Illiquidity has gone from an occasional pitfall to a harvestable risk premium, no more so than with alternative investments. But labelling something as a risk premium doesn’t wish away the risks. They can still be scary. This was a key point made during a panel discussion at the conference called Illiquidity Risk: What Does it Mean for Your Plan?
“Tail risk events can really burn when you’re running a pension plan because we want to be as optimal as possible from an investment perspective but we also must pay our pensioners each and every month,” said Derek Dobson, CEO and plan manager of Ontario’s CAAT Pension Plan. During the depth of the 2008–2009 financial crisis, he recalls, “the only thing we could really sell to raise cash without losing our shirts was Government of Canada bonds.”
Being able to sell, however, is only half the equation. “The number of cash hits that you can have at the same time can be a bit surprising,” Dobson added, enumerating pension payments, foreign exchange charges as the greenback soared, margin calls to maintain collateral, and capital calls for private investment commitments already contracted.
That is not to rule out illiquid investments, explained UBC Investment Management Trust Inc. president and CEO Jai Parihar. But it takes planning to ensure sufficient liquidity in the overall portfolio—buffers in the form of T-bills and government bonds—to be able to meet pension and endowment obligations, counterparty payments for portable alpha strategies and commitments to private investments that may be “drawn when you don’t have money.”
As Parihar noted, prudence dictates that “a certain amount of illiquidity in the portfolio is fine. But if we cannot meet those obligations, then perhaps our illiquids in the portfolio should be less than we would like to have.”
Still, while illiquidity presents challenges, “if you’re paying a monthly cheque to a pensioner, you can’t sell an airport overnight to pay for that” noted Ken Manget, vice-president, infrastructure at the Ontario Teachers’ Pension Plan.
But there is opportunity as well. “You want to be on the other side of that trade. When you have liquidity shocks in the market, if you’re poised so that you have ample liquidity to deal with, you own liquidity requirements,” he said, “you can take advantage of some of the dislocations in the market.” During the financial crisis, Teachers’ was positioned so it was able to manage its liquidity without any need to sell assets.
The key then, said Dobson, is having systems and processes in place that “get the right information to the right people at the right time so they can make the right decisions.”