Asset owners are familiar with chief risk officers (CROs) and even chief investment officer (CIO) but few would yet see the need for a chief liquidity officer despite the fact that portfolios are often seen to be haemorrhaging cash following market volatility events.
Michelle Teng, vice president and co-head of the private assets research program at PGIM’s institutional advisory and solutions (IAS) group, makes the case for creating a chief liquidity officer within management teams.
“Traditionally asset owners tend to focus on volatility risk in their portfolio construction. However, volatility events come and go, and most funds can generally survive them without the need to sell assets at distressed prices. However, funds may not be able to recover from a liquidity drain and an unexpected need to raise cash," Teng told AsianInvestor.
Teng and her colleagues at IAS have done research that shows that liquidity events can create a sudden and unexpected need to raise cash and can threaten a fund’s survival.
Such liquidity risks often force CIOs to make undesirable and often costly portfolio decisions.
“Many types of institutional investors would benefit from focusing on liquidity management, or liquidity risk. These include public and private DB pension funds or DC funds, endowments, foundations and sovereign wealth funds,” Teng said.
Fund liquidity management is particularly challenging due to the need to integrate all aspects of a fund’s liquidity demands and sources. Such an effort includes top-down asset allocation, bottom-up private market deal-making activities and internal and external operations.
“Asset owners have generally increased their allocation to illiquid assets such as alternative investments. That changes the portfolio’s liquidity properties. These asset allocators can also face new and relatively large external liquidity demands following events linked to shocks to the economy, the Covid-19 pandemic being a universal example,” Teng said.
As recently as February this year, the Malaysian government's decided to halt withdrawals from the Employees Provident Fund. That put the spotlight on liquidity management as the state retirement scheme grappled with reduced funds.
Withdrawals at the height of the pandemic have depleted EPF assets, with median savings of account holders halving in 2022 compared with 2019, local media reports said. About 8.1 million account holders withdrew RM145 billion (US$32b) at the height of the Covid-19 pandemic.
“The key implication for investments when there is a steep decline is around liquidity management,” Leong Kar Wye, director of investments, Asia at WTW, told AsianInvestor in February.
AUSTRALIA AND KOREA
EPF is not the only asset owner in the Asia Pacific facing heavy withdrawals during the pandemic.
The Australian government is mulling a ban on early withdrawals after some Australians withdrew on their superannuation to buy homes or used the money for other purposes during the pandemic.
The relatively rare and unfavourable condition of both stocks and bonds tumbling in 2022 has also not helped portfolio values for asset owners in the region.
In Korea, the Public Officials Benefit Association (POBA) was also hit by liquidity challenges. Due to rising interest rate hikes during 2022, the liquidity of Korean financial institutions was influenced by changes in interest rate differentials between commercial banks, non-bank depository institutions and mutual aid associations like POBA.
In addition, POBA was under pressure to meet unpredictable capital calls arising from commitments to overseas alternatives fund vehicles made prior to 2022. The sharp appreciation of the US dollar-to-Korean won exchange rate made those US dollar-denominated capital calls and hedging costs more expensive. The Korean won, meanwhile, depreciated against the dollar by more than 17% from February to October 2022.
“Those three drastic environment changes brought us to some difficulties in terms of liquidity management. That was the additional challenge that we confronted last year, along with global environment changes,” Huh Jang, chief investment officer at POBA, told AsianInvestor in February 2023.
This unforeseen situation means the pension fund now has increasing internal focus on monitoring and controlling the liquidity situation within its portfolio, Huh explained.