Its daily processes are the “money-in, money-out” management of cashflows, and weekly and three-month forecasts of liquidity obligations, such as benefit payments and investment activity. But cashflow sensitivity analyses and changes in the Australian currency are the primary concerns at present. Interestingly, ARIA’s forecasts have not prompted it to set aside dedicated cash reserves for liquidity needs. “We forecast liquidity, and keep an appropriate level of cash in place,” Crafter assures. He says the focus on liquidity management is part of a broader appreciation of risk management within the fund: “The worst things for us are surprises.

Our view is to manage a portfolio to minimise surprises.” The most unwanted surprises for investors are the bad events they don’t foresee. Scenarios can be played out, and action plans stress-tested, but a severe equity market decline, currency swing or the collapse of a significant counterparty is always unwelcome, rarely foretold, and usually catches funds unawares. “We don’t know what comes next,” says Troy Rieck, managing director of capital markets at Queensland Investment Corporation (QIC), in reference to the prospects of future liquidity pressures. “If equities fall another 50 per cent, we’d have a very interesting world.” In an instance of fortuitous timing, QIC began building its current risk infrastructure, which prizes liquidity, three years ago.

The decision to do so was not made in expectation of the global crisis, but in recognition that the past few decades have produced “incredibly benign” market risks if viewed in a more far-reaching historical context, Rieck says. “Twelve months ago, the biggest problem for funds was finding homes for cash. Now they have been hit by a big risk event, after risk has been underpriced and under-resourced. We’re starting to see what under-resourcing the risk management functions of funds can result in,” he says. “Peak-to-trough drawdowns of 50 per cent or more are quite common; it’s not unusual to see a large collapse in listed markets.

A lot of people haven’t thought: ‘what if that happens? What would my fund look like?’” While they are usually conceptually straightforward, liquidity management frameworks are typically difficult to execute well. According to Heather Myers, director of endowment strategy with Russell Investments, “it is virtually impossible to build a portfolio that approaches guaranteed liquidity no matter what happens”. Central to liquidity frameworks are frequent, cautious forecasts and full knowledge of cashflows.

Next come the simulations of episodes of liquidity stress triggered by various events: market crashes, long-duration bond defaults, and swings in foreign exchange rates, among others. In devising potential scenarios, funds should not be restricted to models but explore a wide range of nightmarish circumstances to test the resilience of their fund, and how effective their liquidity techniques are. “How much cash would the fund need if the [foreign] exchange [rate] fell 25 per cent in the next three months?” Rieck asks. “Answering this gives you a set of numbers in your head so you know what could happen in extreme circumstances.”