No one really knows what open-ended funds will do

Abu Dhabi: It’s summer, political uncertainty is in the air, asset prices are plummeting, and concerns about the ability of open-ended funds to withstand a wave of redemptions are rising. Only it’s also the summer of 1962, John F. Kennedy is the US president, and the S&P 500 is seesawing between 69.55 and 54.75.

With much attention focused squarely on the seven UK property funds that have now pulled up the gates in the face of post-Brexit referendum redemptions, it’s worth revisiting an analogous moment in financial market history when the behaviour of open-ended funds was similarly thrust into an unflattering spotlight.

The 1962 Kennedy Slide, when the S&P 500 fell by more than a fifth, is ill-remembered today but offers parallels to the current situation. Back then, market participants fretted about the behaviour of an unknown entity in financial markets “- open-ended mutual funds that allow big and small investors to pool their money into larger portfolios that offer daily liquidity. Practically unheard of in 1929, during the last big US stock market crash, such funds had raised $23 billion (Dh84.4 billion) in assets by the spring of 1962.

As stock prices seesawed, the worry was that mom and pop would pull their money out, requiring funds to raise cash by liquidating their portfolios at the worst possible time.

That doomsday scenario never materialised, however. As equity prices dropped, mutual funds made 530,000 in net purchases of shares. When the market recovered that same week and investors were scrambling to buy back into the rally, the funds sold 375,000 shares and made a tidy profit. Why this happened has never been satisfactorily explained. While it seems obvious that the funds went bargain-seeking during a panic, it’s not entirely clear what allowed them to do so when others were selling.

Counter-cyclical force

It is a query worth repeating following the rapid suspension of UK property funds and one that has already been raised by Bank of England Chief Economist Andy Haldane, who pondered in 2014 whether some large investors could prove to be a countercyclical force in times of market stress or wind up exacerbating it.

While mutual funds counted $23 billion worth of assets in 1962, today they are worth trillions and have, like much of the financial world, expanded their repertoire to encompass less liquid assets including commercial property and, of course, corporate debt. Credit lines and cash buffers have been built up to offset this illiquidity, but the ultimate effect of a massively enlarged and evolved fund industry “- and whether it will prove as level-headed as its ancestors “- remains poorly understood.