SEC proposed regulations can affect index funds

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
Topic Author
Taylor Larimore
Posts: 32839
Joined: Tue Feb 27, 2007 7:09 pm
Location: Miami FL

"Mutual Funds Are Risky"

Post by Taylor Larimore »

Bogleheads:

Mutual Funds Are Risky is the lead story in today's Wall Street Journal's Opinion Page These are excerpts:
(First sentence): "We invest in mutual funds like millions of others, and thank goodness markets still allow the risk without which there can be no reward."

"Financial regulators are again trying to conjure the illusion of safety around this industry."

"Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

"The agency aims to prohibit a fund from investing more than 15% of its money in "illiquid assets."

"Investments carry risks, including liquidity risks. Misleading people into thinking risk can be controlled by regulation would be another SEC disservice to investors. The agency should instead rescind its existing guidelines and urge fund clients to beware."
What do you think?

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle
carofe
Posts: 390
Joined: Thu Mar 20, 2014 7:21 pm

SEC proposed regulations can affect index funds

Post by carofe »

[Thread merged into here, see below. --admin ladyGeek]

What do you guys think about this:

http://www.wsj.com/articles/mutual-fund ... 1454544816

Perhaps most dangerous, the SEC also proposes to formally enact a current agency guideline that is intended to make funds safer but could inflame a panic. The agency aims to prohibit a fund from investing more than 15% of its money in “illiquid assets,” meaning anything that can’t be sold within seven days for roughly the value assigned to it by the fund.
There are other potential problems. How can a fund precisely track a volatile stock index if it is pressured to hold things other than the stocks in the index to meet a liquidity standard?
... and much more if you can read the article.
US Total Stock Market + Intermediate Term Bond. That's it.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: SEC proposed regulations can affect index funds

Post by Tanelorn »

carofe wrote:What do you guys think about this:

http://www.wsj.com/articles/mutual-fund ... 1454544816
Yeah, this has been discussed in part in this older thread:

viewtopic.php?f=10&t=175412

One thing's for sure - the WSJ commenters sure hate the proposal! At the core, I agree with the guy who said that markets define liquidity, not regulators, so it's a bit like trying to ban the common cold or poverty... Sounds good, but good luck with implementation.
User avatar
hornet96
Posts: 811
Joined: Sun Nov 25, 2012 5:45 pm

Re: SEC proposed regulations can affect index funds

Post by hornet96 »

I think this is an especially salient point within the article:
WSJ wrote:This is intended to protect fund investors, but by preventing funds from buying anything that would nudge them above the 15% level, it could prevent flexibility at moments when markets and investors most need it. In a falling market, more and more assets could land in the “illiquid” category and become untouchable to mutual funds, even if fund managers spot bargains that their investors should own. A market rout could accelerate as regulation prevents falling assets from finding buyers.
With these kinds of restrictions placed on mutual funds, which essentially control a huge portion of the investible securities market, this regulation could in essence force extreme capitulation in a severe downtrend as a large population of whom would normally be "buyers" would be removed from participating in the market. In fact, in a severe enough downturn, I could see this very rule actually causing a liquidity crisis in the markets.
WSJ wrote:As funds start categorizing their assets, there may be pressure to conform so as not to be viewed as the outlier without ample liquidity. And so the agency may end up herding everyone into the same popular assets, as they did before the last crisis.
The laws of unintended consequences always seem to crop up in these kinds of proposals.
User avatar
telemark
Posts: 3389
Joined: Sat Aug 11, 2012 6:35 am

Re: "Mutual Funds Are Risky"

Post by telemark »

Cars will always be dangerous, so why not get rid of air bags and seat belts and antilock brakes and all that annoying stuff and just tell customers to be careful?
User avatar
saltycaper
Posts: 2650
Joined: Thu Apr 24, 2014 8:47 pm
Location: The Tower

Re: "Mutual Funds Are Risky"

Post by saltycaper »

Don't see how this will be feasible for corporate bond funds.
Quod vitae sectabor iter?
User avatar
alpenglow
Posts: 1798
Joined: Tue May 31, 2011 12:02 pm

Re: "Mutual Funds Are Risky"

Post by alpenglow »

As adults, we need to be personally responsible for our choices. Investments involve risks. All investors should be aware of the risks they are taking (or not taking), whether they are investing in stocks, bonds, CDs, or what have you.
Northern Flicker
Posts: 15288
Joined: Fri Apr 10, 2015 12:29 am

Re: "Mutual Funds Are Risky"

Post by Northern Flicker »

Taylor Larimore wrote:Bogleheads:

Mutual Funds Are Risky is the lead story in today's Wall Street Journal's Opinion Page These are excerpts:
(First sentence): "We invest in mutual funds like millions of others, and thank goodness markets still allow the risk without which there can be no reward."

"Financial regulators are again trying to conjure the illusion of safety around this industry."

"Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

"The agency aims to prohibit a fund from investing more than 15% of its money in "illiquid assets."

"Investments carry risks, including liquidity risks. Misleading people into thinking risk can be controlled by regulation would be another SEC disservice to investors. The agency should instead rescind its existing guidelines and urge fund clients to beware."
What do you think?

Best wishes.
Taylor
I think the WSJ likely makes more money from mutual fund advertising than it does from individual reader subscription costs, making it unclear (or maybe I should say making it clear) which group's interests are being served by the op-ed.
adamthesmythe
Posts: 5761
Joined: Mon Sep 22, 2014 4:47 pm

Re: "Mutual Funds Are Risky"

Post by adamthesmythe »

> "Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

I can't see the objection to requiring this sort of disclosure.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: "Mutual Funds Are Risky"

Post by nisiprius »

(I can't read the WSJ article and rely on Taylor's summary). Everything is relative. Mutual funds are not the same as everything else you can buy at a brokerage. Mutual funds are supposed to be safer than individual investments in individual assets. And they are supposed to be safer than hedge funds.

Mutual funds are supposed to have regulatory limitations on the amount and kind of risk they take. That's why the Investment Company Act of 1940, which created the mutual fund as we know it, was passed. According to the Investment Company Institute (ICI) some of the core principles behind the law include
  • transparency
  • daily valuation and liquidity
  • limits on leverage,
  • custody, and
  • diversification.
Let's look at liquidity since that's what's under discussion. Taylor quotes the article says saying "The agency aims to prohibit a fund from investing more than 15% of its money in 'illiquid assets.'" This is not some new idea the SEC has come up this. This is their job. The ICI says:
At least 85 percent of a mutual fund’s portfolio must be invested in liquid securities.
The only thing new is that they are trying to come to grips with recent problems in mutual funds due to formerly liquid assets, notably junk bonds, becoming less liquid than before. As I understand it, they are requiring mutual fund companies to do more and detailed reporting, and are trying to find good ways to measure liquidity.

Since one of the whole points of mutual funds is that they provide daily liquidity to investors, obviously mutual funds themselves must invest in reasonably liquid issues themselves, or you have a chasm that is too wide for the fund to bridge.

If junk bonds used to be suitable assets for mutual funds to hold, but no longer are, so be it. Perhaps we can't have junk bond mutual funds any more. More likely, we can have relatively conservative junk bond funds like Vanguard's, but not extremely aggressive ones like Third Avenue Credit Focussed.

Rather than rescind fundamental regulations that have been in place for seventy-five years, investors who would like to take greater risks can always invest in hedge funds--which are now allowed to advertise if they want to, and which are allowed to sell to people with a net worth of $1 million if they want to. We should not be turning mutual funds into hedge funds: if people do not have the qualifications to accept the risk of hedge funds, then they do not have the qualifications to accept the risk of hedge funds in mutual funds' clothing.
Last edited by nisiprius on Thu Feb 04, 2016 1:38 pm, edited 4 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
Barry Barnitz
Wiki Admin
Posts: 3353
Joined: Mon Feb 19, 2007 9:42 pm
Contact:

Re: "Mutual Funds Are Risky"

Post by Barry Barnitz »

adamthesmythe wrote:> "Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

I can't see the objection to requiring this sort of disclosure.
The proposed rules (415 pages) have many potential consequences, affecting large funds, and potential asset class availability. See Nadig's commentary :The SEC’s Liquidity Bomb For Funds | ETF.com
Additional administrative tasks: Financial Page bogleheads.org. blog; finiki the Canadian wiki; The Bogle Center for Financial Literacy site; La Guía Bogleheads® España site.
User avatar
Toons
Posts: 14459
Joined: Fri Nov 21, 2008 9:20 am
Location: Hills of Tennessee

Re: "Mutual Funds Are Risky"

Post by Toons »

telemark wrote:Cars will always be dangerous, so why not get rid of air bags and seat belts and antilock brakes and all that annoying stuff and just tell customers to be careful?
+3
I like that common sense analogy :sharebeer
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
tedclu
Posts: 180
Joined: Fri Feb 06, 2015 2:13 pm

Re: SEC proposed regulations can affect index funds

Post by tedclu »

Sec already has such rule in place. Currently there is a 15% illiquid rule is in place. There is also a 5% max on money market fund. The board review them on a quarterly basis.

What new is the six bucket approach, that is likely be killed by the industry(ICI).
User avatar
dm200
Posts: 23214
Joined: Mon Feb 26, 2007 1:21 pm
Location: Washington DC area

Re: "Mutual Funds Are Risky"

Post by dm200 »

Taylor Larimore wrote:Bogleheads:
Mutual Funds Are Risky is the lead story in today's Wall Street Journal's Opinion Page These are excerpts:
(First sentence): "We invest in mutual funds like millions of others, and thank goodness markets still allow the risk without which there can be no reward."
"Financial regulators are again trying to conjure the illusion of safety around this industry."
"Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."
"The agency aims to prohibit a fund from investing more than 15% of its money in "illiquid assets."
"Investments carry risks, including liquidity risks. Misleading people into thinking risk can be controlled by regulation would be another SEC disservice to Investors. The agency should instead rescind its existing guidelines and urge fund clients to beware."
What do you think?
Best wishes.
Taylor
This sounds like an "OP Ed" piece by someone or some organization with an "agenda" - perhaps that is oppose to any such regulations or restictions. Who is the author of this article? [I don't have a subscription]

Without getting into the details, I have (some strong) opinions on lots of areas where, in some cases, I believe the government regulators and agencies are not doing enough to protect consumers (whether financial or otherwise) and in other cases, are doing "too much" in trying to protect consumers.

I can cite many examples where, I believe, increased regulation and disclosures have been a real benefit to consumers and can also cite many cases where there is zero net benefit - just compliance costs.

One example where "disclosure" was used to boomerang the intent was one of these vacation property land sale deals that used to be common. I recall reading over the details (I was not even considering buying) for these alleged wonderful vacation lot sales and all the wonderful things planned for the development. There was a statement (as required by federal law/regulation of some federal agency/department) that this property could be completely worthless. Then, in the promotional material pitching this "deal", they put in there something like "reviewed by ____________ agency" (implying endorsement, when it was the exact opposite. That is much like saying that the US Postal Service endorses your company because you have a Post Office Box.
adamthesmythe
Posts: 5761
Joined: Mon Sep 22, 2014 4:47 pm

Re: "Mutual Funds Are Risky"

Post by adamthesmythe »

Barry Barnitz wrote:
adamthesmythe wrote:> "Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

I can't see the objection to requiring this sort of disclosure.
The proposed rules (415 pages) have many potential consequences, affecting large funds, and potential asset class availability. See Nadig's commentary :The SEC’s Liquidity Bomb For Funds | ETF.com
Well I was reacting to your summary. You quoted two examples of proposed changes, one of which sounded reasonable and the other eminently reasonable.
User avatar
hornet96
Posts: 811
Joined: Sun Nov 25, 2012 5:45 pm

Re: "Mutual Funds Are Risky"

Post by hornet96 »

See my take here, in the other thread started on this topic:

viewtopic.php?f=10&t=183811#p2787728
hornet96 wrote:I think this is an especially salient point within the article:
WSJ wrote:This is intended to protect fund investors, but by preventing funds from buying anything that would nudge them above the 15% level, it could prevent flexibility at moments when markets and investors most need it. In a falling market, more and more assets could land in the “illiquid” category and become untouchable to mutual funds, even if fund managers spot bargains that their investors should own. A market rout could accelerate as regulation prevents falling assets from finding buyers.
With these kinds of restrictions placed on mutual funds, which essentially control a huge portion of the investible securities market, this regulation could in essence force extreme capitulation in a severe downtrend as a large population of whom would normally be "buyers" would be removed from participating in the market. In fact, in a severe enough downturn, I could see this very rule actually causing a liquidity crisis in the markets.
WSJ wrote:As funds start categorizing their assets, there may be pressure to conform so as not to be viewed as the outlier without ample liquidity. And so the agency may end up herding everyone into the same popular assets, as they did before the last crisis.
The laws of unintended consequences always seem to crop up in these kinds of proposals.
inbox788
Posts: 8372
Joined: Thu Mar 15, 2012 5:24 pm

Re: "Mutual Funds Are Risky"

Post by inbox788 »

adamthesmythe wrote:> "Regulators (SEC) are demanding that funds report which of their assets can be sold quickly without materially affecting their price."

I can't see the objection to requiring this sort of disclosure.
It would be totally useless filled with boilerplate. And reporting would have no way of testing until actual conditions, which is when we'll find out who was right or wrong, and are you going to kick the ones that were wrong when they're down? Whatever they say, it will sound a little like this. Everything we hold can be sold quickly without materially affecting the price in normal markets, but when the markets are in crisis, everything we hold may be temporarily illiquid.

We're still dealing with the fallout from credit default swaps, and while there been improvement in that front, there was little general preparedness before it all happened. Those few who warned us or took the proper positions are geniuses in hindsight, but I don't know which warnings I hear on CNBC daily are the ones I should heed. One moment is one guy saying get out now at 10% before the 20 or 30% correction comes while the next guy warns that you'll miss out if you don't buy this dip.

Regulations are cumbersome and no one want to be designated too big to fail. Many companies are doing whatever they can to get from under it.
User avatar
LadyGeek
Site Admin
Posts: 95466
Joined: Sat Dec 20, 2008 4:34 pm
Location: Philadelphia
Contact:

Re: SEC proposed regulations can affect index funds

Post by LadyGeek »

I merged carofe's thread into here. The software sorts post by time, Taylor Larimore was first.

An earlier thread: SEC Proposes Liquidity Management Rules For Mutual Funds
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.
User avatar
nisiprius
Advisory Board
Posts: 52105
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: "Mutual Funds Are Risky"

Post by nisiprius »

hornet96 wrote:...With these kinds of restrictions placed on mutual funds, which essentially control a huge portion of the investible securities market, this regulation could in essence force extreme capitulation in a severe downtrend as a large population of whom would normally be "buyers" would be removed from participating in the market. In fact, in a severe enough downturn, I could see this very rule actually causing a liquidity crisis in the markets....
These are not new restrictions. It is intrinsic to the idea of an open-ended fund that the fund provides daily liquidity to its shareholders, and has only seven days to meet redemptions, and therefore should invest mostly (85%) in assets that can be readily liquidated within seven days. The new regulations apparently require much more detailed reporting, so as to allow better assessment of whether funds are really maintaining the liquidity they have always been required to maintain. Mutual funds are not supposed to invest in just anything.

Closed-end funds don't need to provide daily liquidity and therefore can invest in less liquid assets. If people want to invest in something that isn't liquid enough for an open-ended fund, why aren't closed-end funds an adequate vehicle for providing access to these assets?
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: "Mutual Funds Are Risky"

Post by Tanelorn »

nisiprius wrote:Closed-end funds don't need to provide daily liquidity and therefore can invest in less liquid assets. If people want to invest in something that isn't liquid enough for an open-ended fund, why aren't closed-end funds an adequate vehicle for providing access to these assets?
That's a reasonable suggestion, but the question is whether they regulators would give the market time to adjust if that's the solution. In the US, CEFs are maybe 1/4 of $1T in assets, while mutual funds are $16T and ETFs another $2T. They're 1-2% of the market and due to their structure, they can't easily expand to offer shares to new buyers after they're created. Time was when Pimco Total Return was bigger than all the CEFs in existence, so if the regulators want to force every non-treasury bond fund into a CEF, that's not going to happen easily or quickly. Plus it would probably be very disruptive to the markets to do fairly, ie to give everyone who didn't want the new CEF version of the fund (with no guarantees you can sell for NAV, or even 90% if it) a chance to sell out of the whole corporate and muni debt sectors and go buy a CD or a treasury fund instead.
stlutz
Posts: 5585
Joined: Fri Jan 02, 2009 12:08 am

Re: SEC proposed regulations can affect index funds

Post by stlutz »

A lot of the commentary on this rule proposal seems to come from those who haven't read the rule or read it very carefully.

The 15% limit on illiquid assets refers to assets that cannot be sold in seven days, irrespective of the position size. Even if you hold 25% of the outstanding issue of a bond, this position would be considered illiquid if the bond has regular trades of a significant size. The rule is focused on the nature of the asset--think private equity or physical real estate.

This 15% threshold has been a strong suggestion in the past; now they are making it a rule.

The other part of the rule is probably more significant--that they need to easily raise 3 days of redemptions easily. Bank loan funds could have a problem here, and even some high yield funds.

The rule generally requires the funds to define what is illiquid and what their 3 day redemption need is as opposed to setting hard rules and definitions. As such, there is certainly discretion for regulators to interpret it in a strict or loose fashion. The most strict reading would probably shut down most high-yield bond funds. The least strict reading may affect about 2 funds in total. Reality will of course land somewhere in between.
Tanelorn
Posts: 2366
Joined: Thu May 01, 2014 9:35 pm

Re: SEC proposed regulations can affect index funds

Post by Tanelorn »

But it's dumb because it's size dependent. If the market will take $15M worth of your stuff in 7 days, you can have a $100M fund and be ok. If you've got a $1B fund, that's no good. But if you break up into 10 $100M funds owning the same stuff, it's fine because you can each pretend you'll get the $15M worth of liquidity at the same time everyone else is trying to get it!
Post Reply