Liquidity – Feature
showcases the contrast between the speed of the moment from someone jumping from a diving board and the static nature of the remainder of the painting. Similarly, institutional investors face the challenge of adapting to sudden changes in a portfolio that is otherwise relatively static. As an insurance investor, Phoenix’s strategy centres on match- ing assets to liabilities. Being predominantly invested on a buy- and-hold basis, Mike Eakins is confident his portfolio can sus- tain challenging trading conditions. But he also sees opportunities for higher returns. “The other bit to notice about less liquid markets, especially in fixed income, is that it goes both ways. Spikes in short-term yields can expose company and government risks and they may have to refinance at higher yields,” he adds. But margin calls continue to be a risk Phoenix monitors closely, particularly in its derivatives portfolio, Eakins says. “We have a collateral management framework, which we have had in place for a number of years. So we manage our potential collateral on an intraday basis. “We continue to scenario test as collateral flows. While we are not sanguine about the current market circumstances we should have a degree of confidence given the robustness of our collateral management framework,” he adds. For Tomlinson, a key priority is to avoid being a forced seller. “In our portfolios, we have a limited amount of contingent-cap- ital exposures or non-linear triggers that can lead to large cash calls,” he says. This is a lesson he has drawn from his experi- ence of the 2007 crash.
“The horror scenario is a full sell off in a market where you have a big and illiquid position. Think Archegos,” Tomlinson adds. “We have seen this before and this is the thing that peo- ple who have been through multiple cycles look out for. Back in 2007, someone wise said to me: Bear Stearns is just a mackerel. At some point, the whale will float to surface. In a systemic cri- sis, you get liquidity withdrawals from the smaller guys who cannot get systemic help and go pop. But there is usually some- one out there, the monster, who is in trouble. Back in 2007, it was Lehman and later other big players.
“In almost every crisis, there is someone out there who is sys- temic and global and has a problem. Asset markdowns will ultimately be feeding through to endowment and pension fund portfolios. And last time around, some big endowments got caught on the wrong side of the liquidity crunch and ended up with fire-sales of illiquid assets to raise cash,” he says. The challenge for pension funds going forward is to hold suffi- cient amounts of cash to respond to short-term market chal- lenges, without losing income to inflation, says Aon’s Calum Mackenzie. “We have been encouraging pension funds to have strong collateral, we call it a collateral waterfall or a collateral ladder, so that they would have a certain buffer of cash or gilts.
Bear Stearns is just a mackerel. At some point, the whale will float to surface.
Richard Tomlinson, Local Pensions Partnership Investments
That would be the immediate first call and the next stage of the waterfall would often be liquid credit, things like asset-backed securities, short-dated bonds, floating rate notes or absolute return bonds. These assets are low risk and can be accessed at short notice. But they are not officially collateral. And then the third tier down from that would be more or less liquid assets that you might need to tap into. For example, diversified growth, hedge fund equity and so on,” he says. Liquidity will continue to play a crucial role, Mackenzie pre- dicts. “There is definitively an understanding that your cash position is important right now. You could have a situation where you get a call from your private equity fund, or your infrastructure fund wanting money to make an investment, at the same time as you can get a collateral call from your LDI manager, wanting money to top up the collateral at the same time as paying pensions and then transfer values being hit. Knowing that you have enough money is important,” he says. While for DC funds like Nest, holding enough cash is less of a concern, deploying it effectively in a volatile market can be tricky. The master trust has awarded a derivatives mandate to rebalance its exposures in challenging market environments and equitising cash for private equity investments. “The effi- cient portfolio mandate was created to avoid situations where we are sitting on large amounts of cash waiting to be invested and not earning a return,” Fernando says. As DC assets continue to grow, she sees the opportunity that such schemes could become important providers of long-term market liquidity, at a time when DB schemes are approaching their endgame.
“In volatile times, you want institutional investors to be the source of stability, not trouble,” Fernando says.
Issue 115 | July–August 2022 | portfolio institutional | 25
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