The importance of transparency in private markets
As illiquid assets become increasingly central to insurers' asset strategies, Mikael Huldt, Head of Alternative Investments, AFA Insurance looks at why transparency is critical
Insurance Investorposted on Thursday, January 23, 2020
Insurance Investor: How important is transparency when investing in private assets?
Mikael Huldt: It is very important; you need to have transparency when investing in private assets in order to determine where your overlapping risks are and if you are truly getting the exposure you thought you would get.
This is important to bear in mind otherwise you don’t know where your risks are and therefore, you can’t take any action.
You need transparency in order to know exactly what kinds of investments you own, how your managers are behaving, the fees you are paying, ESG-considerations etc.
"You need to have transparency when investing in private assets in order to determine where your overlapping risks are"
You need to be able to go into quite a bit of detail in the underlying exposures in order to get the full picture.
This is something that is particularly important if you are in private assets and use an indirect approach working with third-party managers.
They typically need broad investment guidelines, and this sometimes means that your exposures are not always what you thought you were getting in terms of risk, returns, liquidity and so forth.
Insurance Investor: What do you do in these situations where you have this discrepancy between what you think you are allocating to and what is really going on?
Mikael: First, you want to have a good grasp of what you have.
Although you might have something different than what you initially thought, it does not necessarily mean that it’s all bad.
It might be equally suitable from a portfolio perspective, which means you may simply need to modify your other investments activities accordingly to avoid doubling up and creating over-exposures.
It is key from a diversification point of view to know what it is that you are getting, and the label or asset class classification does not tell you everything you need to know.
"One of the advantages of today’s markets is that you can reshuffle your portfolio for portfolio management reasons even though you are holding illiquid investment positions."
If it is something completely different and not beneficial from a portfolio perspective, then you will need to consider how to address this based on your negotiating leverage, room to manoeuvre, structure, etc.
One of the advantages of today’s markets, especially the private markets, is that you can reshuffle your portfolio for portfolio management reasons even though you are holding illiquid investment positions.
Insurance Investor: Do superior returns make potential exposure to hidden risks more tolerable and are there any other benefits associated with diversification?
Mikael: It does depend on what you mean by superior returns, if you look at it from a slightly different vantage point, you could find superior returns that are very short term but I don’t feel that these are necessarily sufficiently attractive to compensate for a lot of the hidden risks.
If it is truly longer-term superior returns, then it depends on whether you see this on an absolute relative basis, but I do feel that in many cases you are better off thinking in relative terms.
"It all depends whether you can quantify and identify what type of risk you are seeing"
It is worth taking some hidden risks and you need to weigh them on a risk/return basis versus other types of investment strategies that you believe have less hidden risks and you are more comfortable with.
It all depends whether you can quantify and identify what type of risk that you are seeing i.e. is it returns, liquidity, under or over exposure, correlations with other asset classes etc.
Even if you don’t have a strong sense of the specific risks, categorising them broadly will help. In terms diversification, obviously spreading the risks is very important.
The other factor is that if you can get a sense of a variety of investments and asset classes then you can see trends picking up in one asset class that is likely to continue into another.
Whether it is through various structures, how management fees are charged or if you see leverage creeping up.
"In terms diversification, obviously spreading the risks is very important."
Similarly, by observing broad trends across various strategies and asset classes, you can make a reasonable assumptions that some of these developments will spill over and go from one strategy to the other, which means you may be in a position to take proactive measures both defensively and offensively.
With diversification, you have the added benefit of foresightedness and the ability to look at a wide variety of asset classes to see potential trends and their trajectories.