Africa’s largest pension fund has redrawn its mandate with its asset manager PIC introducing a clause around consequence management that leaves the PIC liable in the event of inappropriate investment decisions. Elsewhere the fund has just raised the ceiling on its ability to invest more overseas.

Earlier this year, South Africa’s Government Employees Pension Fund, GEPF, completed a review of its mandate with the government-owned asset manager the Public Investment Corporation, PIC, guardian of 82 per cent of GEPF’s R2.09 trillion portfolio. The probe followed a Judicial Commission of Inquiry into allegations of impropriety and political interference at the PIC during Jacob Zuma’s presidency.

A revised mandate will now include new conditions including stipulations around consequence management that leave the PIC liable in the event of inappropriate investment decisions; better disclosure of the PIC’s investment decision making processes and ESG integration, and scrutiny of its fee model in the unlisted portfolio.

“The Commission of Inquiry report said we needed to build into our mandate and redraw the contractual agreements with the PIC. The GEPF board is comfortable that the revised mandates and enhanced monitoring capability will provide better oversight,” says Musa Mabesa, principal executive officer at GEPF.

The concerns of the judicial inquiry focused particularly on the GEPF’s 5 per cent allocation to unlisted investments via mandates with the PIC and a clutch of external asset managers managed by the PIC. “There were weaknesses in the governance processes and approvals needed to be tightened at the PIC,” said Mabesa who was the head of corporate services prior to taking the helm a year ago and who has no illusions of the challenges of heading the largest pension fund in Africa. Peer fund insights into how to manage managers offer valuable insights, like a 2019 benchmarking exercise that explored operations between the Netherlands’ ABP and its asset manager APG. “Our vision is to be the best in class,” he says.

Elsewhere, governance has been boosted by the PIC swearing in a new 12-member board and the asset manager “re-introducing” important positions: chief investment officer, chief risk officer and chief technology officer.

In another important governance seam Abel Sithole, previously in charge at the GEPF, is now CEO and executive director of the PIC.

“We welcome the appointment of Sithole, but we are also fully aware that he can’t do it alone,” says Mabesa.

The governance overhaul has mollified talk of the GEPF mandating to other asset managers or building out its own internal processes.

“The PIC remains our appointed manager and we don’t anticipate changes,” says Mabesa. GEPF manages a tiny 1 per cent allocation to private equity across Africa and the fund’s 9 per cent allocation to foreign equities and bonds is mandated to JP Morgan, Goldmans and BlackRock.

Change is also less likely given the GEPF’s latest results, bathed in the glow of economic recovery. The pension fund returned a net 23.1 per cent for the year led by returns in local equity (44 per cent) local bonds (19 per cent) and offshore equities (24 per cent) with property the only laggard.

Change ahead

But this year’s results belie the challenge of GEPF’s reliance on the Johannesburg Stock Exchange. The fund has a 50 per cent allocation to local equity (80 per cent of which is passive) in an allocation dictated by heavyweight corporates in the index strategy.

Since GEPF currently invests less than 10 per cent overseas (just extended to a 15 per cent ceiling) there is headroom to diversify outside South Africa, but Mabesa doesn’t envisage any drastic change at the moment and says the home bias is due to GEPF’s asset liability model, and continues to serve the fund well.

“It’s a long-term strategy; we won’t make changes to the strategy based on short term events. Last year markets crashed, however three months later bounced back and the same equities that lost money recovered. We will monitor strategy in line with our liabilities and will only change if our liabilities change.”

Still, the prospect of slow economic growth ahead is one of his chief worries given the fund’s overwhelming dependency on the local economy.

“If the economy doesn’t grow, we will struggle,” he admits.

Nor does GEPF have any plans to build out its allocation to private assets.

“A 4-5 per cent allocation to private assets is relatively small, but in rand terms it is a lot of money, especially as the value of the fund grows,” says Mabesa. This despite his acknowledgement of growing unlisted opportunities in Africa’s fintech and renewable energy space.

“All changes to strategy will have to go through the board of trustees and take into consideration the fund’s rand-based liabilities,” he concludes.

Professors at Oxford University, Richard Barker and Bob Eccles, outline the key factors for success of the International Sustainability Standards Board, which was announced at COP26. They say investors need to visibly and vocally encourage both companies and regulators to support the ISSB. 

On November 3 at COP26, the IFRS Foundation (the Foundation) formally announced the formation of the International Sustainability Standards Board (ISSB). It also communicated that it “will complete consolidation of the Climate Disclosure Standards Board (CDSB—an initiative of CDP) and the Value Reporting Foundation (VRF—which houses the Integrated Reporting Framework and the SASB Standards) by June 2022.” The ISSB will also build on the work of the Task Force on Climate-related Financial Disclosures (TCFD).

In addition to this organizational work, the Foundation announced the publication of two prototype disclosure requirements: the “Climate-related Disclosure Prototype” and the “General Requirements for Disclosure of Sustainability-related Financial Information Prototype.” These were developed by the Technical Readiness Working Group (TRWG) and are the first two of eight deliverables in a well-structured program of work which will lay a strong foundation for sustainability disclosures that are as rigorous and relevant as those we have for financial reporting.

We couldn’t be more delighted with this monumental step in providing the information investors need to make long-term capital allocation decisions to support sustainable enterprise value creation. It is more than we hoped for when we published our Green Paper “Should FASB and IASB be responsible for setting standards for nonfinancial information?” just three years ago.

Disclosure standards protect investors and support the integrity of the global capital markets. Accordingly, the establishment of the ISSB has already received global support, from IOSCO, the international body that brings together the world’s securities regulators, and from the G7, G20, and the FSB. The ISSB has also been endorsed by major companies and global investors, as the path to the needed global sustainability standards baseline. It will be advised by the multilaterals (OECD, IMF, UN, and the World Bank).

There remain some voices, however, who are not as enthusiastic as we all are. Such critics object to the very name of the ISSB, decry its focus on the intersection between sustainability and enterprise value, complain that there is no conceptual framework, and seem to generally wish it the worst. To them we say, “The ship has sailed. You now have two choices. Accept this reality and constructively engage or continue to carp while the rest of us get on with this important work.”

Given this context, we think there are four key factors that will determine the success of the ISSB.

The first is effectively integrating the VRF and the CDSB into the IFRS Foundation, including establishing a working relationship with the International Accounting Standards Board (IASB). VRF and CDSB are relatively small and nimble entrepreneurial organizations, and necessarily so given the plethora of emerging sustainability issues on capital markets. The IFRS Foundation, in contrast, is a well-established body with appropriately deliberative processes. These organizations have different cultures and people with different skills. There will also be the challenge of coordination across geographies, including Frankfurt, Montreal, London, San Francisco and Asian locations to be named. Yet, while merger integration is always challenging, there are strong reasons to be optimistic. All organizations in the merger have a strong sense of shared mission. All are operating from a common definition of materiality based on enterprise value creation. And an appropriate level of funding is being put in place so that the ISSB has the financial resources necessary to do its job.

Second is the strong engagement of investors, companies, auditors, and regulators. Investors need to visibly and vocally encourage both companies and regulators to support the ISSB. Early news is encouraging based on the investor responses to the IFRS consultation and announcements. Most recently, the 62 members in 12 countries and with over $52 trillion in assets under management of the SASB Standards Investor Advisory Group have expressed their strong support for the ISSB and its plans to use SASB’s standards as a basis for industry-specific requirements, to be developed through the global due process for which IFRS is known. It is the responsibility of companies and their auditors to implement the ISSB’s standards. They must prepare themselves to do so. Finally, while the ISSB can establish standards, it cannot mandate their use. This is no different than with IFRS accounting standards. Jurisdictions around the world, in their own ways, must support the ISSB through their rules and regulations on corporate reporting. The G20’s position is a great start. The UK has already said it will create a mechanism to adopt and endorse ISSB-issued standards. The ISSB’s commitment to industry-specific disclosures is also headed in the right direction. IOSCO has called out the importance of industry-specificity. Its role to bless standards for cross-border use also makes their strong support of the ISSB notable.

Which gets us to the third key success factor — coordination with jurisdictions involved in their own standard setting efforts, in particular the EU and the US. The EU is looking to pass legislation for its Corporate Sustainability Reporting Directive (CSRD). The SEC is likely to be issuing some rules on climate disclosure later this year or early next. What is important is for common topics, such as greenhouse gas emissions, to be reported on in the same way. Ideally, the ISSB will set the “global baseline” that the EU will add to, and the US will aspire to. This is what some of the largest EU companies have already said they want. In the European context, this global baseline must serve investors’ information needs in a way that complements the EU’s “double materiality” approach.  We value voices calling for information on a company’s sustainability performance that is not currently related to long-term enterprise value creation, a demand that can be met by regulation from a state actor like the EU, or by companies voluntarily reporting using standards from NGOs such as GRI. Nothing in the ISSB’s standards will prevent companies from reporting on additional sustainability matters that, for whatever reason, are not material to investors. Nor does the ISSB’s proposition prevent jurisdictions, such as the EU, from mandating disclosure on a double materiality basis. Those who advocate for double materiality should focus on advocating governments to mandate additional disclosure requirements.

Finally, it is important for the ISSB to get off to a good start. This means participation by all relevant stakeholders in the ISSB’s due process to establish standard-setting priorities, develop a conceptual framework, and expose prototypes and draft standards for public comment.  The work of the TRWG has given the ISSB a strong “running start” on all of these items, but it is important to note that the TRWG prototype disclosure requirements are not formal exposure drafts, let alone final documents as some have implied. Rather, they are recommendations with formal consultation and board deliberation to follow, thereby following the same rigorous due process used by the IASB.

Three years from our Green Paper we now have the ISSB. Three years from now we are confident the world will have an effective ISSB that has the strong support of investors and companies, and institutional legitimacy from regulators. The work of the ISSB will improve capital allocation decisions by both companies and investors. Is it a silver bullet? Of course not. But the world will be a far better place with the ISSB than without it.

Richard Barker is Professor of Accounting and Deputy Dean and Robert G. Eccles is Visiting Professor of Management Practice at Said Business School at Oxford University.

 

 

 

 

In its latest position paper, Australia’s Future Fund outlines its investment approach in a new investment landscape characterised by the end of 60:40 portfolios, inflation, declining corporate earnings and climate change – amongst others.

Australia’s Future Fund, the $245.8 sovereign wealth fund, plans to modestly increase its structural risk profile to better target its 10-year benchmark of 6.1 per cent desired returns while continuing to appropriately moderate risk. In the year to June 30 it raised its risk profile and this will continue [See Future Fund adds risk and generates best ever return.]

In its latest position paper the fund also details plans to develop its models and governance to better combine its long-term investment strategy with the ability to move flexibly. Elsewhere, the fund notes an increased illiquidity tolerance given the current investment environment favouring skill-based returns that are worth the higher fees.

The plan is to also apply additional resources to identify and pursue high conviction value-add exposures particularly in private markets and debt. Private markets provide inflation protection and defensive characteristics, but the fund also sees public markets adding value via strategies that closely manage the use and costs of illiquidity.

Future Fund’s latest analysis of its investment approach is the consequence of significant changes catalysed and accelerated by COVID-19 that are creating a new investment order. Expect lower returns, more inflation risk, more divergence, conflict and market fragility, the fund argues. The current investment environment will also test long held assumptions and question the conventional wisdom that has guided the fund since it was established in 2006.

“We believe that the investment thinking that has delivered strong returns over recent decades needs to be revisited,” writes the fund. “We believe that preparation and monitoring the investment environment and testing our thinking and the assumptions on which it is built, are the best ways we can position our investment program to generate strong returns, with acceptable risk, over the long-term.”

It’s led the fund to consider a variety of plausible scenarios and consider how it can evolve and position the portfolio to be as robust as possible in those scenarios. All the while playing to its key characteristics and advantages of having a long-term investment horizon, a total portfolio approach and the ability to partner with high calibre investment organisations globally.

Paradigm shifts

The paper highlights paradigm shifts that are shaping the investment order in ways that should encourage investors to think afresh about their portfolios.

Deglobalisation is replacing globalisation as the hitherto free movement of goods and services, investment and people across national borders slows and in significant cases reverses. It’s resulted in tensions between the world’s two largest economies while technological developments are more closely guarded as part of national security policy.

Countries have reasserted their national interests, controls over national laws, and put a domestic focus over and above an open international system. National economic policies have moved towards greater state intervention and controls.

Technological innovations have allowed firms to develop operating models based on intangible assets, such as data and software platforms leading to the rise of digital conglomerates. Innovation advantages have led to disruption and dispersion within industries.

Many developed markets face ageing populations and have been reliant on migration to counter population contraction and ageing. Asset inflation has exacerbated wealth inequality between generations. In developed countries younger people may experience disadvantage in security of employment, house prices, higher education debt and record levels of national debt.

Physical climate risk has become more severe over time. Insured losses from natural disasters have increased from around $10 billion per annum in the 1980s to $45 billion in the last decade (inflation adjusted). Direct overall losses have been four times the size of insured losses and have increased approximately threefold in the last 30 years. Companies with carbon-intensive operations and value chains are potentially vulnerable to market repricing. Renewable energy is becoming cost competitive with traditional generation sources.

In the US corporate earnings have increased from around 5 per cent of GDP in 1990 to 8-10 per cent today. This has been driven by the use of technology and innovation to drive productivity improvements from intangible assets, capital friendly tax arrangements, restructuring, offshoring and automation which has reduced costs. If these trends come to an end, or reverse, (perhaps as a result of deglobalisation and populism) and without new sources of growth, expect downward pressure on earnings and equity returns in the decades ahead.

The forces that have brought inflation under control have ebbed or are now in reverse and the response to the financial crisis of 2008 and to the more recent pandemic have added to government debt burdens. Fiscal stimulation has added to burgeoning entitlements which can only be met by pro-inflationary policy.

In the aftermath of the financial crisis, institutional independence has been eroded through the introduction of measures such as Quantitative Easing, yield curve controls and other forms of central bank intervention in government funding markets in an effort to induce or support fiscal spending. The pandemic has further accelerated this shift.

As monetary policy reaches its limits and technological disruption provides scale with its low capital expenditure requirements, the traditional economic cycle is under threat and traditional metrics for assessing fair value are being challenged. There is an argument that the base rate and risk premium component of risk asset discount rates should be structurally lower – and valuations structurally higher than they have been through modern financial history.

Government bonds have been the defensive anchor of investment portfolios for over 30 years with the traditional 60/40 equity bond portfolio relying on negative correlation between the two asset classes. Nominal bond yields are significantly lower so the scope for bonds payoff is reduced. Investors have ended up paying to benefit from bond rallies rather than being paid. If inflation begins to rise the bond-equity correlation may prove much less beneficial going forward.

“I wouldn’t dare tell a company how it should be run, they are the experts. Rather than tell a board how to behave I would rather have them compete,” says Paul Droop, group pensions CIO of the Bank of Ireland who believes regulation is damaging free market competition in a worrying new shift that  poses the single biggest risk for investors.

That old photograph taken in the early 20th century of a horse and cart alongside one of Henry Ford’s first cars is often used today to describe the seismic energy transition ahead as the world moves from petrol and diesel to electric cars. But it belies one crucial difference. The first cars were a consequence of a market-driven change – no one told people to buy them. Today new rules decree that people can’t drive petrol cars for much longer, discouraging investment in the companies that make them.

Leaving aside value judgements and not expressing a view on the climate emergency, it is this emerging and worrying shift from liberal, market-based economies to centrally planned and regulated ones that poses the single biggest risk for investors, argues Paul Droop, group pensions CIO at the Band of Ireland, overseeing the €7 billion Bank of Ireland’s Staff Pension Fund (BSPF).

“There is an increasing shift away from liberal markets, promoted and driven by a growing range of sources. On a spectrum from very open and liberal market economies to another extreme of centrally planned, the world appears to be moving significantly towards central planning and control,” he says in an interview from the fund’s Dublin headquarters.

It’s not just visible in increasingly pervasive climate regulation. The pandemic has hastened the trend, ushering unprecedented rules and restrictions in response to COVID many of which still haven’t been removed.

“Permanent rules have come about regarding what we can and can’t do; how we behave and how we interact with one another.”

And it’s not only governments and regulators driving the shift. Asset owners and managers are hastening the trend too says Droop, particularly concerned about the growing role – and pressure – on shareholders to intervene in corporate governance.

“I wouldn’t dare tell a company how it should be run, they are the experts. Rather than tell a board how to behave I would rather have them compete.”

Only that competition is increasingly stymied in a threatening backdrop for BSPF’s portfolio exposed to the entire market and structured to tap every kind of risk. Droop’s risk management philosophy has virtually no reliance on alpha but emphasises diversity and resilience instead. The listed markets should be a field of competition where every buyer and seller can come together, he argues. That vibrancy and health depends on the best companies securing the most favourable access to capital and the worst falling by the wayside but rules that define what makes a good company distort the field.

“It should be a competition open to all where the best win and those that aren’t as good fail.”

Exposure to everything

Exposure to everything is vital in today’s uncertain world where investors can’t be sure what really lies ahead.

“Information about the past isn’t even that good,” he says. Some investments go wrong, others thrive but that’s competition within the market for capital.

“For every failure, we are on winners as well,” he says. “We don’t filter anything out. If we have diversity, the strategy will naturally benefit from any opportunity, without having to try and predict what it might be and take explicit and specific risk to articulate that view.”

It’s a risk management strategy that is as suitable for ESG as any other source of risk, today and historically.

“A market capitalisation-based exposure to global listed equities would be superior to an approach that screened, tilted, held assets according to some arbitrary rules or was actively managed according to views of the manager. Diversity as a risk management process should still work for any risk presented by ES, or G issues if you believe it does for, say, global monetary policy.”

Effective risk management has to refer to the price of assets and securities, he adds. Yet if managing risk simply means, say, “buying windmills and selling coal miners” without reference to the price, investors aren’t effectively managing risk. Especially in an environment like today when he says everyone seems to be tilting the same way. “From a risk management perspective, this type of behaviour leads people to buy overpriced assets and sell under priced ones – which isn’t very good risk management.”

Diversity wins

Since he joined the fund in 2011, Droop has transformed the asset allocation. He’s increased liability hedging, diversified across asset classes and boosted coverage of private markets with the BSPF allocation currently split between equity (13 per cent) credit (23 per cent) secured income (7 per cent) real estate, infrastructure and absolute return (5 per cent each) and liability hedging (42 per cent)

A risk management philosophy that eschews alpha and champions diversity and resilience to mitigate uncertainty means he avoids all managers with highly concentrated or opportunistic approaches. He also spends less on fees.

“We tend to employ managers at the more ‘boring’ end of the scale. Total management fees across the portfolio are about 30 basis points, which includes some very expensive private and hedge fund strategies.”

Droop, who runs the portfolio with one assistant and is responsible for the thought leadership and idea generation, links the fund’s success to this clear delineation of duties and a willingness to do new things. In the six years to December 2020 the BSPF’s return seeking assets have returned 7.6 per cent. He also credits the trustees and governors for not chasing fads but remaining faithful to a core belief and philosophy. And he has no plans to change anything.

The fund’s liabilities are hedged enough – if he was to hedge anymore he worries he would lose benefits or risk diversification on the margins – and he added two new credit strategies last year. Investment themes like China, or new technologies, are already captured in the diverse approach that doesn’t try to pick winners.

It leads the conversation back to his central argument. A portfolio built to tap all parts of the economic value creation chain in a market-based economy where every investment behaves differently but each individual asset has a role in the play, doesn’t require much maintenance. Or at least until governments start interfering.

“Moving economies to central planning and control amounts to a net loss for everyone. The market should be allowed to sort it out.”

Being ready for anything, a focus on risk management, using more leverage and opportunities in technology are key characteristics of the portfolio of the future according to investors who spoke at the Fiduciary Investors Symposium recently.

Resilience and risk management, exposure to digitization and climate opportunities, and a keen eye on talent management will be some of the most important elements in portfolios of the future, according to James Davis, chief investment officer of OPTrust.

Davis says that risk management is now as much a source of value creation as a control function and his focus is on building a portfolio that is as resilient as possible which means only allocating risk – a scarce resource – with purpose.

OPTrust is also establishing relationships to better understand crypto and blockchain innovations and he said blockchain and tokenisation are significant, with a need for investors to understand them to know which opportunities to tap and which parts of the economy to avoid because of approaching disruption. This was a view echoed by David Veal, chief investment officer of the Employees Retirement System of Texas who said “I’m excited by tokenisation”.

“I think you could add a whole new layer of liquidity to existing assets and potentially open up new investments to investors,” Veal said.

Other speakers at the conference said investors should be preparing for a new tokenised economy where assets are fractionalised, divided up amongst potentially millions of investors into tiny portions of ownership on a blockchain. Jenny Johnson, president of Franklin Templeton said this will enhance liquidity, price discovery and accessibility to high value, illiquid assets like real estate at a fraction of current transaction costs.

Meanwhile the Abu Dhabi Investment Authority is thinking about technology across all its investment functions with director of the strategy department, Jean Paul Villain, saying a decision to invest more in in-house technology came with the realisation that a slowdown in its capacity to generate alpha was linked to a lack of investment in big data and AI.

ADIA is making up for lost ground investing in different kinds of quantitative approaches, collecting, cleaning and testing data to apply across the portfolio from long-short equity allocations to tactical positions and facilitate access to the best managers.

The fund is also pushing more actively into private assets, especially private equity and infrastructure where it first invested in 1992 and 2005 respectively.

More investment in private equity is a key component of CalPERS’ portfolio of the future as it builds out its private equity allocation from 8 per cent to around 13 per cent.

The fund’s new asset allocation also includes global equity, reduced from 50 to 42 per cent, fixed income from 28-30 per cent, real assets moving from 13 to 15 per cent, and an allocation to private debt of 5 per cent marking its first foray into this asset class from an SAA level.

It will also include a 5 per cent allocation to leverage for the first time.

Mindful of board concerns that leverage adds operational risk and brings extra hazard in market environments where both equity and bonds sell off, interim chief investment officer, Dan Bienvenue, said the investment team have spent months exploring the fund’s ability to manage leverage – and liquidity.

It has involved centralising the strategy at a total fund level rather than at an asset class level, running scenarios around what the portfolio would look like and modelling diversified pathways to liquidity during times of market stress when the pressure of leverage makes finding liquidity harder.

Into the future CalPERS is wary of investing in China. Despite being a contributor to economic growth and important diversifier, investing in China comes with challenges like the accuracy of data, shadow banking and finding the right partner, Bienvenue said.

Related, Professor Stephen Kotkin says that the climate emergency, China and Fed policy pose the most systemic investor risk ahead.

He said investors in China now face considerable ESG risk and are struggling to align allocations to China with their ESG goals.

He said another key risk comes from an unfamiliar source: a dramatic misstep from the Fed.

The Fed is the most important global institution and if it starts to cause havoc by a policy misstep it will be bigger than the climate crisis or China, Kotkin said.

 

The rising popularity of private assets has made liquidity risk a growing concern for institutional investors, who need to carry enough liquidity for possible downturns, but avoid the opportunity cost of carrying too much, says Michelle Teng, vice president of the Institutional Advisory and Solutions group at PGIM.

Private assets are appealing for their attractive risk-return properties and diversification potential which is not available to investors limited to public markets. But as demand rises for private assets in the search for alpha, liquidity risk has become a growing concern for investors.

While funds that closely manage volatility risk in their portfolios can generally survive periods of short-term volatility, sustained liquid asset drawdowns are a greater concern and can cause lasting damage to portfolios, according to Michelle Teng, vice president of the Institutional Advisory and Solutions (IAS) group at PGIM – the global investment management business of Prudential Financial.

With funds facing lower inflows at the same time as there was a capital flight to safer asset classes – all the while marking to market their FX hedging positions – funds with large private asset allocations faced difficulty with liquidity management, Teng pointed to the experience of institutional investors in March 2020 during a conversation in a Market Narratives podcast interview.

CIOs need to emphasise liquidity risk measurement in order to manage liquidity during these times, which involves ensuring they have enough liquidity to meet their liquidity demands over more than just the immediate term, Teng said.

“In March 2020, some funds experienced heavy liquidity demands that they were able to meet, however, these heavy liquidity demands continued well into April,” Teng said. “At that point, CIOs started to have liquidity worries. Fortunately…government intervention came to the rescue and liquidity demands quickly tapered off after only a couple of months. But what would have happened if help didn’t arrive for six months or longer?”

 

 

Teng said the growth of private capital markets has seen a range of up-and-coming companies stay private longer without going public, making their gains unavailable to investors who don’t invest in private markets.

With general partners (GPs) of private equity funds deciding when they call the capital and make distributions back to limited partners (LPs) who are investors, this creates uncertainty around the timing and amount of cash flows of private equity investments.

Further complicating the matter, when a fund doubles its private equity allocation from, say, 15 to 30 percent, the portfolio’s liquidity risk is not simply doubled. There may be a point where liquidity risk suddenly jumps much higher, Teng said.

“So if liquidity is not managed properly, the CIO may end up in a situation that they are forced to sell illiquid assets with a big haircut to raise cash, or they may have to sell assets that are hard to reacquire later.”

Teng said a fund’s overall liquidity is a consequence of independent decisions being made by different teams, such as the asset allocation group which makes decisions at the portfolio level, and the private equity team which sources deals and makes decisions on a deal-by-deal basis.

It is the CIO’s challenge and responsibility to understand the interaction of these decisions, and how they may affect the portfolio’s overall liquidity risk over time, Teng said, but a lot of CIOs lack tools to measure liquidity risk over the entire investment horizon. Some only forecast liquidity for short periods and lack a total portfolio view on liquidity risk over a multi-year horizon, she said.

Teng said it is not always a problem of having insufficient liquidity. Some funds who were chastened by the GFC may carry too much liquidity, leading to an opportunity cost that drags down performance.

As a result, PGIM IAS has been focused on tracking cash flows from different asset classes over varying investment horizons, with an asset allocation framework that helps CIOs think through the consequences of changing asset allocations between liquid and illiquid assets.

This framework brings together various moving parts   to help CIOs evaluate their portfolio’s liquidity and performance under different scenarios in a consistent way, Teng said.