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Regulators seen tightening focus on pension fund liquidity

Pensions watchdogs are likely to increase their focus on the issue of liquidity within pension fund investment, taking steps to force the funds to demonstrate they are considering the implications of moves to less liquid instruments, a conference has heard.

Speaking at the IPE Conference & Awards in Barcelona, Pascal Blanqué, chief executive and head of institutional business at asset manager Amundi, said: “We will see regulators more and more asking for proper liquidity policies, including a proper definition of liquidity starting with liquidity indicators, pricing policies and new relationships with counterparties.”

This move towards change in liquidity polices will result from the shift in market structure seen in recent years, as banks have retreated from the market making while investors simultaneously frantically seek yield, he said.

“This liquidity problem we have got on the table – on the one hand, we have an excess of macro liquidity (quantitative easing) and, at the same time, a deterioration in micro liquidity,” Blanqué said.

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“What we will see is higher volatility, and this can happen even in the Bund market.”

But while liquidity is about risk, Blanqué argued it is also about opportunities, such as liquidity-orientated strategies.

Long-term investors must ask themselves whether they need liquidity.

“My feeling is, generally, the fund industry underestimates the liquidity risk,” he said.

Blanqué said there was huge confusion between what was listed and liquid, too much focus on daily liquidity in the long-term investment space and an under-appreciation of the illiquidity premium.

Carsten Stendevad, chief executive of Danish supplementary labour market pension fund ATP, had earlier told the conference the dramatic drop in sovereign bond market liquidity since 2002 had contributed to a radically changed investment environment.

“This has had a profound effect on us,” he said, adding that shrinking liquidity had been a huge challenge for ATP.

Stendevad outlined a range of strategic changes the pension fund has made to adjust, centred around increasing its investment flexibility.

Antoni Canals, president of La Caixa pension fund in Spain, told the panel discussing strategy priorities for 2016 and beyond that his pension fund was taking steps in its long-term policy to have ever fewer investment-grade bonds and more illiquid assets.

It takes this approach, he said, because it is a full defined contribution pension scheme, and liquidity is not a special issue.

But Canals acknowledged the controversial phenomenon facing pension funds such as ATP of diminished bond market liquidity combined with the regulatory need to cover liabilities.

“When one needs to hedge the liabilities, and regulation puts pressure in that way, maybe the whole concept is wrong,” Canals said.

Olivier Rousseau, executive director at French national pension reserve fund Fonds de réserve pour les retraites (FRR), said pension funds had to be careful about the concept of chasing illiquid assets. 

“If you do it because you no longer get the returns you expect from safe bond investments, and you are chasing very long-duration infrastructure debt or real estate debt, then that can be another aspect of moving outside the natural habitat, and that can be very risky,” he said.

The danger, he said, could come when the low-yield situation of sovereign bonds reverses.

But he qualified the remark, saying he was just being cautious.

“It remains that there is something very interesting in the illiquid space and particularly as a result of regulatory changes after the crisis,” he said.

Meanwhile, Poul Winslow, head of thematic investing and external market portfolio management at the Canada Pension Plan Investment Board, said he shared many of the concerns about the lack of liquidity in bond markets but that his institution was focusing even more on illiquid investments.

“The key for us, particularly in the coming years, is that we are changing to become even more long-term focused, and that will mean we increase our focus on illiquid investments even more,” he said.

He said the investment board had a very long-term horizon, with payments not set to exceed contributions in the pension system until 2023.

“We spend a lot of time with the board debating what does that really mean and how do we express that,” he said.

“We have concluded that our risk appetite is even bigger than it has been in the past.”

The CPPIB will now increase its exposure even more to equity-like risk.

While an increase in public equity exposure will be part of this, Winslow said, the board will focus very much on private equity infrastructure and other illiquid assets.

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