The time of reckoning for those super and other funds offering ready access to investors while holding large exposures to illiquid assets was going to come one day. Most thought it would be when member bases had aged, and money being drawn down was significantly more than money being contributed. In which case, super funds felt they would have had plenty of time to prepare.

However, the COVID-19 crisis has bought this forward. The increasing ease with which investors can make switches between investment options in a nervous environment and the government’s recent announcement allowing many Australians to make $20,000 withdrawals from super has accentuated the looming storm. Good policy? Perhaps not, but you play what is in front of you.

Recent days have seen considerably more discussion on the dilemmas facing super and other funds with large exposure to illiquid assets. Perhaps the more important focus should be considering what will/needs to change as a result of these pressures and how to get to a more robust industry solution capable of handling extreme scenarios.

What could change

The possibility of the RBA helping to facilitate liquidity for super funds in the current environment has been raised, especially if the $20k withdrawals are greater than the $27 billion currently expected by the government. Perhaps such involvement could temporarily allay some of the concerns I have raised further on in this article, but I fail to see how this is a good long-term solution contributing to financial system stability in the future.

Among changes possible as a result of these pressures my speculations are as follows:

  • The trend to larger funds via mergers will accelerate with fewer small/mid-sized funds.
  • Potentially, only the largest of funds will be able to invest significantly in illiquid assets and most of this will be via direct holdings in assets rather than via institutional funds. (not good for the institutional illiquid asset management industry).
  • A possible cap on the amount of illiquid assets (direct and funds) that could be held by super funds (and even non-super retail managed funds) offering regular redemptions/switches.
  • Super funds may place greater constraints on switching,  at least for investment options that hold illiquid assets.
  • Some super funds, especially remaining smaller ones, will move over time to have significantly less exposure to unlisted assets, and especially if listed assets continue in a bear market and become cheaper.
  • Investors and the industry will become even more skeptical of volatility of return as a sensible measure of risk.
  • Overall, investors will become more risk averse as a result of their current investment experience  and the more uncertain economic situation over coming years. Much of the money leaving growth-oriented investment options won’t be coming back any time soon.

What happened

The pain of an investment crisis happens first in listed assets and only later in illiquid, unlisted assets, and sometimes the latter impact is small. Indeed, if the crisis is short and mild those unlisted assets can usually escape largely unscathed. But that’s not likely this time. Of course, the downside in listed assets may also have further to go but clearly significant pain has already occurred. With illiquid, unlisted assets that pain may be only just beginning.

The irony is the pace with which super funds adjust asset valuation of their unlisted assets will heavily dictate what the rational decisions of members/investors should be.

Super funds holding high weightings to illiquid, unlisted assets are in a hard place. On the one hand large, near term downward adjustments (including some sales at lower prices) will move valuations closer to the levels implied by the pain in listed assets and theoretically, should discourage some switching and withdrawals. It is also a more equitable situation for remaining investors.  However, this will see poorer-reported performance in the near term, that could encourage other disappointed investors to switch/withdraw.

On the other hand, being slow to make downward adjustments in valuations can make it quite rational for investors to withdraw what they can or switch to cash or a more conservative or liquid investment option.

But where’s the bottom?

The concern being expressed by some funds and politicians is that this means investors are getting out at the bottom.

Really? Who knows if we have seen the bottom, even in listed assets? Nevertheless, I can see how such an argument does have more validity for a portfolio of listed assets only, although doubt we have seen the ultimate bottom. However, I struggle with such a view when we are talking about funds which might have 20, 30 per cent, 40 per cent (or in case of some of the retail managed fund offerings), 50 per cent plus in illiquid, unlisted assets (property, infrastructure, private equity, private debt, some other alternatives) whose valuations are typically still far from reflecting anywhere near the movements and valuation levels in listed markets.  I am not suggesting that unlisted asset prices need to match those listed falls, but the current gap across some areas is stark.