Preqin tracks listed private equity prices and discounts/premiums to NAV which can be used as a proxy for secondary market prices and discounts. According to its data, the discount observed for secondary market interests increased steeply in Q1 2009 with the median funds of funds reaching a discount in excess of 70%. Those discounts have closed in recent years, Preqin says, which has coincided with increased levels of secondary market activity and investor interest.
As the secondaries markets in private equity and infrastructure emerge and gain acceptance among investors, the scope for greater efficiency of liquidity and cost through liquid alternative vehicles in previously illiquid areas grows.
“Private equity and infrastructure secondary markets are emerging,” Sungard’s Wormald says. “That’s the genius of financial markets – their ability to create new markets all the time. As these asset classes become more cost effective, we see liquid alternatives emerging as investors become less willing to pay over the odds. Those willing to use their illiquidity capability will increasingly seek out the less liquid end of the spectrum.”
STILL UNTESTED
While the future looks bright for liquid alternatives, they remain untested. This raises concerns for investors in terms of the liquidity they will actually be able to realise should another significant crisis period strike.
Many of the liquid alternative products on offer have been developed since the financial crisis so investors do not have the benefit of seeing how they would behave in liquidity terms during a stress period. Although UCITS has stringent liquidity requirements, there is a danger some funds might not maintain the proper level of portfolio liquidity to meet investors’ needs in times of market stress.
Olivier Lebleu, head of international business, Old Mutual Asset Management says: “Expectations of permanent liquidity are not always going to be met. UCITS rules allow for gates, and some strategies will not be as liquid as they seem in times of stress.”
One adviser described this potential liquidity mis-match is an “accident waiting to happen.” As investors become increasingly savvy and continue to push for the greater cost efficiency of risk, liquid alternatives will play an evermore important role in portfolios. In some cases investors will have to accept more liquidity comes with the inherent downside of lower returns, but in others, these products will allow investors to access alternative strategies with less risk and at lower cost, potentially increasing the rewards they achieve.
That said, the product area has yet to prove itself through a crisis period, which could prove critical.
As the Church Commissioners’ Joy says: “The big problem with liquid alternatives is that during a crisis, the liquidity available to investors can be markedly different to the liquidity of the underlying assets. So often marketing teams package assets into liquid forms, but that proves disastrous in a crisis.”
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