When the Governor of the Bank of England speaks, it is always worth listening to, and he is on to something when he writes about market liquidity; he is surely right to flag the dangers of the narrow exit doors in a crowded investment room. We are told that more than $30 trillion of global assets are held in investment funds that promise daily liquidity to investors despite investing in potentially illiquid underlying assets, such as emerging market debt. What happens when everyone wants to leave at the same time? In days gone by it was the banks which needed to worry about the queues snaking out of the portals of the buildings, and onto the street: death by popular acclaim. Now it happens out of public view, and in a different sector: the fund management industry. There is (to quote Mr Carney), ‘a structural mismatch between the frequency with which [investment funds] offer redemptions, and the time it takes them to liquidate their assets.’ We have seen recently two high profile examples of this in the London investment world; indeed, it doubtless prompted the observation of the Governor in his Tokyo speech last month, but he draws what is ultimately a complacent conclusion: ‘under stress they may need to fire-sell assets… a vicious feedback loop that can ultimately disrupt market functioning.’
Ultimately? Might we be talking a few millionths of a second here? The interconnectivity of markets, and the sophistication with which systematic trading machines can target assets, amplify the vulnerability inherent in this mismatch. It is a greatly unpleasant thing to see the playing out of a modern day ‘run on a bank’, but the lesson it should instil is that there are not many steps from the particular to the pandemic.
Banks could survive safely for generations without having to worry about the fact that only a few people could get their deposit money back on a given day, because only a few people ever did need their money back each day: the wonders of fractional banking. So it has been with investment. It is why property can be held in a fund with daily trading, despite the vagaries of the property market