In a recent speech at the London Business School, Bank of England executive director for financial stability Andrew Haldane argues that we are heading into a new ‘age of asset management’ that will create new challenges for regulators and could destabilize economies in the future.
Growth in asset management industry
The asset management industry is growing rapidly, according to PricewaterhouseCoopers it is on track to hit $100 trillion AUM by 2020. Alternatives, including hedge funds, private equity and other specialized funds, has gone from $2 trillion AUM in 2003 to $6 trillion in 2012, and passively managed tracking funds have grown even faster, from $2 trillion in 2003 to $8 trillion in 2012.
For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More
This growth in managed funds isn’t inherently problematic, but Haldane mentions three characteristics that regulators need to watch carefully.
First, concentration in the asset management industry is even higher than it is in banking, with the top 10 institutions holding 28.3% of the market compared to 22.4% for banking. The largest asset manager, BlackRock, Inc. (NYSE:BLK), has more than 5% market share on its own. Asset managers don’t play the same role in the economy as banks, and it would be hard to predict the fallout of a company like BlackRock somehow failing, but it certainly wouldn’t be pretty.
Patient capital may have been part of the problem: Haldane
While long-term capital should use its ability to survive market cycles to buy risk when it’s at its cheapest and resell when the market is full of buyers, the exact opposite happened during the financial crisis.
“Funds with the strongest shoulders appear instead to have ducked for cover, while the weakest appear to have engaged in a gamble for resurrection,” said Haldane. “Patient capital ought to part of the solution to the long-term financing puzzle. In practice, it may have been part of the problem.”
Individual investors buy high and sell low because they are acting emotionally, or worry about remaining afloat in case of a sustained downturn, and it seems that asset managers cater to their clients’ state of mind. Additionally, market value is often a factor when determining the weight given to different assets, so a drop in price can cause pension funds and others to sell, when they should be buying (and vice versa).
Portfolio allocation trends impact long-term financing
Finally, Haldane sees a trend of de-equitization in asset manager portfolios, partially driven by regulations that encourage investment in low-risk assets such as government bonds. This process and the bad reputation that securitization has gotten since the end of the financial crisis could put pressure on long-term financing as asset managers form a larger and large part of the economy.