The Bank for International Settlements has warned of risks from rising concentration in the asset management industry and the increased investment in emerging markets.

In its latest annual report the BIS said the portfolios of asset management companies have soared and they are now a major source of credit as banks have shrunk their balance sheets.

The BIS said asset managers were responsible for managing roughly twice as much money in 2012 as they did a decade previously, and this has coincided with an increase in the market share of the largest players.

“Many of these top asset management companies are affiliated with and/or operate under the same corporate umbrella as large, systemically important financial institutions,” the BIS added.

The BIS said portfolio managers are evaluated on the basis of short-term performance, and revenues are linked to fluctuations in customer fund flows.

“These arrangements can exacerbate the procyclicality of asset prices, feeding the market’s momentum in booms and leading to abrupt withdrawals from asset classes in times of stress,” the report said. “Greater concentration in the sector can strengthen this effect. “

The report said another concern from concentration is that operational or legal problems at a large asset manager may have disproportionate systemic effects as they are now a source of credit.

The report said: “This, together with high size concentration in the sector, may influence bond market dynamics, with implications for the cost and availability of funding for businesses and households.”

The BIS said most asset managers do not put their balance sheets at risk in managing funds but highlighted hedge funds who actively manage portfolios and can have a high appetite for risk and leverage.

“The hedge fund manager has own funds at risk and is rewarded on the basis of performance,” the BIS added. “Similarly, a hidden form of leverage relates to the implicit reassurances of capital preservation made by money market funds.”

The BIS also warned that the asset management industry’s burgeoning presence in emerging markets could amplify asset price dynamics under stress, especially in fixed income markets.

The annual report said: “Like an elephant in a paddling pool, the huge size disparity between global investor portfolios and recipient markets can amplify dislocations. It is far from reassuring that these flows have swelled on the back of an aggressive search for yield: strongly procyclical, they surge and reverse as conditions and sentiment change.”

A higher proportion of investors with short-term horizons in emerging market debt could amplify shocks when global conditions deteriorate, especially due to the shift to exchange-traded funds. ETFs have grown to a fifth of all net assets of dedicated emerging market bond and equity funds from around 2% a decade ago.

Last year in the US the Office of Financial Research, which provides data on financial stability to the Financial Services Oversight Council, issued a study analysing the potential for the asset management industry to pose a systemic risk. The Securities and Exchange Commission asked for public comment on the report.

The CFA institute, which represents investment professionals, said in a comment letter to the SEC in December that the OFR should request additional data.

“While the Report recognizes that the asset management industry covers a diverse range of activities, it often suggests correlations between activities and potential risk that appear overly broad,” added the CFA. “For these and other reasons discussed below, we strongly encourage further data gathering and a continued analysis of the issues before reaching conclusions about whether prudential regulatory measures are needed for this industry.”

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