Investment Fund Risk: The Tale in the Tails

Efforts to develop risk assessment metrics for the non-bank financial sector have been given impetus following the post-crisis broadening of the IMF's Financial Stability Assessments and recent efforts by the Financial Stability Board to address structural vulnerabilities from asset management activities. Using a novel database of investment funds reporting in Ireland, we employ Marginal Expected Shortfall metrics to capture investment fund exposures to pervasive industry-wide tail events. We reveal the primary fund sectors most responsible for widespread extreme return shortfalls. Fund attributes are then used to explain (mostly) the cross-sectional variation in marginal expected shortfall using panel regression techniques. We find that leverage, derivative usage, redemption rates, cash holdings, openness and retail investor focus are important factors that consistently explain the variation in fund-specific sensitivity to pervasive tail risk. Finally, we provide new evidence that ex ante exposure to pervasive extreme negative returns explains significantly more of the risk premium implicit in ex post returns than traditional beta.