BIS: Passive Bond Funds May Pose Threat To Financial Stability

Listen, there is absolutely no downside whatsoever to the epochal active-to-passive shift, ok?

Everyone knows that the best way to encourage price discovery and to generally ensure that markets are performing their traditional function as a conduit for the efficient allocation of capital is to open up every corner of every market to unsophisticated retail investors by way of securities with intraday liquidity. It’s even better if you make those same securities tradable by those same retail investors 24-7.

The benefits of this setup are obvious. On the equities side of the equation, you funnel massive amounts of money blindly into cap-weighted indices thereby creating a self-referential, perpetual motion machine that drives the prices of the winners inexorably higher.

As not-at-all-dangerous as that dynamic is, the situation is even safer and less disaster prone in the fixed income space. Take corporate bonds for instance. Everyone knows that retail investors are experts at evaluating opportunities in junk bonds and emerging market debt. In the same vein, no one knows more about duration risk in IG than Joe jack-off with his Ameritrade account. That’s why what’s needed are low-cost corporate bond ETFs that, in the case of high yield and EM debt, sport a super-safe liquidity mismatch that definitely won’t be laid bare in the event of a fire sale catalyzed by an acute risk off episode.

All of this is obvious, which is why there are so many ETFs now and it’s also why anyone who criticizes the proliferation of things like, say, fixed income ETFs, is a shady person and a paid shill for active managers who are just mad because their coke/hooker money has dried up in the age of low-cost passive investing.

Well speaking of shills for active management who are mad about not being able to afford coke and hookers, the BIS is out raising fresh concerns about fixed income ETFs. Specifically, the central bank for central banks (as the BIS is not-so-affectionately known), notes that the growth of passive bond funds could be encouraging borrowers to lever up.