Part 3 of the Asset Class ‘Back to the Future’ series. Chief Investment Officer, Philip Rose, reflects on the 2011 Asset Class and our approach towards illiquid assets.
What we said...
Investors need a clear process on two levels:
1. At the strategic asset allocation level
The key consideration is that an allocation to illiquid contractual asset should “do no harm”. It should not compromise other strategic objectives, whether they be increasing expected returns or reducing funding level volatility.
The discipline of a required return and risk budget ensured investors:
1.) were not unduly thrown off target by a lack of illiquid investment opportunities
2.) were able to meet their requirements using both liquid credit and liquid market asset allocations
2. At the individual investment mandate level
Clients want to react quickly to any available investment opportunities. They also want to ensure the illiquidity premium is sufficient to meet their objectives.
This can be achieved by:
Giving managers the flexibility to invest across a wide range of illiquid credit assets
a robust illiquidity premium framework
One of the reasons for the limited supply of infrastructure debt was that most of it came from the primary market.
The sale of existing secondary portfolios already on bank balance sheets tended not to happen, except for a few banks that were being wound down.
Performing assets (for the most part) stayed on bank balance sheets. This helped support prices, but limited the opportunities for investors.
Investment in Secured Funding
Even more so than infrastructure investment, secured funding was the case of the dog that did not bark.
This was largely down to central banks and regulators ensuring banks could access financing relatively easily from deposits and lending facilities.
This meant banks had little appetite to pay fees to finance even complex assets, as the price of unsecured financing was relatively low.
The lack of liquidation pressures across complex credit assets supported asset prices, but meant that
1.) there were relatively few attracting secured funding opportunities and
2.) outright exposure to credit assets was a more attractive investment opportunity
...and what happened
The UK infrastructure debt market has not developed as much in volume as many market participants had hoped back in 2011.
Investors who managed to get invested have, so far, had positive outcomes on yields. But these have been relatively small and the queue for acceptable infrastructure assets remains long.
The investor base has also become larger. Investors such as insurance companies and banks, who require relatively little in the way of illiquidity premium, dominate many of the higher quality deals.
In terms of constructing investment mandates, give managers the ability to access both liquid and illiquid assets within the same mandate.
This gives managers the ability to invest when credit spreads are high even though illiquidity premiums are tight. This ensures managers do not have an incentive to overestimate illiquidity premia in order to be invested.
Click to go back to Asset Class 2017