly clear with buyers about how quickly the underlying assets can be liquidated in times of stress.
As thorny as the problem is, supervisors must find ways to prevent investors from seeing their funds trapped behind doors when the next stock market crash hits.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
To contact the editor responsible for this story:
Melissa Pozsgay at [email protected]