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.
10  BIS central bankers’ speeches  Chart 1 Total AUM of US insurance companies, pension funds, mutual funds and other funds, 1946 – 2013 ICPFs Mutual funds (a) Other non-property funds  Per cent of GDP 250  Chart 2 Total AUM of UK insurance companies, pension funds and mutual funds, 1980 – 2012 ICPFs  Mutual funds  Per cent of GDP 250  200  46 51 56 61 66 71 76 81 86 91 96 01 06 11  150  150  100  100  50  50  0  Source: US flow of funds  80 83 86 89 92 95 98 01 04 07 10  Chart 3 Relationship between GDP per capita and managed assets  Chart 4 Global assets under management in selected specialised mutual fund types(a) 60,000 50,000 40,000  Emerging market Corporate bond High Yield Mortgage-backed Total Return  $ billions 900  30,000  800 700 600 500 400  20,000  0 100 200 300 AUM of ICPFs and mutual funds as per cent of GDP  0  Source: OECD, ONS, Investment Management Association and Bank calculations  (a) Other non-property funds include closed-end funds, exchange-traded funds and money market mutual funds  GDP per capita, $ current prices  200  300  10,000  200  0  100  Source: OECD Statistical database and Bank calculations.