PIMCO: Outflows Do Not Pose Systemic Risk

Asset managers and outflows from their funds do not pose a systemic risk to the financial system, PIMCO has argued.

In a 27-page letter to the Financial Stability Board (FSB), the Newport Beach, California-based bond shop said its handling of runs from the Total Return Fund after Co-Founder and CIO Bill Gross’ exit proves their stability.

“There were no ‘fire sales’ or ‘forced selling,’ and PIMCO never had to—or even considered—supporting the Total Return Fund or any of its other funds,” CEO Douglas Hodge wrote.

PIMCO’s submission comes as the FSB and other regulators are assessing the systemic risk posed by the largest asset managers and investment funds in the wake of the financial crisis. Earlier this month, BlackRock argued that risks in asset management should be addressed through product and market regulation rather than a “too big to fail” approach.

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According to the firm, Gross’ abrupt resignation in September last year sparked $23.5 billion and $27.5 billion in outflows in September and October 2014, respectively, “specifically concentrated in the days surrounding the announcement.”

Despite heavy runs, PIMCO said it was able to maintain risk exposures and replenish cash buffers across other funds. The firm said liquidity and redemption risks were a priority, adding that it used derivatives for exposures and inflows to support cash buffers.

“There were no ‘fire sales’ or ‘forced selling,’ and PIMCO never had to—or even considered—supporting the Total Return Fund or any of its other funds.” —Douglas Hodge, PIMCOFurthermore, concerns about asset sales putting “downward pressure on market prices” are misplaced, PIMCO claimed, as bond market performance was driven by macroeconomic and geopolitical issues, “not PIMCO’s redemption activity.”

“Even if mass redemptions were to occur and prices were to decline, we do not believe they would lead to a systemic event given the unlevered nature of mutual funds,” Hodge said. “While investors may lose invested capital, those losses have limited spillover effects to the rest of the financial system.”

In the immediate aftermath of Gross’ exit, fixed income managers told CIO the longer-term impacts on bond markets from the move would be minimal. This was despite speculation that some market shifts were at least partially linked to large PIMCO exposures that were expected to be unwound.

The now-$110 billion Total Return Fund surrendered its crown as the world’s largest bond fund to Vanguard in May, following 24 consecutive months of outflows. The firm’s data showed investors had pulled more than $110 billion from the fund since its peak of $293 billion two years ago.

In the same month, the firm’s Global Equities CIO Virginie Maisonneuve resigned after 17 months on the job. It was also reported that PIMCO would be shutting down two active stock strategies.

However, the bond giant continues to push into equities and announced Monday that it has launched six new stock funds in collaboration with Research Affiliates using the subadvisor’s smart beta strategies.

PIMCO said the new funds will cover equity exposures in US large, US small, international, global, global excluding the US, and emerging markets.

Alternative mutual funds—or liquid alts—have escaped scrutiny for long enough, according to a US Securities and Exchange Commission (SEC) official.

“These funds often operate in a gray area of mutual fund regulation,” SEC Commissioner Kara Stein said Monday in a speech at the Brookings Institution, a policy think tank in Washington, DC.

“Promising high liquidity—which all mutual funds must do—on illiquid assets that have not traditionally been a part of mutual funds does not seem in keeping with the intent of the Investment Company Act,” Stein continued.

“I hope that as the commission considers action in the area of liquidity, it asks hard questions about new and innovative products, as well as emerging risks. Do the retail investors investing in these funds truly understand and appreciate the liquidity of the fund?”

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Stein noted the difficulty of defining what, precisely, counts as a liquid alt product, and drew the boundaries widely. If the regulator agrees with Stein, any manager running an exchange-traded or mutual fund using non-traditional asset classes or strategies, illiquid assets, or relying heavily on derivatives should brace for extra SEC attention.

The sector has been one of finance’s great growth areas over the past several years. Between 2008 and the end of 2014, alternative mutual fund assets increased by more than 575% to $311 billion, according to Morningstar data.

Now, Stein argued, it’s time for regulators to catch up.

“Today, alternative mutual funds promising the upside of hedge fund investments with the liquidity of traditional mutual funds are all the rage,” she told the audience. “I think that this trend should give everyone pause, and regulators and the public need to be asking questions about this development.”

Stein has held senior financial advisory positions with a number of high-profile federal lawmakers and drafted significant portions of the Dodd-Frank Act, according to the SEC. In 2013, President Barack Obama appointed her to one of five commissioner roles at the regulatory agency.

Read Stein’s full speech: “Mutual Funds: The Next 75 Years.”