How big funds are adapting to new liquidity landscape

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(pictured: Lou Maiuri)

Liquidity has risen to become top priority in the management of fiduciary funds for both asset owners and fund managers, according to a joint survey by State Street and the Alternative Investment Management Association.

In a report published last week, London-based AIMA and Boston-based State Street say regulations stemming from the 2008 financial crisis, coupled with historically low interest rates and slow rates of growth in the global economy have constrained the ability of many banks to perform their traditional roles as market makers, which in turn has impacted broader market liquidity conditions.

The survey of 300 institutions – 150 asset owners such as pension funds and insurance companies and 150 managers, of which 50 were hedge fund managers – showed 48 per cent believe that the current decreased market liquidity is a secular and permanent shift.

The report says more than three-fifths of survey respondents say current market liquidity conditions have impacted their investment management strategy, with nearly a third rating this impact as “significant”, and are reassessing how they manage risk in their investment portfolios.

More broadly, they are adjusting to an environment of less liquidity in which trading roles have been transformed, new market entrants are emerging, and electronic platforms and peer-to-peer lending are changing the way firms transact their business.

Lou Maiuri, head of State Street’s Global Exchange and Global Markets businesses, said: “Increased regulation and the pressure to manage costs have significantly changed market liquidity conditions… The new liquidity paradigm is causing many players in the investment industry to think again about the fundamentals: what roles they play, where they invest, and how they transact their business.”

The report says investors and managers were focusing mainly on three areas:

Rationalising the risk: The liquidity shift has serious ramifications for investors globally. They are seeking to develop the right strategies and tools to help them succeed in this complex new environment.

This includes improving the way they measure and report on liquidity risk, and reassessing how they manage risk in their investment portfolios.

  • 42 per cent of all respondents say the changed market conditions are making it more challenging than before to report their liquidity position to their board or regulators
  • 44 per cent of respondents plan to invest to improve their risk –reporting capabilities.

Optimising the portfolio: Investors and managers are shifting their allocation strategies to take account of new liquidity conditions. While more liquid fund vehicles such as ETFs, UCITS funds and ‘40 Act’ funds have been gaining ground, a holistic strategy that balances risk with return across the whole portfolio is critical.

  • 53 per cent of asset managers and asset owners are planning to add more liquid investments to maintain exposures.
  • 44 per cent are increasing the size of their cash allocation against future liabilities or redemptions.

New rules, new tools: The new market liquidity conditions are inspiring many players in the investment industry to invest in new solutions and platforms such as peer-to-peer lending that provide alternative sources of liquidity.

  • 49 per cent say the role of non-bank institutions as liquidity providers will grow and 42 per cent say that this growth will come from hedge funds.
  • Nearly half (47 per cent) say hedge funds may play an important role in providing liquidity in more volatile markets.
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