Investors have taken a shine to illiquid assets in their search for yield and, as Lynn Strongin Dodds reports, this relationship shows no sign of fading.
“Five years ago, equities were delivering returns of 10% to 15%, but over the next five years we expect that figure will drop to around 5%. By contrast, the illiquidity premia is expected to be up to 3%, which is appealing.”
Andrew Stephens
It is easy to understand why illiquid assets have gained such a following over the last few years. Yield-starved investors have been pushed into higher growth assets as interest rates continue to bump along the bottom. The pickings are getting slimmer due to overcrowding, although there are still plenty of opportunities on offer.
Caution is required, however. “I would argue investors should not become complacent and think they will be rewarded for their risk,” says Antti Ilmanen, head of AQR’s Portfolio Solutions Group. “The spreads look decent compared to Treasuries, but if you look at many of these illiquid asset classes on a standalone basis, they are also trading at historically low yields so when interest rates eventually rise, they too will suffer from capital losses.”
Ilmanen argues the real benefit of investing in illiquid assets is the smoothing effect that can be achieved through diversification and low correlations with other assets. “Investors should realise there can be an illiquidity premium in equity and bond markets with for example, small versus large caps and that at different times in the cycle public markets will outperform private equity while direct real estate and real estate investment trusts often generate the same returns over time.”
ILLIQUIDITY PREMIA
The popularity of illiquid assets is unlikely to diminish as long as traditional investments such as stocks and bonds fail to deliver the much-needed results for pension funds to meet their minimum requirements and long-term liabilities.
As Andrew Stephens, managing director of Blackrock’s UK institutional business, notes: “Five years ago, equities were delivering returns of 10-15%, but over the next five years we expect that figure will drop to around 5%. By contrast, the illiquidity premia is expected to be up to 3% which is appealing. Depending on the objectives of the pension fund, we are seeing these assets account for up to 12% of the overall portfolio.”
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