The International Monetary Fund's latest Global Financial Stability Report is asking an important question, which, for dramatic purposes, I will paraphrase this way: Is Bill Gross too big to fail?
Mr. Gross, the fallen king of the bond market, was having a tough go of it before his unhappy departure from Pacific Investment Management Co. last month. His Pimco Total Return Bond Fund trailed 65 per cent of its rivals over the past year, according to Bloomberg News. Investors has been pulling their money out of the fund since May of 2013 as Mr. Gross misjudged when the Federal Reserve would end its asset-purchase program. In 2014, he missed out on a relatively strong showing by longer-term debt. The crown Mr. Gross threw off in anger had become noticeably tarnished.
Yet that didn't stop Mr. Gross's decision to leave the firm he started and join Janus Capital Group from roiling markets. The Total Return Fund he managed at Pimco promptly saw more than $23-billion (U.S.) in redemptions, its most ever. Bond markets wobbled. The Financial Times reported this week that investors had sold hundreds of billions of dollars worth of interest-rate derivatives, a security favoured by Mr. Gross. News on Wednesday was the fund Mr. Gross will manage at Janus attracted $66.4-million in September.
The turmoil around Mr. Gross's departure from the world's biggest bond fund highlights an issue that has become a growing concern of international regulators. The asset-management industry has become so concentrated that missteps by one of only a handful of firms risks triggering a financial tsunami akin to bankruptcy of Lehman Brothers Holdings Inc. six years ago. The IMF is right to get people talking about the threat.
Part of the problem is us. We retail investors exhibit herd-like behaviour. Massive asset managers such as Pimco and BlackRock Inc. are attractive places to place our money because so many others have chosen to do so. The result: those firms get bigger and bigger. The 10 biggest global asset managers control $19-trillion (U.S.), according to the IMF. That's serious money.
The IMF worries about "brand risk." Given the money management business is base on reputation, when an individual asset manager screws up, chances are the entire firm will suffer. Capital flight from boutique investment shops matters little. A rush to the exits from firms such as Pimco and BlackRock is something to fret about.
There are other reasons to worry. The IMF observes the potential for a mismatch between redemption terms and a firm's access to cash. Many riskier credit funds hold assets that trade infrequently and therefore could struggle to return clients' money if too many redemption orders came in at once. The concentration of assets also is reducing diversity because market signals are being determined by a small group of people who control tremendous amounts of money.
The asset management industry has become a bigger player in the economy. Banks and insurers are constrained by post-crisis regulation, limiting their ability to push money into the system. Asset managers fill the void. They also are arguably less risky than banks because they tend to use the cash of their clients rather than borrow money to make financial bets. The government is in no way obligated to bail them out if they get into trouble, which theoretically guards against moral hazard. At least until now.
Having dealt with the biggest banks and insurers, global regulators now are considering whether firms such as BlackRock should be added to the growing list of institutions that are so big they require special oversight. BlackRock, Pimco and others are pushing back, saying regulators misunderstand their industry. The IMF's latest assessment suggests otherwise. There has been a good deal of thought put into the risks posed by the evolution of the asset-management industry. Regulators have every reason to press ahead, even if Mr. Gross now is managing much less money.