How can funds mitigate the risk of illiquid assets?

A possible way to mitigate the risk of investing in illiquid markets could be by limiting the ability of members to switch between investment options, according to State Street.

Speaking to the Australian Institute of Superannuation Trustees (AIST), David Grose, head of alternatives-Australia at State Street, said there were benefits to investing in private markets, but they came with liquidity risks. 

Therefore, he said, it was important to consider structural and governance changes that might arise for a fund and how they would affect those assets. 

“Ultimately, as long as there’s a mismatch between the liquidity of the underlying investments and the liquidity offered to members, some of these risks will inevitably continue to exist,” Grose said.

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Two options suggested could be limiting members’ ability to switch between different investment options or implementing a delay, which would reduce problems with investors trading on outdated prices.

“Regulators could encourage super funds to limit the ability of members to freely transfer between different investment options. I’d question whether the majority of members have a real need to switch between investment options more than once or twice a year, which is permitted at the moment.

“If a limit was placed on this and on transferring between different funds, it would reduce the problems caused by investors trading on old prices for private market assets.”

The Australian Prudential Regulation Authority (APRA) introduced SPS 530 Investment Governance in Superannuation last year, and it was hoped this would resolve some challenges posed by illiquid assets and improve funds’ governance.

The paper covered issues such as stress testing, valuations and liquidity management.

Stress testing was likely to be more difficult, Grose said, if a fund held private market investments as they were less transparent than those in a public market. 

“SPS 530 really requires them to demonstrate that they’ve satisfied themselves in relation to appropriate valuations and considered any conflicts of interest that the manager may have faced,” he said.