In the previous blogs in this series, we’ve talked about how Redington’s 7 Step Framework provides the Manager Research Team with the research strategy we use to assess the broad universe of investment opportunities. We aired these thoughts publicly for the first time at a Forum for asset managers earlier on this year, which gave us the opportunity to talk through the way we approach such matters with the wider investment community. This event was attended by representatives from 19 houses with combined assets under management of over £7 trillion.
At the end of the afternoon, we gave our attendees the opportunity to provide their own perspective on how a range of ‘traditional’ asset classes might fit the dual credit / ‘market’ and liquid / illiquid framework we use to assess the funds that come our way for review.
To recap, the main reasons we adopt this two-way matrix are as follows:
– Credit offers contractual cashflows and the chance to earn returns through the ‘pull to par’.
– Having the most valuable asset in the world is no good at all if you can’t sell it when you need the money. There is a limit to the amount of illiquidity any investor can take.
We asked our assembled guests to classify a series of asset classes both in terms of liquidity (x-axis) and in terms of the predictability of their cashflows (y-axis). On the second of these, it’s needless to say a somewhat tricky task to rank certain assets as offering more ‘contractual’ returns than others. The saga of the ‘contractual cashflows’ due to pre-2008 investors in Lehman Brothers, for example, continues to this day.
The results that emerged from our exercise in crowd-sourcing are shown on the charts below:
Looking at the above charts, a number of conclusions become apparent:
1. As can be seen from the scatter plot, managers are confident of liquidity in developed equity markets (in fact, even more confident than they are regarding liquidity in FX markets). They are also confident of the predictability of the cashflows generated by the asset class – possibly an indication that the relative predictability of dividend payments is perceived to act as a natural offset against equity price volatility. However, it is important to note that, as equities cannot be redeemed at par, price volatility is ultimately an inescapable component of the overall return generated by the asset class.
2. Managers are also relatively sanguine around liquidity in corporate bond markets, in spite of warnings that reduced bank capacity and smaller dealer inventory sizes could lead to trading becoming increasingly difficult. This is also the case for liquidity in high yield, although it’s worth noting the relatively wide distribution of responses we received in this respect, with answers coming in the range of -4 to +5. A similarly wide spread was also the case for EM debt, although differences in opinion regarding liquidity here are perhaps more explicable thanks to the effect of investing in different currencies.
3. At the illiquid end of the spectrum, it’s fair to say that the answers we received were broadly as expected. However, it’s important to note that, with illiquid opportunities, the predictability of cashflows can vary substantially from individual asset to individual asset. Investing in infrastructure equity, for example, can target either current income from an operational project or capital growth via a private equity-type arrangement.