Alternatives Create Illiquidity


    Holistic liquidity management requires positions that provide some liquidity hedge in event of market correction, protective hedges when they are cheap, and removing unintended exposures such as currency, says Greg Nordquist, director of overlay strategies at Russell Investments Implementation Services, LLC. Speaking on ‘Managing liquidity in an illiquid world’ at the ‘2016 Russell Investments Seminar,’ he said today’s capital market assumptions reflect the reality of global interest rate policies. The financial crisis cut returns from 7.5 to 5.5, but then rates dropped and dropped forcing down returns. However, pension plans need more than five per cent to meet their obligations, they need six or seven per cent to fill the return gap. To do so, they turned to alternatives which provided returns and diversification, but sacrificed liquidity. There are other practical challenges from increasing the use of alternatives in a portfolio. Larger allocations to alternatives mean there is a smaller liquid asset base to meet liquidity needs. As well, in a drawdown, funding needs and benefit payments stay constant while the asset base drops. The cap call/distribution ratio increases and there can be unanticipated risks from currency and potential concentration. A holistic approach to management can help position the fund to weather these risks.