We’ve seen more uncertainty in markets in recent months, but we haven’t seen a broad and sustained increase in risk aversion. If fund managers were to suddenly shift their asset allocations, the moves could spark a sharp reversal in portfolio debt flows. The business models of investment funds could further amplify the resulting stresses.
For instance, the liquidity of ETF shares is widely thought to be higher than that of the underlying assets.11 In a stress situation, herd behaviour among ETF investors could amplify changes in asset prices and lead to widespread contagion. What will help keep us on track? All of this is pretty sobering.