Liquidity shock a wake-up call for boards

The liquidity shock triggered by the outbreak of the coronavirus should serve as a wake-up call for the boards of superannuation funds whose focus on short-term performance measures has led to higher allocations of unlisted assets, according to one industry veteran.

Rob Prugue, principle consultant at Callidum Investment Research, said league table rankings and heat maps, known as agency risk, had become a more dominant concern for boards than investment and liquidity risk or membership cohorts. The former chief executive of Lazard Asset Management in Asia Pacific also said that some funds had used illiquid assets to reduce volatility in a portfolio as well as to “manoeuvre themselves around the league tables.”

“The crisis has triggered a liquidity shock which has become a wake-up call for superannuation funds to redirect their focus back to their long-term objectives rather than on how they rank on a year-by-year basis,” Prugue said in an interview with Investment Magazine. “I do see boards embracing agency risk over the principle risk as the greatest challenge going forward.”

Australia’s largest super funds all say that they have enough liquidity to manage current market conditions, at least for now. Even so, they also concede that the downturn in equities, member switching and the government’s new hardship provisions that allow more Australians to tap their super earlier, have stretched liquidity buffers and prompted funds across the industry to sell equities and bonds to bolster reserves.

Prugue said while overall allocations to illiquid assets had been reduced since the global financial crisis, markets had also become more erratic and unstable and demographics had deteriorated which led to more net outflows – “those two reasons alone should have seen the allocations to illiquids cut.”

“The question now though relates to some funds who have been using the perceived price stability of illiquids as a way to manage their gross returns and therefore manage their rankings in a league table and heatmap,” the consultant said, who was also head of international equities at State Super during the mid-1990s. “Why? Because that is how they get rewarded. I don’t blame the CIOs or management for doing that.”

While allocation to illiquid assets vary widely between individual funds, the prudential regulator’s latest figures show that superannuation funds on average have at least 15 per cent allocated to unlisted assets including 5 per cent in unlisted property, 6 per cent in infrastructure and 4 per cent in unlisted equity.

UniSuper said its balanced fund, where the majority of is member assets are invested, had around 7 per cent invested in unlisted, while AustralianSuper and Cbus have about 22 per cent and 28 per cent, respectively. Hostplus and Rest, whose membership base in the hospitality and retail sectors are among the hardest hit from the coronavirus, have around 40 per cent in less-liquid assets that include property, infrastructure, private equity and credit.

Hostplus and Rest have both said that they have enough cash and other liquid assets to “comfortably” manage the illiquid portions of their portfolios.

“In the world that positions your fund more competitively, illiquids can be an attraction,” said Prugue. “However the caveat is that when shocks do occur… all assets revert back to a correlation of one regardless of whether they are liquid or illiquid. The great lie of investment management…. is that illiquids are less risky than liquids.”