Is BlackRock a black swan? The world’s largest asset manager says not. It reckons big individual funds, especially the leveraged variety, present the more likely future systemic danger, not the firms that run them. That’s self-serving for BlackRock, which manages $4.3 trillion of assets. It also, however, makes sense and fits with history.
The Financial Stability Board, which coordinates international regulatory efforts, asked for feedback by Monday about the global dangers posed by investment vehicles. It is part of a broader quest for a definition of what the Bank of England’s Andy Haldane last week called “a new high-water mark for impenetrable financial acronyms” – NBNI G-SIFIs, or non-bank, non-insurer global systemically important financial institutions.
With regulation on the way for such giant enterprises, it’s no surprise that according to a summary of its response, BlackRock agrees with the FSB’s starting point, which is to focus on funds not managers. It’s true that asset managers are largely immune to the failure of funds they oversee. Investors are the ones on the hook. Requiring asset managers to hold more capital also wouldn’t make a fund-level meltdown any less likely.
BlackRock further argues that leverage is a better indicator of a fund’s systemic risk than size. For a big provider of index funds and ETFs, this too may favor the company over, say, hedge funds where fund-level borrowing is more prevalent. But it’s also logical.
Long-Term Capital Management, the hedge fund that imploded in 1998 is one example of the peril of high leverage. Another is Carlyle Capital Corp, the mortgage bond fund that borrowed $32 for every $1 of assets at the end of 2007 only to be wound up, insolvent, the following March. Other characteristics also matter, including how easily sold a fund’s holdings are relative to the ability of investors to withdraw their cash.
Managers aren’t completely in the clear. After all, BlackRock and Pimco parent Allianz, among others, broadly match the biggest global banks for total assets involved. And a problem in one fund could prove contagious. As Haldane notes, however, reputational trouble is likely to be a one-off, making it less dangerous than something market-wide. And it would not spread as fast as a “run” on a single investment vehicle, allowing time for remediation or the transfer of funds to a new manager.
Still, regulators might take more comfort from what looks like the start of a smooth leadership transition at BlackRock than the recent controversy over the role and influence of Bill Gross at Pimco.
Investment firms with assets concentrated in fewer, larger funds than BlackRock will probably have a different perspective. And in a complex market there’s scope for watchdogs to distort the playing field rather than making it safer. BlackRock, however, is essentially on target. Ultimately, there’s more to fear from leveraged funds than big managers.