Do rising rates mean CIOs must think differently about illiquid investing

Three chief investment officers examine how rising rates might impact liquidity constraints and whether asset owners might shy away from illiquid assets

Insurance Investor Editorposted on Wednesday, August 28, 2019

As rates start to rise, investors may need to rethink illiquid investments

Thiss excerpt is taken from the roundtable: The dichotomy of liquid versus illiquid assets: How a return to volatility, the threat of rising rates, a declining IPO market, and overvaluation are impacting investment decisions.

You can read the full roundtable in the research report Insurance Asset Management, North America 2018, which can be downloaded here.

Panellists:

  • Rip Reeves, Chief Investment Officer, AEGIS Insurance
  • Aaron Diefenthaler, Chief Investment Officer, RLI Corp.
  • Jack Nelson, Chief Investment Officer, Everest Reinsurance

Insurance Investor: Do you believe that the possibility of rising rates will cause a sense of pause in further investments in illiquid assets?

Rip Reeves: Not from our standpoint, primarily because we made the decision five years ago to allocate to a handful of the private/direct markets.

One element quite different in the private sector, relative to the public market, is the funding queue. Direct lending, real estate equity, private equity, and hedge funds typically have a lead time of 1-3 years before you may reach your targeted allocation – obviously there are exceptions.

"Direct lending, real estate equity, private equity, and hedge funds typically have a lead time of 1-3 years before you reach your targeted allocation"

In a handful of these allocations, we are still in the queue towards our target allocation. Therefore, it is a long-term investment plan not likely to be influenced by a midstream event – such as rising rates.

Aaron Diefenthaler: Although illiquid assets have to compete with more traditional capital markets instruments no matter the level of risk free rates, the relative value choice in my mind comes down to liquidity premium not absolute value.

For us, there hasn’t been any change; we are a living, breathing organization with consistent cashflow to put to work in all interest rate environments across all sectors.

Certainly, during times of rising rates, you want to understand the risks associated with the market-to-market impact on your bond portfolio and on capital. However, for a P&C entity, when you consider the dollar impact of realistic rate scenarios against an ability to reinvest, I think most can overcome any concern.

"We are a living, breathing organization with consistent cashflow to put to work in all interest rate environments across all sectors"

Jack Nelson: I agree with my colleagues. As investors interested oriented toward income production, we need to hunt for yield wherever we can find it. However, given the outlook for interest rates, we are avoiding taking duration risk to get additional yield, so taking some liquidity risk is something we actively consider.

Rip: As the high grade, fixed income sectors have become more efficient and forecasted returns continue to be low, given low/rising interest rates – the private markets are a reasonable attraction.

And rising rates – and low/negative returns on high grade fixed income investments – isn’t likely going away next year.

This low/negative investment environment may be a tailwind for CIOs to examine the suitability of private investment allocations in their overall strategy -- but it is likely to be a smaller allocation relative to unrestricted investment pools (non-insurance).

"This low/negative investment environment may be a tailwind for CIOs to examine the suitability of private investment allocations in their overall strategy"

The other thing to remember when analyzing private markets is the strategic nature of the sector, given the liquidity lock-up.

Liquidity monitoring becomes a more rigorous process, as you increase illiquid allocations. Therefore, a short-term change in the interest rates or volatility levels won’t necessarily alter your course -- because your investment is likely tied up for 5-10 years.

This excerpt is taken from the roundtable: The dichotomy of liquid versus illiquid assets: How a return to volatility, the threat of rising rates, a declining IPO market, and overvaluation are impacting investment decisions.

You can read the full roundtable in the research report Insurance Asset Management, North America 2018, which can be downloaded here.

 

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