Open-end investment funds a potential vulnerability to assets markets: IMF

Mutual funds, which grew significantly to $41 trillion globally in the first quarter of 2022, represent a major potential vulnerability for asset markets, the IMF said on Tuesday, calling for greater international regulatory coordination to ensure their effectiveness.

In its latest edition of the Global Financial Stability Report, the International Monetary Fund found that open-ended funds play an important role in financial markets, but those that offer daily redemptions while holding illiquid assets can amplify the impact of adverse shocks by increasing the likelihood of investor runs and emergency sales.

This is contributing to volatility in asset markets and potentially threatening financial stability, it said.

These concerns are particularly relevant now as central banks normalize monetary policy amid heightened uncertainty about the outlook. A disorderly tightening in financial conditions could trigger significant redemptions from these funds and contribute to stress in asset markets, the report said.

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Given the global operations of funds and their cross-border spillover effects, liquidity management practices should be deployed consistently at the global level to ensure their effectiveness, which requires greater international regulatory coordination, the IMF said in the report.

The report, released ahead of the annual meetings of the IMF and World Bank, says policymakers should ensure these funds are using appropriate liquidity management tools.

A wide range of tools are available to potentially mitigate the vulnerabilities and systemic impact of open-ended funds, but effective implementation of these tools is lacking.

Mutual funds have experienced significant growth since the global financial crisis. The total value of their net worth has quadrupled since 2008, reaching $41 trillion in the first quarter of 2022 and accounting for about a fifth of non-bank financial sector assets, the IMF said.

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Fabio Natalucci, Deputy Director of the Money and Capital Markets Department; Mahvash S. Qureshi, Division Head in the IMF’s Money and Capital Markets Department, and Felix Suntheim, Senior Financial Sector Expert in the Global Financial Stability Analysis Division of the IMF’s Money and Capital Markets Department, wrote a joint blog post on the subject.

Aside from the market turmoil caused by the pandemic, our analysis shows that returns on assets held by relatively illiquid funds are generally more volatile than comparable holdings that have less exposure to those funds, particularly during times of market stress, they said .

The IMF said additional liquidity management tools could include limiting the frequency of redemptions by linking them to the liquidity of fund portfolios to directly address the underlying vulnerability related to liquidity mismatch.

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More rigorous oversight of funds’ liquidity risk management practices by supervisors and regulators should be considered, she recommended.

Given the adverse cross-border spillovers, recipient countries must adopt appropriate policy measures to mitigate potential systemic risks from volatile open-ended fund flows,” the IMF said.

“This should include the continued deepening of domestic markets, the use of macroeconomic, regulatory and cash flow management measures, and foreign exchange interventions in line with the recommendations of the International Monetary Fund’s Institutional View, the report said.

(Only the headline and image of this report may have been edited by the staff at Business Standard; the rest of the content is auto-generated from a syndicated feed.)

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