Feature – Liquidity


Settlements, which points out that the implied volatility of US treasury yields increased by more than 20 basis points during 2022. Moreover, liquidity deteriorated even in core bond mar- kets, such as the US, UK, Germany and Japan, to its lowest lev- els since the global financial crisis.


It’s easy to say that the boom in private markets is over, but I don’t think that is the case.


Mike Eakins, Phoenix


Another indication is that bid-offer spreads, the difference between the price dealers buy and sell a security for, have wid- ened. This has been a problem with larger institutional trans- actions, which would have to be broken down into smaller amounts to be executed.


Marginal adjustment


requirements for pension funds, who embark on leveraged investments, are a lot more ambivalent and are generally regu- lated by agreements with counterparties.


This means that in the event that institutional investors who employ leverage fail to meet margin calls, the risks fall back onto the banks who issued the derivatives in question, as the 2021 collapse of the family office Archegos Capital illustrates. The collapse of the $36bn (£29.1bn) family office saw billions of dollars written off across global banks, from Credit Suisse to Deutsche Bank, UBS and Nomura. With that in mind, one dreads to think what the impact of write-offs from the LDI cri- sis would have been, had the Bank of England not intervened. But the problem goes beyond LDI. As central banks embark on quantitative tightening, there is now growing concern that non-bank financial intermediaries might retreat from this role as liquidity providers globally. Such a trend could have far reaching implications for the nature of credit provision in the global economy and the asset allocations of institutional investors.


First strains The US Federal Reserve has barely embarked on quantitative tightening but the first strains in market liquidity are already tangible, as the IMF warns in its latest financial stability report. It concludes that market liquidity has deteriorated across all major asset classes. “There is a heightened risk of rapid, disor- derly repricing which could interact with—and be amplified by—pre-existing vulnerabilities and poor market liquidity,” the organisation says. This trend is also highlighted by the Bank for International


36 | portfolio institutional | February 2023 | Issue 120


This in turn means that investors will now think more carefully about their exposure to illiquid assets, predicts Mike Eakins, Phoenix’s chief investment officer. “One of the things we are likely to see in the UK is that there will be marginally less demand for private market assets than there was [last year]. If you can invest in government bonds at 3.5%, you don’t need to go out and shoot below zero in private markets,” he says. But Eakins adds that this will most likely be a marginal adjust- ment. “It’s easy to say that the boom in private markets is over, but I don’t think that is the case. “A lot of pension funds, insurance companies and asset man- agers have invested a lot in private markets. You can’t just sud- denly stop these investments; you need to keep managing your portfolio. “Second, private market assets are a good fit for our liabilities because we can tailor the cashflows to meet our liabilities,” he says. But fund flows from the year end suggest that institutional investors are building bigger liquidity cushions. European money market funds reported close to €124bn (£108.8bn) in inflows in October alone, as fund flow data by Efama shows. Meanwhile, bond and equity funds booked €21bn (£18.4bn) and €14bn (£12.2bn) in outflows, respectively.


Insurance challenges


The 2022 liquidity crunch in the gilt market has had a different impact on insurers, who must hold capital in reserve under Solvency II rules. “The LDI crisis didn’t really affect us,” Eak- ins says. “We use derivatives for cashflow matching, not investment exposure. We saw some significant margin calls, but because we are a regulated insurer, we had excess liquidity and did not have to sell any additional assets.” But these Solvency II rules are due to be reviewed, as chancel- lor Jeremy Hunt announced in the autumn statement. Hunt pledged to reduce the risk margin whilst easing the matching adjustment rules in an attempt to attract more investment into infrastructure. The move has been broadly welcomed by the insurance industry.


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