Schemes warned to keep an eye on illiquid assets

Even assets as mainstream as corporate bonds have an illiquidity risk to them, which should be taken into account, the British Coal Staff Superannuation Scheme (BCSS) has warned.

Scheme investment committees have been warned to monitor how the liquidity risks of certain assets change over time, and how these assets relate to the rest of their portfolio.

These warnings come as the Treasury has urged schemes to invest in long-term infrastructure projects to support the economy, and said it will help make sure they have the "capacity, opportunity and incentive" to do so.

Speaking at the UK Leadership of Pensions summit earlier this month, Sion Cole, executive director of UK institutional business at UBS, said schemes were not doing enough to monitor how the liquidity of their investments are changing over time.

He said: “Don’t just consider the percentage in the portfolio today but consider how that is going to change over time.

"Any illiquid asset class cannot easily be rebalanced, so you have added in another risk there.”

Scheme view

David Brief (pictured), a member of the BCSS investment committee, told the conference schemes had to be careful about the illiquidity of investments such as company debt.

“One of the issues that you do have is if people go further into corporate bonds,” he said.

“People don’t understand about just how illiquid corporate bonds are.”

Schemes which may have diversified into higher-yielding debt or even moved funds from equities into corporate debt or alternatives may be ignoring the liquidity risk of those investments.

But Brief added an overall liquidity crisis would only affect “a few funds which have had enough money in illiquid assets”, so would not be a major challenge to most.

More institutional investors are requiring instant information on liquidity from their asset managers, according to the Investment Management Association (IMA) 2010-2011 survey.

"Everyone expects to have information instantly about every kind of risk, including liquidity, which has not been focused on as much before," it reported an industry insider as saying.

But another insider added these investors, of which a large proportion is made up of pension funds, can confuse illiquidity with poor correlation – how two investments move in relation to each other.

Building for the future

Mark Hoban, the financial secretary to the Treasury, urged pension funds in a speech last week to support the UK economy by investing in infrastructure projects, and said the government was going to help them do so.

"At a time of widespread market anxiety, when returns on  most types of investment are extremely volatile and uncertain, investors  across the board are looking to de-risk and secure long dated income  producing assets," he said.

"Infrastructure investment is has the potential to offer those  secure, sustainable and strong returns that investors are looking for."

But Kerrin Rosenberg, UK chief executive at Cardano, said schemes could be making a “huge mistake” to lump into liability-driven investments such as infrastructure without taking into account their ancillary risks.

He said: “If you take credit risk and liquidity risk, make damn sure that the rewards you get from that credit you for that risk.”

Infrastructure was such an investment, he added, where the quality of the underlying asset was undermined by “disappointing results”.

Schemes are being forced to consider less typical investments to match their inflation liability due to the unabating low yields in index-linked gilts.

This presents a dilemma: either they opt for a more expensive asset which provides a closer hedge, or a cheaper asset with less correlation.

Brief said the index-linked gilts were still the “best” answer for pension funds wishing to hedge their inflation liability, but he added it was “not a very happy one”.

“The issue is whether you can bear to pay the cost of the insurance premium,” he said. “Not many people can.”