Liquidity Management – The Third Pillar?

We’ve reported previously on output from the annual Amundi–CREATE series that started in 2014. There is always a plethora of great insights that are shared from among leading pension voices from multiple pension markets. This year’s survey included 158 plan sponsors (74% private) from 17 markets representing nearly $2 trillion in pension assets. I think that this year’s survey took on an element of greater urgency given the impact that Covid-19 is having on markets and economies, and thus pension systems. Obviously, there remains great uncertainty as to the duration of this crisis and the long-term implications for every aspect of our society.

As one would suspect, there were many asset allocation questions posed in this survey, including expectations for returns during the next decade and one that asked whether markets would once again reflect underlying valuations. But the one that caught my attention the most was the one about liquidity. I was pleasantly surprised that 57% of respondents felt that liquidity management will become the third pillar of asset allocation after risk and return. We couldn’t agree more that managing liquidity in this environment will prove to be absolutely critical. As proponents of cash flow driven investing (CDI), we believe that plans MUST secure their benefits and expenses in the near-term providing a longer-term runway for the plan’s growth/alpha assets to perform. This is especially true in this environment as plans have been aggressively building alternative portfolios in an attempt to add some juice to their returns.

In addition to having a greater exposure to alternative investments with lock-up periods, which reduces available liquidity, plans of all kinds are likely to see little to no increase in contributions given the impact on business, union hours, and state and municipal budgets. Having to “make do” with what they currently have, plans will need to restructure their asset allocation and investment structure to reflect this new reality. By dividing the asset base into beta and alpha assets, plan sponsors and their consultants can dedicate a portion of their portfolio to liquidity assets (Beta assets) to fund near-term benefits and expenses (i.e. 1-10 years). This allows the Alpha assets to grow unencumbered, as the last thing one should want is to be forced to raise liquidity from assets that are growth assets and might not have natural liquidity. We refer to this as “maximizing the efficiency of the asset allocation”. You can read about our thoughts on this subject in the July 21, 2020 Ryan ALM blog post.

Protecting and preserving defined benefit systems is critical to the US having a retirement system that will actually allow workers to retire with dignity. Conducting business as usual, especially in this environment is not a winning formula. It is time to get back to basics by focusing on plan liabilities and the generation of cash (liquidity) to meet those promises. Are you ready?

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