Andrew G Haldane: The age of asset management?
Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at
the London Business School, London, 4 April 2014.
* * *
I would like to thank Sarah Breeden, Antonia Brown, Edd Denbee, Ronnie Driver, Ronan Hodge, Tamara Li,
Pippa Lowe, Varun Paul, Jonathan Rand, Martin Taylor, Lewis Webber and Jack Worlidge for their help and
comments.
It is a great pleasure to be speaking at this London Business School conference on asset
management. Given the topic and my area of responsibility, I thought I would discuss the
links between asset management and financial stability.
This issue is not new. But it has become topical recently as the asset management industry
has grown and changed shape. Partly in response, regulators globally have begun to explore
the risks to the financial system that might be posed by non-banks of various stripes,
including asset managers. I want to discuss those risks and their potential policy implications.
I want also, however, to discuss some of the opportunities asset management offers. The
industry is a key bridge between end-savers and end-borrowers, between the financial and
real parts of the economy. As the banking system continues to de-risk, strengthening that
bridge could well strengthen both the financial system and wider economy.
The evolution in asset management
Let me start with some facts on the evolution of the industry. Asset management is, of
course, an agency activity. Assets are managed on behalf of end-investors, whether
institutional (such as pension funds and life insurance companies) or retail, the former
typically through Separately Managed Accounts, the latter through Collective Investment
Schemes.
The industry's Assets Under Management (AUM) are currently estimated at around
$87 trillion globally (TheCityUK (2013)).1 This is large. It is equal to around one year's global
GDP or around three quarters of the assets of the global banking industry. It has also grown
fairly rapidly, with AUM roughly doubling over the past decade in dollar terms.
The longer-term picture is more striking still. In the United States, AUM have risen almost
fivefold relative to GDP since 1946, from around 50% of GDP to around 240% of GDP
(Chart 1). In the United Kingdom this pattern has been replicated, but over a much shorter
time period since around 1980 (Chart 2). Across most OECD countries, the patterns are
similar. The asset management industry has, it appears, come of age.
The drivers of this growth are reasonably well-understood. The pool of prospective global
savers has become larger, older and richer, each of which tends to be a boon for the asset
management industry. Since 1950, average life expectancy has risen by nearly 50%, world
population has risen by a factor of three and world GDP per capita has risen by a factor of
nearly 40. There is a strong cross-country correlation between GDP per capita and AUM
relative to GDP (Chart 3).
Accompanying this has been a sharp rise in the ratio of global wealth to income. Among
Western economies, this ratio has roughly doubled since 1950 from around 200-300% of
GDP to around 400-600% of GDP (Piketty (2014)). Among other things, this has been
attributed to post-war capital market liberalisation causing an upward shift in asset prices.
Looking forward, none of these global forces - population, ageing, incomes, wealth - are
likely to go into reverse in the near future. Between now and 2050, life expectancy is
expected to increase 9% (to 77 years), global population to rise by a further 30% and real
GDP per capita to rise almost threefold. Wealth-to-income ratios, while high, remain below
their peaks in the 18th and 19th centuries and so could rise further (Piketty (2014)).
These trends will be given impetus by changes in the pattern of global growth. The fastest
growing economies globally will be those where penetration of the asset management
industry is lowest. Developing markets currently represent less than 20% of global personal
financial assets, but represent 40% of global GDP.2 By 2050, developing countries will
represent 60% of global GDP. In China and India, personal financial assets have grown at a
rate of 25% per year for the past 20 years.
All of this suggests that the global asset management industry is likely to continue its
upwards march, absolutely and relative to the economy. For example, PWC recently forecast
that AUM would top $100 trillion by 2020 (PWC (2014)). Simply extrapolating GDP per capita
trends forward using the relationship in Chart 3, AUM could reach $400 trillion by 2050. If
these trends are even roughly right, asset management may not only have come of age - we
may be about to enter the Age of Asset Management.
As important as the absolute scale of the asset management sector is its composition. On
the assets side, a number of important trends are at play. One is the rapid growth in
specialist funds, often investing in less liquid asset classes. This is evident in the growth of
so-called alternatives, such as hedge, private equity, real estate, infrastructure and
commodity funds. These have risen from under $2 trillion AUM in 2003 to over $6 trillion by
2012, or from 5% to 10% of global AUM (Boston Consulting Group (2013)).
Accompanying that, there has been strong growth in funds active in specialist, often illiquid,
markets - for example, high yield bond funds and emerging market funds. Since 2008, these
funds have grown at an annual rate of around 40% per year, outpacing growth in the global
mutual fund industry by a factor of four (Chart 4).3 Also rising rapidly have been flows into US
mutual loan funds, which spiked to $63 billion in 2013 having averaged $15 billion in the
preceding three years.
A second striking feature has been the rise in the importance of passively managed funds,
including Exchange Traded Funds (ETFs) and other index-tracking strategies. These passive
or tracking funds have risen from $2 trillion in 2003 to almost $8 trillion by 2012, a rise in
global market share from 5% to 13%. Within this, ETFs have been growing at an annual rate
of around 30% for the past decade with AUM currently standing at $2 trillion.
A third trend - the mirror image of the first two - has been the declining share of actively
managed funds operating in large-cap equity and government fixed income markets. Their
slice of the global AUM pie has fallen sharply over the past decade, from two-thirds to around
a half. For some institutional investors, this is part of a longer-term trend towards
"deequitisation" - a dreadful word - to which I will return.
The reasons for these shifts in portfolio allocation are not difficult to fathom. Like many
advanced economies, the asset management industry is facing its own version of the
"squeezed middle". Active funds operating in core markets, in the middle of the risk/return
distribution, are feeling the pinch: from above, due to the rise of alternative funds and
strategies seeking higher return in a low yield environment - the search for yield; from below,
due to the rise of passive funds and tracking strategies delivering lower cost to investors -
the quest for cost.
From an end-investor perspective, both of these trends are understandable. Yet they also
potentially carry risk implications, both for end-investors and for the financial system as a
whole. For example, the shift towards illiquid assets heightens market risk for investors. And
the move into passive and tracking strategies increases the potential for investor herding and
correlated market movements (Bolognesi and Zuccher (2008)). Both potentially have
implications for financial markets dynamics and systemic risk.
Turning to the liabilities side of the balance sheet, here again some important trends are at
play. Among the most important is the progressively greater share of investment risk being
put back to end-investors, with commensurately less being borne by intermediaries and
companies. One clear example is found in the pensions industry, with the structural shift
away from Defined Benefit (DB) and towards Defined Contribution (DC) pensions.
Here in the UK, the proportion of DB schemes offered to new members has fallen from 31%
to 14% since 2008. Contributions to DC funds have been roughly twice as large as those to
DB funds since the early part of the century. And the picture is similar on the life insurance
side, with virtually all of the growth in UK life insurers' balance sheets since the early part of
this century coming from unit-linked products where the investment risk is borne by
endinvestors (Chart 5).4
The measures announced in the UK Budget a couple of weeks ago will add momentum to
these trends. These will remove the effective requirement on most retirees to purchase an
annuity with DC pension pots once retirement age is reached. This will increase the flexibility
of investors' portfolio choice. But it will also tend to place a greater onus on these
endinvestors to manage the associated investment risk.
These trends in the contractual structure of liabilities have risk implications for end-investors
and the financial system as a whole. A key question, here, is how household behaviour is
likely to respond to bearing these additional risks, especially in situations of stress. Will
investors ride them out or run to the hills, stick or twist? It is impossible to know for certain.
But experience during the crisis is revealing.
Then, households in a number of countries exhibited acute risk-sensitivity and risk-aversion.
For example, UK households responded to heightened market risk by reducing contributions
to long-term savings products, such as life insurance and DC pensions. Household net
contributions to life insurance and pension funds fell from £54 billion in 2006 to £11 billion in
2008. This suggests some skittishness on the part of retail investors when faced with
investment risk.
In summary, over the course of the past decade or so, the asset management industry has
fundamentally changed shape. It is now large and is set to get larger still. The assets it
manages are increasingly being allocated into illiquid assets or indexed strategies. And the
risks on these asset allocations are increasingly being borne by (perhaps trigger-happy)
endinvestors.
Too-big-to-fail
Given this evolving structure, what risks to financial stability might the asset management
industry pose? The financial crisis alerted us to the perils of banks that are "too-big-to-fail".
During the crisis, the collateral damage from big bank failure necessitated state bail-outs.
These nourished the beast that had already eaten the farm. A variety of regulatory reforms
are being put in place in an attempt to house-train this beast (Haldane (2012a)).
One natural question, then, is whether the asset management industry has spawned similar
such behemoths. Two relevant factors here are, first, the relative degree of concentration in
the industry and, second, the scale of its largest players. Table 1 shows the world's top 10
largest asset managers and banks by asset size.
The degree of concentration across the two industries is broadly similar. The top 10 asset
managers account for just less than 30% of the sector, the top 10 banks a little more than
20%. Their balance sheets are also similarly-sized. In aggregate, the top ten banks and
asset managers total $20 trillion and $25 trillion in assets respectively. The world's largest
asset manager (Blackrock) is around a third larger than the biggest bank (ICBC). But, on the
other side, nine of the top 10 banks are larger than their asset management equivalents.
On the face of it, then, the structure of banking and asset management is not too dissimilar.
But the risks to these balance sheets are also quite different. As an agency function, asset
managers do not bear credit, market and liquidity risk on their portfolios. Currently, Blackrock
has over $4 trillion of assets under management, but has only $9 billion of assets of its own.5
Fluctuations in asset values do not threaten the insolvency of an asset manager as they
would a bank. Asset managers are, to a large extent, insolvency-remote.
They are not, however, insolvency-immune. An individual manager or fund does face
operational and reputational risk - for example, arising from a Maxwell Pensioners-sized
fraud or an Arthur Andersen-shaped reputational hit. We have seen examples of this in the
past - the large outflows from Gartmore's funds following the departure of key staff prior to
its acquisition by Henderson; or the outflows from Axa Rosenberg in 2011 following an
alleged fraud.
Nonetheless, if these are the sources of insolvency, then failure of an asset manager is likely
to be different than for banks. Fraud and reputational risk tend be idiosyncratic. Keynes said
of sound bankers that they were ruined in a conventional way along with their fellows so that
no-one could be blamed (Keynes (1932)). If Keynes was right, then asset managers may be
a different breed.
Yet even if the "fail" element of too-big-to-fail is a red-herring, the "big" is not. Distress at an
asset manager may aggravate frictions in financial markets, in particular frictions in market
liquidity. One example would be an asset fire-sale. This might arise if assets from a failing
fund were offloaded at a pace and scale that caused indigestion in the underlying market
(Office of Financial Research (2013), Hau and Lai (2012)). If so, asset prices would be driven
south, possibly to well below their long-term or fundamental value. Put differently, illiquidity
risk premia in those markets could be driven to sub-optimally high levels.
This fire-sale friction might be fanned by the actions of investors or counterparties. Falling
asset prices may be the prompt for withdrawal (in the case of open-ended funds) or sales (in
the case of closed-end funds). In some respects, this would mimic a banking "run", albeit
operating through non-conventional channels (Chen et al (2010)). This could itself induce a
further round of asset fire sales in an amplifying loop.
The good news here is that, unlike in banking, history is not littered with examples of failing
funds wreaking havoc in financial markets. The historical examples we have tend to be
confined to small and isolated corners of the financial system.
But, as any self-respecting asset manager would tell us, past performance is no guide to the
future. This is especially true in an industry as large and as rapidly changing as asset
management, with asset portfolios becoming less liquid and more correlated and investor
behaviour becoming more fickle and run-prone. Future illiquidity pressures in financial
markets, generated by asset management distress or wholesale portfolio reallocation, may
be larger and more potent. In other words, Black Swan risk in asset management may be
real and rising (Taleb (2007)).
Pro-cyclicality
In practice, such adverse financial market dynamics are more likely to arise from asset
managers behaving in a correlated fashion, perhaps because they face a common set of
constraints or sources of stress. In this respect, it is possible to identify a set of market-wide
conventions or regulatory practices which have the potential to drive common behaviour
among asset managers and their institutional client base. These have the potential to turn
idiosyncratic market frictions into systemic market failures.
Around a year ago, the Bank began working with some academics and industry practitioners
to explore these dynamics. In particular, it focussed on evidence of pro-cyclicality among
insurance companies and pension funds (ICPFs) - their potential to amplify, rather than
damp, the risk cycle through their portfolio choices. A report from this group will be published
later in the year.
Academic and industry evidence points to at least three channels through which ICPF
behaviour could generate pro-cyclicality:
Market Conventions: Investors face an acute information problem when judging the
performance of their fund manager (Rajan (2005)). One way of mitigating that problem is by
benchmarking fund performance, either to others in the industry or to an industry-wide index.
That is an important reason why relative return benchmarking and index-tracking is
commonplace. There is also evidence that investors adjust their portfolios on the basis of
these relative metrics - for example, with stronger inflows into funds whose relative
performance has been superior (Chevalier and Ellison (1997), Feroli et al (2014)).
These market conventions have the potential to amplify pro-cyclical swings in asset prices
and investor flows. For example, in market upswings fund managers are likely to try and
juice-up returns by searching for yield in an attempt to outperform their benchmark. The
reverse occurs in the downswing when there will be a quest for safety to boost relative return
rankings.
But if everyone is playing this game, the result will be pro-cyclical pressures on asset prices,
adding exuberance to the upswing and pessimism to the downswing. This increases the
potential for mis-pricing in asset markets - by turns, risk premia becoming first too thin and
then too fat. Relative return benchmarking creates, in effect, a Red Queen Race for the asset
management industry (Ridley (1993), Haldane (2012b)).
Other asset management conventions may also generate pro-cyclical swings. For example,
index-tracking strategies, including through ETFs, will tend to increase asset correlations and
herding in investment flows (Bolognesi and Zuccher (2008)). The use by asset holders of a
small pool of consultancies for investment advice may also generate correlated investment
strategies. And the use of short-term performance mandates for fund managers is also likely
to amplify pro-cyclical swings in asset allocation and asset prices.
Accounting Rules: The 2000s saw the introduction of Financial Reporting Standard (FRS)
17 in the UK and Statement of Financial Accounting Standard (SFAS) 158 in the United
States. This fundamentally changed companies' accounting practices in respect of their
pension obligations. In particular, companies were required to value pension assets at fair
(that is, mark-to-market) values, with liabilities typically discounted using a corporate bond
rate. Pension surpluses and deficits then needed to be recorded on balance sheet.
This change in accounting rules reshaped company and pension fund behaviour. For
example, in a downswing, risky asset prices and safe rates tend to fall, raising measured
deficits. Faced with this, pension funds will have an incentive to sell risky assets and
purchase bonds to better match their assets and liabilities (Amir et al (2010)). But this will
itself tend to drive down yields further, boosting market-valued liabilities and thereby
encouraging further matched bond purchases in a pro-cyclical spiral (Plantin et al (2008)).
A similar dynamic affects insurance companies. Between them, FRS 26 and 27 specify
valuation conventions for measuring insurers' assets and liabilities. Some of these involve
marking assets to market and discounting liabilities at a risk-free rate. This, too, has the
potential to generate pro-cyclical loops, with sales of risky assets whose prices are already
falling and purchases of risk-free assets which in turn increases the market value of liabilities
and the incentives to hedge further.
Regulatory Rules: Risk-based regulatory rules can contribute further to these pro-cyclical
tendencies. For example, consider a pension fund or insurance company operating close to
its risk-based capital or funding requirement and whose bond portfolio is downgraded and
suffers a drop in price. This has the effect of both reducing measured solvency due to
marking to market and raising required risk-based capital requirements - a double whammy.
In response to this, ICPFs may have an incentive to sell their downgraded assets to de-risk
their portfolio. But this will tend to depress further asset prices in a pro-cyclical spiral. Merrill
et al (2012) provide evidence of just this dynamic at work. Following downgrades of
nonagency RMBS in the US, insurance companies had an incentive to sell their downgraded
securities to reduce their capital requirements. Merrill et al show that this selling occurred at
lower prices among those insurance companies marking-to-market.
What additional evidence do we have of such pro-cyclicality? One piece comes from looking
at investment allocations by institutional investors over time. As an example, Chart 6 plots
growth in the S&P 500 against the change in the portfolio allocation to equities among US life
insurers between 1996 and 2012. It shows a high correlation, with rises in equity prices
inducing reallocations into equities.
This suggests a potentially significantly pro-cyclical swing in portfolio behaviour. For
example, a 10% rise in the S&P on average increases the equity portfolio share by over one
percentage point - or around $70 billion given the scale of US life insurers' balance sheets.6
If done quickly, this could be a potent procyclical amplifier. Similar patterns are evident
among life insurers in other countries.
A second piece of indirect evidence comes from the behaviour of regulators. There have
been several incidences over recent years of regulators loosening regulatory constraints to
forestall concerns about pro-cyclical behaviour in a downswing. For example, UK regulators
loosened regulatory constraints on insurance companies in the early 2000s following the
bursting of the dotcom bubble. This was due to fears of selling pressure on equities being
amplified as insurance companies de-risked their portfolios as they neared regulatory
constraints. Pension fund regulators have taken similarly-motivated actions recently due to
depressed real yields boosting the market value of liabilities.
A third piece of evidence comes from analysing the impact of ICPF asset allocation decisions
on asset prices. In particular, at the Bank we have analysed the impact of purchases of
longterm UK indexed-linked debt by UK ICPFs since the early 1990s (Zinna (2014)). Over this
period, the combination of accounting and regulatory rules led to large cumulative purchases
of long-term government debt by ICPFs. At the same time, long-term real yields fell from
around 4% to around -1%.
Controlling for other factors, such as the supply of government debt, research at the Bank
has sought to identify the impact of ICPF purchases on the yield curve. It finds the impact to
be material, especially at the longer end of the yield curve. Over the period 1990 to 2010, it
finds that pension funds purchases lowered the two-year real yield by around 70 basis points
and 20-year real yields by around 165 basis points, with the price pressures most acute
during the period 1996 to 2004.
For insurance companies, the bulk of the buying pressure comes somewhat later (2006 to
2010) and the impact is somewhat smaller (30 basis points and 75 basis points respectively).
Nonetheless, if these ready-reckoners are even roughly right, they suggest a very significant
impact of ICPF portfolio allocation on yields, and hence on incentives to hedge further, in a
pro-cyclical spiral.
This evidence, while far from conclusive, provides some important clues. There are
indications of correlated, pro-cyclical swings in asset allocation and asset prices induced by
asset managers' and their clients' behaviour. Like bankers, institutional investors have risen
and fallen with the herd. Keynes' bankers and today's asset managers may not after all be
such different beasts.
Patient capital
There is a second, long-term, set of risks and opportunities posed by the asset management
industry. Perhaps the defining feature of the sector is the long-term nature of its liabilities,
especially for institutional investors like ICPFs. This makes the sector a potentially important
source of long-term financing to households, companies and governments - for example, in
the form of equity and long-term debt.
Yet the data tell a different tale. Chart 7 plots the portfolio allocation of UK ICPFs over the
past quarter-century. The most striking trend is the erosion in ICPFs' direct holdings of UK
equities, where the portfolio share has fallen from around 50% in the late 1980s to less than
10% today. Their shares of the UK stock market have mimicked this path. There has been a
huge "de-equitisation" of portfolios. Although this pattern is not found universally across
countries, it is also evident in, for example, Japan and France.7
There is no single cause of these portfolio trends in the ICPF sector. Some explanations are
benign. For example, as the population ages and a larger chunk near or reach retirement,
pension liabilities mature. We would then expect to see pension funds switching into
lowerrisk, shorter-duration assets, such as fixed income securities. And this is indeed what has
occurred.
But this seems unlikely to have been the sole explanation for de-equitisation. In particular,
regulation and accounting appear to have played a significant role. Take the UK. In 1995, the
Pensions Act introduced a Minimum Funding Requirement (MFR) - the ratio of assets to
liabilities - of 90%.8 The discount rates on liabilities were linked to UK government bond
("gilt") yields. This drew trustees to gilts, and away from equities, as a matching asset to their
liabilities.
The Pensions Act 2004 abolished the MFR and replaced it with a scheme-specific funding
requirement that further embedded the market-value approach to liability valuation. At around
the same time, FRS 17 required publication of corporates' pension fund surpluses or deficits.
This also had the effect of encouraging companies and fund managers to avoid volatile
assets, such as equities, and purchase low volatility government securities to avoid large
published swings in pension surpluses and deficits.
These changes in regulatory and accounting rules are not unique to the UK. There have
been a number of empirical studies of their consequences in other countries which point
clearly to them having encouraged a secular switch from equities into lower-duration fixed
income securities, in particular government securities (Greenwood and Vayanos (2010)),
Amir el al (2010), Andonov et al (2013)).
Yet the consequences of de-equitisation, for the financial system and the wider economy,
may be just as dreadful as the word itself (Furse (2014)). Equity does a much better job than
debt of sharing risk between borrowers and lenders as repayment terms adjust automatically
with servicing capacity. Equity is also better able to support the financing of long-term
investment projects because it is perpetual. So a world without equity is likely to be one with
poorer risk-sharing and weaker long-term investment.
To illustrate these costs, consider the portfolio behaviour of pension funds around the
financial crisis. At this time, global equity prices fell sharply and risk appetites evaporated.
These are precisely the circumstances in which pension funds, as long-term investors, could
play a stabilising, counter-cyclical role. In particular, those pension funds with stronger
balance sheets might be expected to bear greater risk when its price is cheap - for example,
by buying equities.
In fact, the evidence suggests quite the opposite happened. We have looked at the portfolio
behaviour of over 2000 corporate pension funds between 2006 and 2012, splitting them into
those with "strongest" and "weakest" balance sheets. Strongest is defined here by the net
funding position (ratio of assets to liabilities) of the pension fund. Chart 8 shows the changes
in equity portfolio allocations of the strongest and weakest pension funds, together with the
FTSE All-Share index, over that period.9
Both the strongest and the weakest pension funds began the period with a similar equity
allocation. As equity prices started to fall in 2008, however, the allocations of strongest and
weakest funds diverged sharply. The strongest pension funds reduced significantly their
allocation, effectively cutting it in half, while weak funds maintained or increased their
allocation. By the end of the period, the strongest funds had half the equity allocation of the
weakest.
At one level, these portfolio reallocations made sense - the strongest protecting their
surpluses by de-risking, the weakest trying to close their deficits by re-risking. Yet, from a
longer-term or societal perspective, these reallocations are troubling. To cushion the risk
cycle, we would wish to see stronger long-term investors purchasing risk when it was cheap.
That would benefit both investors and the economy. Capital that can afford to be patient
should be patient.
But those funds with the strongest shoulders appear instead to have ducked for cover, while
the weakest appear to have engaged in a gamble for resurrection. In the longer-term, this
type of behaviour is likely to worsen returns to investors. It will also amplify cycles in the
financial system and economy by draining risk-taking when it is already weak. Patient capital
ought to part of the solution to the long-term financing puzzle. In practice, it may have been
part of the problem.
Regulatory policy
That naturally begs the question of what, if any, policy response might best deal with the
risks and opportunities asset management poses. From a potentially long list, I will focus on
three areas.
First, Too-Big-to-Fail. Here, the jury is still sitting. In January, the Financial Stability Board
(FSB) published a consultation paper on its proposed methodology for identifying non-bank,
non-insurer globally systemically important financial institutions - or, in what may represent a
new high-water mark for impenetrable financial acronyms, NBNI G-SIFIs. Asset managers
are being considered among this class. Based on the consultation results, the FSB will report
to the G20 later this year.
Views on that consultation will be interesting and I am sure at least some of you here will be
offering some. We are in the intellectual foothills when understanding and scaling the
transmission channels through which asset managers could generate systemic risk. And
given the recent changes in the scale and structure of the industry - a world of less liquid
assets and runnier liabilities - these channels may be more potent tomorrow than they were
yesterday. Against this backdrop it may be premature, and probably imprudent, to be ruling
out future sightings of asset management Black Swans.
At the same time, as regulators we should avoid tarring all birds with the same brush. For
example, even if the financial market externalities associated with asset management failure
were found to be potentially large and damaging, some of the conventional too-big-to-fail
solutions may not be the right ones. For example, because asset managers are essentially
unlevered, leverage or capital-based tools may be the wrong tool to tackle market failures.
Tools which act on liquidity risk - minimum liquid asset requirements, restrictions or gates on
liability redemptions - may be more suitable.
Second, procyclicality. Asset management has at least the potential to amplify pro-cyclical
swings in the financial system and wider economy. If so, it may contribute to the mis-pricing
of risk with risk premia undergoing cycles of feast and famine. That still leaves some big
questions begging. How large are these mis-pricing cycles? How do they affect risk-taking in
the financial system and activity in the wider economy? And, if so, how best can public policy
modulate those cycles?
At present, we do not have good empirical answers to any of those questions. Jeremy Stein
at the Federal Reserve Board has recently offered some answers (Stein (2014)), drawing on
work by Feroli et al (2014). He notes that portfolio adjustments by asset managers can cause
abrupt and asymmetric adjustments in risk premia which may have a significant impact on
economic activity and systemic risk. On that basis, he makes a case for monetary policy
leaning against financial market vulnerabilities, even when they are not sourced in leverage.
The evidence here is fully consistent with Stein's and Feroli et al's: the behaviour of
unlevered asset managers may have the potential to induce pro-cyclical swings in portfolio
allocation and in risk premia, with damaging consequences for systemic risk and economic
activity. But whereas Stein discusses the role of monetary policy, a natural first line of
defence against such swings is so-called macro-prudential policy.
It is early days for macro-prudential policy. It marks a radical depa