Itzhak Ben-David is Associate Professor of Finance at The Ohio State University. This post is based on a recent paper authored by Professor Ben-David; Francesco Franzoni, Professor of Finance at the University of Lugano; Rabih Moussawi, Assistant Professor of Finance at Villanova University; and John Sedunov, Assistant Professor of Finance at Villanova University.
The U.S. asset management industry has become increasingly concentrated in recent times. Over the last 35 years, the largest institutional investors have quadrupled their holdings in the equity market. As of September 2015, the largest asset manager oversaw 5.1% of the total equity assets in SEC 13F filings, and the largest 10 managers managed 23.4% of these assets, which represents about 35% of overall institution ownership.
Such concentration of assets held by the largest asset managers is arguably associated with increased risk concentration, which can have a systematic impact. In other words, the risk that the largest institutions pose is that idiosyncratic shocks to any large individual player in an economy is hardly diversifiable, due to their sheer size (Gabaix, Gopikrishnan, Plerou, and Stanley, 2006; Gabaix, 2011). In this vein, large institutional investors are not equivalent to a collection of smaller independent entities; rather, they have an incompressible institutional identity that leaves a large footprint in the market. That is, they are “granular,” and idiosyncratic shocks to those large institutions are also “granular” in that they cannot be diversified away or absorbed by the market. The asset management space indeed has experienced many examples of idiosyncratic events at the institutional investor level that have had widespread repercussions in the financial system. Recent examples include the bankruptcy of Lehman Brothers in 2008, JP Morgan’s trader (the “London Whale”) who built a large short position in credit default swaps that led to trading losses exceeding $6 billion within weeks, and the sudden departure of co-founder Bill Gross from Pimco in September 2014 which caused unprecedented large withdrawals and consequent drastic liquidations. It is important to note that idiosyncratic events need not be rare or extreme to have an impact on asset prices. A large institution that initiates trades to accommodate investor flows, or for portfolio rebalancing, or for risk-management reasons may cause price dislocations. Regulators have expressed similar concerns about systemic risks that could result from the high concentration of assets under a single large manager.
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