Author: James Painter, CEO
There is an acute need to reconsider the desirability of liquid assets as an investment option to secure the long-term future of pension funds. Whilst the risk-averse instinct to latch onto liquidity as a pension fund manager is understandable on the surface, when you dig deeper it can result in myopic decision-making which jeopardises the fund’s long-term sustainability.
While a degree of liquidity is required to ensure that short-term liabilities can be met, over-insistence on liquidity can result in a reduced opportunity set of investments. This means lower investment returns and ultimately a greater burden for the sponsor, which is a drain on public finances in the case of public pensions.
The long-dated liability structure of a pension fund gives managers the time to invest in a variety of high-yield assets, with infrastructure and renewable energy sources being prime examples. Through allowing investment in these less liquid, but also more lucrative, investments, Investment Managers will not have to pay the liquidity premium and also enjoy the benefits of a far less volatile portfolio through the added asset class diversification.
Therefore pension fund trustees may need to ask themselves the question: do I need to access the majority of my investments in cash when there is a crisis? If they don’t, there may be an opportunity for them to give their investment managers the freedom to partially move away from liquid investments in favour of alternative opportunities that offer the potential of a greater long-term investment return.
Such a method of improving investment returns may well be necessary if we are to redress the deficit in the public pension fund, which will require either an injection of funds from the government and, by extension, the taxpayer, or a fundamental shift in approach so we can drive a higher investment return. The second option is a much more attractive one and a far more sustainable one.
However, one of the biggest challenges for pension fund trustees in re-evaluating liquidity is not the ability to understand the issue but how to implement such a philosophy within their existing investment strategy. Where funds are run by ‘advisory’ consultants this may be problematic, as the bulk of the assets will be held in traditional asset class funds which offer little more than a proxy for the general market. However where trustees have embraced the concept of fiduciary management and use active discretionary managers, reducing their liquidity requirement could prove an astute move.
When considering the Channel Islands pension funds, such a move would also prove highly beneficial for the islands’ economies as we have a high number of quality active discretionary managers working here who already have the investment solutions to restructure liquidity profiles and boost the long term investment return.