The single biggest risk facing the superannuation industry is liquidity mismatch, according to Mercer business leader, investment consulting Australia and New Zealand, Simon Eagleton.
The risk arises from a mismatch between liquidity of fund assets and the 'at call' nature of super fund liabilities, Eagleton said.
“Liquidity mismatch has the potential to [cause] widespread industry damage”, Eagleton said.
Mercer has generally taken a conservative approach to liquidity mismatch risk within its defined contributions (DC) client base. Its average client illiquid asset exposure is 12 per cent. Eighty five per cent of Mercer DC clients have less than 20 per cent illiquid assets, and the maximum is 30 per cent, Eagleton said.
The top eight performers of the Chant West survey in 2008 had an average strategic weight to illiquid assets of 27 per cent, almost three times that of the broader industry average. Three of these top performers have more than 36 per cent in unlisted assets, with actual exposure today well in excess of this.
Eagleton said it was entirely plausible that a single fund finding itself in liquidity stress could lead to a contagion effect engulfing the industry.
“All it takes is for a single fund to get into trouble to push other funds into a position of stress,” Eagleton said.
A fund must understand its own liquidity risks, but also incorporate the expected behavioral response of its members and other funds’ members if another fund gets into trouble, Eagleton said.
“My worry is that were we to see some funds get into serious liquidity stress situations due to liquidity mismatches, and were this to become public, we could see a regulatory response that would go too far."
Eagleton said one possible response is for the regulator to enforce hard limits on asset allocation to illiquid assets, "which I think would be detrimental to diversification and returns".
"Wherever in the world we have seen regulatory constraints on asset allocation, invariably we also see sub-optimal performance outcomes.”
Eagleton said in his view the most sensible regulatory response is to enforce much better disclosure of liquidity than at present.
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