Anticipating the credit crunch, some institutional investors readied their portfolios for an imminent bear market, while the majority stuck to strategic weights backed by long-term return assumptions. But who among either group thought that liquidity, the ultimate facilitator of portfolios, would become so thin that their strategies would become compromised for lack of it? In the grip of a fierce market that has wiped out returns from most asset classes and torn the local currency down from its near-greenback-parity high, superannuation funds are managing liquidity pressures that will seemingly not abate for some time.
Paying benefits; rebalancing; meeting member demands for cash; funding expensive currency hedges, capital calls and other operations are among the gamut of severe liquidity challenges being negotiated by the industry. Originating with the collapse of structured credit markets, gut-wrenching writedowns and a mass deleveraging process shuddered through global financial markets, destroying billions in invested capital. Today’s liquidity stresses are the most severe in the history of superannuation to date.
They became particularly acute when Lehman Brothers, a counterparty of many trades held by managers worldwide, failed. Allocations across the globe were wound up and sent to the sheltered harbour of the
US Treasury bond market, and the Australian dollar depreciated sharply. The wealth destruction caused by this bear market has been fast and brutal, and its shocks have diminished funds’ access to the essence of their existence: liquidity. While the capability of retirement savings funds to pay benefits remains intact, their ability to implement predetermined investment strategies has, in some cases, been undermined.
As a general rule, the extent of a fund’s liquidity stress depends on how heavily it has allocated to unlisted assets, which now account for greater shares of portfolios since listed markets have cascaded. Now that funds with more unlisted assets are, for the most part, less liquid, there is a broader awareness that liquidity can “evaporate more sharply in areas where people don’t expect it to, and stay away for longer than what was expected,” say Celia Dallas and John-Austin Saviano, of US consultancy Cambridge Associates.
Previous bear markets have sent indexes on doubledigit annual declines, but this financial crisis has also dealt blows of market illiquidity and multiple asset class falls to superannuation funds. The most exacting liquidity challenge to date for funds has been the rapid deterioration in value of the Australian dollar, which in some cases required forced-selling of assets to maintain currency hedges for global listed and unlisted investments.