Managing liquidity stresses is a fact of life for defined contribution funds, but the unprecedented early release schemes introduced by both the Australian and United States governments during the onset of Covid-19 brought this challenge to a new level.

The superannuation landscape may be permanently changed on the back of this precedent, and collective defined contribution plans such as Australian superannuation funds and UK master trusts need to be prepared for either participant actions such as member switching, or government actions such as early release schemes, argues Michelle Teng of PGIM in a new research report (Super Funds & Master Trusts in a World of Member Switching, Early Release Schemes & Climate Calamities, available via the link).

Speaking to Conexus Financial managing editor Julia Newbould on the ‘Insight for Outcomes’ podcast series, Teng said funds were facing the confluence of two liquidity-challenging trends: the introduction of early release schemes and encouragement from governments that they support economic growth by investing in illiquid private assets like private equity and infrastructure.

Prudent CIOs are unlikely to keep asset allocations unchanged in the face of this new landscape, Teng said.

“Generally, CIOs would move some of the risk-seeking assets, which tend to be less liquid, to lower-risk and more liquid assets, for example from private assets to stocks, or from stocks to bonds and cash,” Teng said. “This change of portfolio allocation to better manage liquidity risk incurs a hidden cost of expected portfolio performance that affects all participants.”

As holding extra liquidity comes at a cost to performance and funds cannot afford to respond to heightened liquidity risks by simply become defensive, particularly now that Australian funds are subject to the Australian Prudential Regulation Authority’s annual performance test, Teng said.

Rather, they need more advanced tools to help them quantify the cost of adapting their portfolios and make more confident asset allocation decisions. “The challenge for CIOs is to coordinate their top-down asset allocations with their bottom-up private asset investing activities, and in the meantime they need to meet a number of liquidity demands,” Teng said.

Newbould asked whether early release schemes had shown governments may be willing to make funds available during natural catastrophes, which may become more frequent as the planet warms up.

“The short answer is we don’t know, but there is a possibility,” Teng said. Members may rightfully question the point of having a retirement plan if they cannot afford to rebuild their house, she said, noting the United States passed legislation in 2021 allowing disaster distributions from retirement plans for calamities other than the Covid-19 pandemic.

More broadly, the impact of these decisions from governments will go far beyond the Covid-19 pandemic, Teng said, raising awareness across the industry about how to better manage liquidity. Industry participants, including policymakers, need to better understand the tradeoff between the liberality of early access programs and expected portfolio performance in the long term, she said.

“Our research may help governments and policymakers identify portfolio allocation consequences and costs of contemplated rule changes,” Teng said. “These costs would be borne by all participants.”


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