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Large bond funds, including products from BlackRock, Franklin Templeton and Invesco, are holding more than double the cash they held five years ago as fears about liquidity in the fixed income market weigh on asset managers.

Analysts believe fund managers have increased their cash balances because of regulatory concerns about fixed income liquidity and the failure of Third Avenue, the US investment house.

Third Avenue was forced to shut its $800m high-yield bond fund in December after it ran out of money to pay redeeming investors without having to dump bonds at fire-sale prices.

Franklin Templeton’s Global Bond fund and BlackRock’s Strategic Income Opportunity fund, which both rank among the 10 largest bond funds in the world, have more than doubled their cash holdings to at least 18.5 per cent of their assets over the past five years, according to figures from Morningstar, the data provider.

“In light of the Third Avenue affair, groups may be holding more cash to ensure they can meet possible redemption requests,” said Sean Tuffy, head of regulatory intelligence at Brown Brothers Harriman, the financial services company.

A similar trend has emerged in Europe’s large fixed income funds, where cash holdings at Carmignac’s Sécurité fund and Invesco’s Euro Corporate Bond fund more than quadrupled since the start of 2011.

The rise in cash holdings comes as fixed income liquidity — a measure of how easy it is to sell a bond quickly at a suitable price — dries up.

Since the financial crisis, dealer banks, the traditional middlemen in fixed income trading, have reduced their bond inventories significantly because of stricter regulations.

Alastair Sewell, senior director in the fund and asset management group at Fitch, the rating agency, said: “We see material activity from fund managers to structure portfolios to address the liquidity-parched environment we are in. They range from the traditional to the more exotic.

“The traditional way is to have more cash in the portfolio. We see some evidence of funds having higher cash balances.”

As well as liquidity concerns, the higher cash position in fixed income funds has been linked to portfolio managers trying to time the market, and the increased use of instruments such as derivatives, which results in funds holding cash as collateral.

Brian Reid, chief economist at ICI Global, a trade body for asset managers, said: “Funds will hold cash for immediate usage to meet redemptions, but also for buying opportunities.”

Invesco, the $740bn fund house, said it held higher levels of cash and other liquid assets in its corporate bond product during recent quarters because of the relatively low yields on offer in the fixed income market.

Sandra Crowl, an investment committee member at Carmignac, said: “The cash positions help balance the risk profile of the fund.”

A spokesperson for BlackRock said its Income Opportunities fund is maintaining a higher allocation to cash and cash-like equivalent investments than they have historically in order “to reduce volatility in the portfolio and take advantage of potential investment opportunities”.

Mr Tuffy said it is a “positive development” if fund managers are holding additional cash to deal with liquidity concerns.

“It shows that asset managers are being responsive to market conditions and illustrates that there may be no need for additional regulatory intervention.”

Many financial regulators have raised concerns about the impact a liquidity crunch could have on the asset management industry and the wider economy.

The US watchdog, the Securities and Exchange Commission, has put forward controversial proposals to overhaul how mutual funds deal with liquidity, while the UK’s Financial Conduct Authority is accessing the risks posed by fixed income-focused investment funds.

As well as increasing cash holdings, asset managers have also been taking other steps to deal with possible large-scale redemptions from bond funds, including growing their fixed income trading desks.

Finance theory creates a distorted image of the investment world

The things we name risk free are now some of the riskiest, warns New Sparta’s Jerome Booth

From time to time, political leaders have faced a choice between breaking up large business conglomerates when they become too powerful, or getting cosy with them.

US presidents Andrew Jackson and Theodore Roosevelt chose the former, enabling the US to stay competitive and productive. After 2008, our leaders chose the latter, often taking bankers’ advice, with senior personnel switches between private and public sectors. The cosiness with ever-larger banks has, in part, been fed by the ideas that banks can self-regulate, and an idea from finance theory that markets are naturally efficient.

Finance theory’s practical limitations are serious and well-documented, but that has not stopped its widespread application. Simplistic assumptions have led to massive errors and crises again and again. When “impossible” events occur and models crash, investors simply reboot their computers and start again.

Finance theory has contributed to huge distortions in the way savings are invested. Pension funds have grown to dominate stock and bond markets over the past few decades. There have been many benefits, but a big cost has been herd behaviour in asset allocation due to asymmetric incentives.

Winning or losing conventionally leads to little personal cost or benefit to the average pension fund asset allocator. Unconventional success may lead to a pat on the back, yet to lose unconventionally can be career limiting. The result is herding, including the use of theory known to be deficient, because one’s peers also use it.

Up to a certain age toddlers don’t believe things exist if they cannot see them. Some of us are a bit like that in finance: if we cannot measure it, we ignore it.

Risk is multi-faceted and complicated, different for different people because we have different liabilities, information, reaction speeds and behavioural and institutional constraints. Most people care more about large permanent loss than volatility, yet risk has become synonymous with easy to measure past asset price volatility.

In the late 1950s, Harry Markowitz, the US economist, said an asset’s volatility (“risk”) can be explained by three things: idiosyncratic movement not correlated to any other stock, which can be diversified away; co-variances with other stocks — a measure of the degree to which returns on two risky assets move in tandem; and correlation to an index.

For computational ease he simply ignored the co-variances with other stocks. Ever since it has wrongly been assumed it is impossible to perform better than an index with lower volatility, indices have been used to define asset classes and these asset classes have been used as the building blocks of asset allocation.

Furthermore, the definition of what is and what is not an asset class is arbitrary, a function of sustained marketing more than anything else.

The resulting distorted set of asset classes does develop, but unfortunately changes in the real world are probably occurring faster. The most obvious two cases of distortion are the woefully inadequate allocations to emerging markets, which now comprise the bulk of economic activity on the planet, and to illiquid assets.

To add to this distorted image of the world, we are now in a period of significant global structural imbalances, high indebtedness in the developed world and international monetary imbalance in particular. Macroeconomic understanding of these structural problems should be driving overall asset allocation, but it is not because finance theory has nothing to say about macroeconomics.

There is no mean reversion (the theory suggesting prices and returns eventually move back towards the average) in markets with structural change, but asset allocator models assume mean reversion anyway, regardless of macroeconomics, politics or historical knowledge. Such knowledge is not as easy to evaluate as it is to put a few numbers in a model and read the output.

Looking back and extrapolating is what finance theory helps us do. This has its place, but can preclude the ability to see the largest, most dangerous, structural shifts.

Finance theory seemed to work well enough in stable macroeconomic environments, but is now misleading asset allocators into false complacency.

The things we name risk free — an abuse of the English language — are now some of the riskiest. Investing in assets perceived as risky may constitute the best hedge available for the worst scenarios.

- Says: "we should look from the angle that the economy has entered the 'new normal' period."

- Global economy poses challenges to China; Cannot "overlook the risks from unstable financial markets, falling prices of commodities and risks of geopolitics."

Radical Investing Advice: Do Nothing, Nada, Zilch, Zippo

Target-date funds are a reminder that the test of any action is whether it is better than inaction

For some people, the best way to hit the investment target is by not even taking aim.

With “target-date funds,” which hold a pre-selected basket of mutual funds and change it gradually over time, workers can invest for retirement with their hands tied behind their backs. Once they start investing, they never have to make another decision — and many never do.

It seems paradoxical that anyone could learn anything from people who do nothing. But even investing experts need to be reminded that the test of any action is whether it is better than inaction.

A study released this past week by Vanguard Group, the asset-management giant, looked at the behavior of nearly 18,000 participants in a corporate retirement plan with about $1.2 billion in assets. Between the end of 2014 and the middle of last year, the plan rolled its participants into a new set of target-date funds; employees could “opt out,” or choose to move their money into other choices, but that required them to make an active decision.

It turned out that 84% of the employees who were automatically moved to target-date funds stayed there.

That may have prevented some of them from taking too much risk. One in seven had at least 90% in stocks beforehand; after the shift to target-date funds, only half as many did.

Getting bumped into target-date portfolios also helps prevent investors from taking too little risk. Almost a tenth of the participants had less than 20% of their retirement money in stocks; after the shift to target-date funds, fewer than one in 100 savers was so underexposed.

True, most investment managers have a profit motive for promoting these funds. Target-date portfolios are cheap to run and generally earn higher fees for the managers than exchange-traded funds do. They are also the epoxy of the fund business: They glue investors’ money almost permanently into place.

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Retirement savers in target-date portfolios trade only one-fourth to one-sixth as often as those in a mix of other funds, according to data from T. Rowe Price Group and the Vanguard Center for Retirement Research. Even in the darkest days of the financial crisis, most of these people did absolutely nothing.

Still, such inertia may be good for investors. Morningstar, the research firm, found last year that target-date funds earned an average of 5% annually over the 10 years through the end of 2014. But the typical investor in those funds earned 6.1% annually, or an average of 1.1 percentage points more per year.

That’s because the standard way of calculating fund returns measures the performance of a lump sum invested at the beginning and kept constant until the end. Real people, of course, add or subtract money along the way. But target-date investors, by never budging and automatically adding to their holdings with every paycheck, buy more when markets are down, giving their overall results a slight boost if stocks continue to rise.

Target-date investors, says Jeff Holt, an analyst at Morningstar, “are less prone to take matters into their own hands and move their assets around when markets are gyrating.”

Nevertheless, as another study released this past week shows, many people are resistant to the incredible power of investment inertia.

Financial Engines, a firm in Sunnyvale, Calif., that provides advice on retirement accounts, asked 1,000 plan participants about target-date funds. Among those who don’t rely heavily on these portfolios, more than half said they believe they can pick better funds themselves.

Yet earlier research by Financial Engines found that participants with little or no money in target-date funds underperform them by an average of 2.1 percentage points annually.

If you are enterprising, you enjoy the challenge of trying to outsmart the market — and, therefore, will find a target-date fund boring and unsatisfying. If you are defensive, you don’t want the worry and regret that can come from frequent changes of course — so a target-date fund could suit you just fine.

But even enterprising investors need to be reminded that less can be more.

A classic study from 1992 found that fund managers could have added nearly one percentage point to their average returns each year if they had picked all their stocks on Jan. 1 and then gone on a year-long vacation, never trading at all.

​Over the past decade, as the blogger Ben Carlson recently pointed out, most of the nation’s largest endowment funds — for all their brainpower and experience — underperformed a mindless portfolio of three funds that simply mimic the stock and bond markets.

Doing nothing isn’t for everyone, but all investors should think twice before they do anything.

The easy money for companies like Tiffany, Prada, Oscar de la Renta and Baccarat is not so easy to come by these days.

But the biggest names in luxury are coming together at the end of this month in New York City for the first-ever French-American Luxury Symposium, presented by the French-American Chamber of Commerce, per our Lisa Fickenscher.

Oscar de la Renta’s CEO Alex Bolen will be at the event alongside Chanel USA’s Olivier Stip, senior vice president of fine jewelry, and Sarah Tam, a merchandiser at Rent the Runway.

“The slowdown that started last year will continue into 2016 with projections of 1 to 2 percent growth in the luxury market,” said Elsa Berry, president of FACC. “These are difficult times on many levels.”

The venerable brands that have been around for decades will rub elbows with newer players like Shinola and even Google, which will be represented by Marc Speichert, global client partner at the tech company.

IS there any scarier nightmare than President Donald J. Trump in a tense international crisis, indignant and impatient, with his sweaty finger on the nuclear trigger?

“Trump is a danger to our national security,” John B. Bellinger III, legal adviser to the State Department under President George W. Bush, bluntly warned.

Most of the discussion about Trump focuses on domestic policy. But checks and balances mean that there are limits to what a president can achieve domestically, while the Constitution gives a commander in chief a much freer hand abroad.

That’s what horrifies America-watchers overseas. Der Spiegel, the German magazine, has called Trump the most dangerous man in the world. Even the leader of a Swedish nationalist party that started as a neo-Nazi white supremacist group has disavowed Trump. J. K. Rowling, author of the Harry Potter books, reflected the views of many Britons when she tweeted that Trump is worse than Voldemort.

Leading American conservative thinkers on foreign policy issued an open letter a few days ago warning that they could not support Trump. The signatories include Michael Chertoff, the former secretary of homeland security, Robert Zoellick, the former deputy secretary of state, and more than 100 others.

“Mr. Trump’s own statements lead us to conclude that as president, he would use the authority of his office to act in ways that make America less safe,” the letter declared.

A starting point is Trump’s remarkable ignorance about international affairs. And every time he tries to reassure, he digs the hole deeper. Asked in the latest debate to name people whose foreign policy ideas he respects, Trump offered Gen. Jack Keane, and mispronounced his name.

Asked about Syria, Trump said last year that he would unleash ISIS to destroy Syria’s government. That is insane: ISIS is already murdering or enslaving Christians, Yazidis and other religious minorities; executing gays; destroying antiquities; oppressing women. And Trump wants ISIS to capture Damascus?

A second major concern is that Trump would start a trade war, or a real war. Trump told The New York Times in January that he favored a 45 percent tariff on Chinese goods, then denied ever having said such a thing. The Times produced the audio (that part of the conversation was on the record) in which Trump clearly backed the 45 percent tariff, risking a trade war between the world’s two largest economies.

Trump has also called for more U.S. troops on the ground in Iraq, and raised the prospect of bombing North Korean nuclear sites. A poorly informed, impatient and pugnacious leader can cause devastation, and that’s true of either Kim Jong-un or Donald Trump.

The third risk is to America’s reputation and soft power. Both Bush and President Obama worked hard to reassure the world’s 1.6 billion Muslims that the U.S. is not at war with Islam. Trump has pretty much declared war on all Muslims.

The damage to America’s image is already done, even if Trump is never elected. Simply as a blowhard who gains headlines around the world, he reinforces caricatures of the United States and tarnishes our global reputation. He turns America into an object of derision. He is America’s Ahmadinejad.

On Twitter, I suggested that Trump was pugnacious, pugilistic, preening and puerile, and asked for other P words to describe him. The result was a deluge: petulant, pandering, pathetic, peevish, prickly, pernicious, patronizing, Pantagruelian, prevaricating, phony, presumptuous, potty-mouthed, provocative, pompous, predatory and so many more, including the troubling “probably president.”

There’s something heartbreaking about the prospect that America’s next commander in chief may be a global joke, a man regarded in most foreign capitals as a buffoon, and a dangerous one.

Trump is not particularly ideological, and it’s possible that as president he would surround himself with experts and would back off extreme positions. It was a good sign that on Friday he appeared to reverse himself and pledged that he would not order the U.S. military to commit war crimes, yet that’s such an astonishingly low bar that I can’t believe I just wrote this sentence!

In any case, Trump is nothing if not unpredictable, and it seems equally plausible that he would start new wars. It’s a risk that few sensible people want to take. As Mitt Romney notes, “This is the very brand of anger that has led other nations into the abyss.”

Peter Feaver, a Duke University political scientist who was a national security official in the Bush White House, noted that most Republicans are united in believing that President Obama and Hillary Clinton have damaged the United States and added to the burdens of the next president.

“Yet what Trump promises to do would in some important ways make all of the problems we face dramatically worse,” he told me. “Why, at a moment when the country desperately needs our A-team, would we send in the clowns?”

Reforms designed to increase the safety and stability of financial markets could cost European pensioners up to €4.7bn annually, according to a group of leading retirement schemes.

Three Dutch pension managers, APG, PGGM and MN, and Insight Investment, the third-largest asset manager in the UK pension market, have written a letter to the European Commission highlighting concerns that returns to pensioners are at risk from new rules governing derivatives trading.

“This will hurt pension fund participants. They will ultimately pay the price,” said Thijs Aaten, managing director of treasury and trading at APG.

Since the financial crisis, a number of pension funds have increasingly used derivatives in order to protect their investments against unexpected changes in interest rates and the threat of inflation.

The letter’s signatories fear new rules on capital requirements, which were designed to prevent another global banking crisis, could force pension funds across Europe to raise up to €420bn in cash annually in order to continue to hold derivatives.

“This is a significant and disproportionate cost to European pensioners,” said Vanaja Indra, regulatory reform director at Insight Investment.

Under the latest iteration of the Basel III rules, which came into force last year, banks that sell derivatives require buyers to provide an additional cash buffer as security to protect against volatile price swings.

That cash buffer, known as variation margin, can change daily. In periods of heightened market stress, banks issue margin calls, demands for more cash, to derivative users.

Pension funds generally hold minimal levels of cash. The four investors, who collectively account for more than €1tn in assets, are concerned they will be forced to sell assets such as equities and bonds to have enough cash to continue trading derivatives.

This could result in an annual bill for European pensioners of between €2.4bn and €4.7bn, according to the pension funds’ estimates.

Ms Indra said pension funds should be allowed to continue to offer their existing holdings of high-quality government bonds, instead of cash, as security when conducting private bilateral derivative transactions.

The four managers are also concerned that the new rules could fuel volatility in times of market stress by forcing them to accelerate asset sales to meet increased demands for cash from derivative issuers.

Italian closet trackers sanctioned by regulator

The Italian regulator has taken action against some of the largest investment companies in its home market for mis-selling actively managed funds that closely hugged an index.

Consob, the Italian finance watchdog, investigated the 10 largest domestic asset management companies over concerns they were selling funds that charged high fees for active management but simply following an index.

The practice, known as closet tracking, has caused controversy throughout Europe over the past 12 months. A number of national regulators discovered a high proportion of actively managed funds tend to mimic an index.

This is regarded as a harmful form of mis-selling that has left millions of investors significantly worse off than if they had bought a cheap index fund in the first place.

A spokesperson for the Italian watchdog said it took “remedial action” against a number of the companies it examined.

It declined to name which companies were affected, but said they were made to change their fund documents to ensure “the investment policy description [was] consistent with the management style actually adopted by the manager”.

The Italian regulator plans to carry out another investigation into closet tracking in the coming months, partly in response to research published last month by Esma , the European markets watchdog, examining the issue.

Esma found that between 5 and 15 per cent of actively managed equity funds in Europe could be closet trackers, but said it was the responsibility of national regulators to identify and sanction problem funds.

Research published last week by Morningstar, the data provider, showed Italy has the highest rate of closet tracking of all European countries.

Two-thirds of fund assets in Italy have an active share — a measure of how much an equity fund’s holdings differ from its benchmark — of below 60 per cent over the past three years.

The 60 per cent threshold is widely considered in academic circles to be the lowest acceptable level of active share for an actively managed fund.

Morningstar also found that a fifth of supposedly active equity funds across Europe failed to reach this threshold, implying the extent of the closet tracking problem could be much worse than Esma suggested.

Matias Möttölä, senior research analyst at Morningstar, said: “Among the least active funds, we found that almost all closet indexers underperformed their benchmark. If combined with high fees, such a fund is rarely a good choice.”