Proposals to improve investment funds ‘resilience
The International Monetary Fund (IMF) describes the role that investment funds play in financial crises and in global financial stability. The IMF proposes concrete measures to strengthen liquidity risk management to deal with client’s daily liquidity needs and mitigate the negative effects of liquidity tensions derived from fire-sale assets pro-cyclical dynamics.
The article´s key highlights would be the following:
- Prominent role of investment funds in the economy and in the global financial stability: According to the report around 50% of the world's financial assets are currently managed by non-bank institutions. Investment funds are key to explain that growth that has become an essential engine for prosperity of many corporates and households, but also a source of cross-border risk transfer in times of crisis.
- Liquidity risks in times of crisis: The search for higher returns in a low interest rate environment has led a part of these funds to invest in assets with higher risk and less liquidity (higher yield private debt or real estate assets). In times of adverse shocks (such as the pandemic crisis), clients ask for liquidity forcing funds to sell invested assets. Asset fire-sales generate drops in market values and capital outflows from companies and emerging countries, putting under pressure their promise of liquidity and amplifying the effects of the crisis.
- The IMF proposes concrete measures to safeguard global financial stability boosting the resilience of investment funds. For example:
- To disincentivize the early sales of investment fund´s shares when adverse shocks occur, by decreasing the value of selling fund´s shares early on in favor of investors who do not sell, thus avoiding sell-off episodes.
- To create liquidity tools, such as increasing counter-cyclical and liquidity buffers, or to allow to limit the sale of a part of the position, or to repay with other liquid assets, such as treasury bonds, instead of cash.
- These measures could be applied consecutively or in combination depending on the severity of the crisis.