A couple of prominent investment funds are currently living through a portfolio manager’s worst nightmare: So many customers are demanding their money back that withdrawals need to be frozen.
Amit Deshpande, a former longtime risk manager, sees it as a wake-up call. In particular, he’s watching the growing ranks of asset managers who rely on ETFs to act as cash equivalents. He wonders whether the funds can be sold off to pay fleeing clients in times of stress as seamlessly as the stewards of the $4 trillion market would like.
In other words, are exchange-traded funds the ATMs many managers believe them to be? Or will they fail to sell quickly enough and at sufficient prices during a crunch to fulfill customer demands?
“We’ve taken a bunch of semi-liquid securities, put that into an equity wrapper, said now you’re an equity and now you’re liquid,’’ said Deshpande, currently head of fixed income quantitative investments and research at T. Rowe Price Group Inc. “It doesn’t always work that way.’’
Client Withdrawals
Skeptics have long questioned how easily ETFs can be turned into cash during a sell-off. But most of the focus has been on the funds facing their own client withdrawals, not money managers holding ETFs to pay off investors in other kinds of funds.
The growing concern comes as active managers such as U.K. stock picker Neil Woodford, Switzerland’s GAM Holding AG and London-based H20 Asset Management grapple with redemptions. Bond ETFs in particular are eliciting alarms. They account for less than 1% of the fixed-income market, but assets have grown quickly to $1 trillion and they’re increasingly popular as cash substitutes.
About half the institutions that own bond ETFs are using them for cash management, according to a survey by Greenwich Associates. Eaton Vance Corp. uses a loan ETF to avoid cash drag in its short-duration strategic income fund, for example.
Fund Liquidity
Much depends on the mismatch between the liquidity of the funds, which trade every second, and that of the securities they own. Proponents argue that this means ETFs better reflect the value of their holdings than slower-to-react mutual funds. But concerns linger that any breakdown in the relationship between the prices of the funds and their securities, particularly in fixed income, could imperil owners.
The European Systemic Risk Board recently warned that price decoupling could raise systemic risk by destabilizing institutions that rely on ETFs for quick cash. The U.S. Securities and Exchange Commission didn’t respond to requests for comment.
Boosters say that ETFs are ideal cash replacements thanks to a unique structure that makes them more liquid than other types of funds. While ETFs expand and contract as money flows in and out, they also trade on exchanges like stocks.