First is a mismatch in liquidity offered by investment funds with redemption terms that may be inconsistent with the liquidity of underlying assets. Many credit funds hold illiquid credit instruments that trade infrequently in thin secondary markets.
Second is the large amount of assets concentrated in the hands of a few managers. This concentration can result in “brand risk,” given that end-investor allocation decisions are increasingly driven by the perceived brand quality of the asset management firm. Sharp drawdowns in one fund of an asset manager could propagate redemptions across funds for that particular asset manager if its brand reputation is damaged, for example through illiquidity or large losses.
Third is the concentration of decision making across funds of an individual fund manager, which can reduce diversification benefits, increase brand risk, or both.
Fourth is the concentrated holdings of individual issuers, which can exacerbate price adjustments.
Fifth is the rise in retail participation, which can increase the tendency to follow the herd.
Policymakers and markets need to prepare for structural higher market volatility. Doing so requires strengthening the system’s ability to absorb sudden portfolio adjustments, as well as addressing structural liquidity weaknesses and vulnerabilities.
Advanced economies with financial markets at risk for runs and fire sales may need to put in place mechanisms to unwind funds should they come under substantial pressure that threatens wider financial stability.