The hidden risks in simple funds

The International Monetary Fund has warned of the lurking danger in unit trusts and exchange-traded funds.

"Is your mutual fund a menace?" asks Wayne Arnold in Barron's. "The International Monetary Fund (IMF) is worried it might be."

In the latest edition of its annual Global Financial Stability Report, the IMF has raised the question of whether tighter regulation of the traditional banking sector has had the unintended result of pushing risk into some unlikely corners of the financial system notably what it calls "plain vanilla investment funds", such as mutual funds (known as unit trusts in the UK) and exchange-traded funds.

This sector has "ballooned since the financial crisis", says Bylan Talley in The Wall Street Journal. Asset managers globally now oversee more than $75trn (the equivalent of the world's GDP), up from around $45trn ten years ago, according to the IMF's figures. Many of those assets are managed by a few big asset managers, implying that "any change in the consensus on interest rates or the global economy can send shock waves through markets".

"The problem isn't just the size of the funds," continues Arnold. "It's that they are increasingly crowding into the same securities, particularly bond funds into emerging-market bonds. It's this herding behaviour that can make them so dangerous."

If funds are suddenly forced to sell these assets for example, by "skittish" retail investors pulling their money out the results could be "devastating". Hence the IMF wants fund managers to consider ways in which they can reduce this risk, such as charging redemption fees to dissuade investors from rushing to the exits at the same time.

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