When to stay liquid - how insurers are choosing the right investment strategy

Nick Dixon, investment director at AEGON UK examines the case for listed versus private market assets and explores how insurers can strike the right balance

Insurance Investor editorposted on Tuesday, November 05, 2019

Nick Dixon, Investment Director, AEGON UK

Insurance Investor: What are the pros and cons of investing in listed assets and how do these compare with the pros and cons of investing in private markets?

Nick Dixon: When I reference private assets, I mean illiquid, unlisted securities not traded on the stock exchange, and for listed I assume you mean those that are traded on the stock exchange.

Daily trading, pricing and having the option to sell and exit investments quickly are important foundations of investor confidence.

It is similar to us leaving our money in a bank rather than under the mattress because we know that it will be safe and if you need it at any time you can get it. This is the same for investments, as if you know you can get it if you need it, this gives you the confidence to put it there in the first place.

"Being able to trade something daily is a simple concept that people can understand."

Being able to trade something daily is a simple concept that people can understand which makes it a confidence builder.

Whilst it is tempting to believe that a wall of money going into certain funds such as workplace default funds will continue, it can quickly turn into a wall of money coming out if confidence changes.

You don’t want to not be able to get your money out at a particular time when you may need it or when markets are becoming  stressed. If it closes at a particular point because the illiquid assets can’t be sold, this is highly problematic.

"There are good reasons for listed, liquid assets being the right vehicles for investment funds"

There are also expenses to consider, typically highly liquid stocks and bonds are low cost whereas the cost of trading and owning private assets is much higher, which can really eat away at your net returns.

Linked to this, because liquid assets are priced by the market’s collective wisdom from many different people with many different perspectives, if I randomly buy BP or Vodafone, I will randomly buy it at the correct market price. Whereas if I buy half of a private company, it may or may not be the right price.

There are good reasons for listed, liquid assets being the right vehicles for investment funds.

II: For long-term investors like insurers, should they accept the illiquidity of private markets in exchange for the promise of higher returns?

Nick: There are circumstances when they are appropriate. One instance where unlisted assets can work is in investment trusts.

Property investment trusts are a better vehicle for property than standard investment funds because if I sell the investment trust, I am selling it to another investor in the market but the trust doesn’t have to sell any property.

The trust invests in the illiquid asset rather than me having a direct holding. The investment trust model also works well for other illiquid assets.

Another example of where unlisted can work well is if an insurer has got a well understood set of long term liabilities, such as a set of future annuity payments, which stretch out over the next 30-50 years, where the liability is monthly income payments and people can’t suddenly demand money back. You can model this to reasonable confidence.

"Property investment trusts are a better vehicle for property than standard investment funds"

Long-term illiquid assets that closely match annuities or other liabilities can be appropriate.

For instance, an equity release mortgage is a good illiquid asset to stick into an annuity set of assets because it contains characteristics that can closely match the annuity liabilities on the other side.

Likewise, investing in a motorway or other infrastructure with fairly high certainty of income streams that can meet your income liabilities.

There are certainly areas where these can be appropriate but not in bog-standard retail investment funds.

II: What trends do you see developing in the next 12-18 months around listed or private assets?

Nick: Listed assets will continue to play a key role in the mainstream investment funds especially workplace investing, where they will remain the core asset category across bonds and equity.

Trading costs will continue to decline almost to a marginal cost of practically zero and therefore the costs of buying, selling and holding these assets will decline. This will raise net returns for end investors which will be a good thing.

With unlisted securities there is definitely scope for growth in circumstances where they are appropriate. Clearly, to generate retirement income and as more and more people reach retirement and require income, there is a role for unlisted securities in helping to guarantee income which would be a big opportunity.

"Listed assets will continue to play a key role in the mainstream investment funds especially workplace investing"

I also feel that property rather than being held in traditional funds will be increasingly held in investment trust vehicles so that you don’t suffer the same liquidity mismatch as one does in a standard fund. This trend will accelerate in the next couple of years.

There is a lot of loose talk about unlisted and illiquid assets and for mainstream investment funds, the absolute core foundation of these will be liquid trade-able, publicly listed securities which are keenly priced by the markets, can be sold and bought at any point in time and give people confidence that if they invest their money they will be able to get it out without time delay.

This will be a huge builder of investor confidence when it is very difficult for people to understand these things so that someone simply saying they closed a fund to protect the client, which at a technical level may be correct, but my mother simply wouldn’t understand that.

II: Is there still a lot of stigma around the liquidity of private assets?

Nick: I wouldn’t say there is a stigma but there is certainly worry around it.

If I, along with some partners, invest in a hotel and the deal amongst all of us is that our money will be locked up for five years that would be fine because we are well informed, it is clear what we are signing up to and we understand that you can’t invest in an asset and be demanding your money back after two months.

This, however, is mainly for the specialist investor or the fund that is trying to match some income liabilities and not for the man in the street.

"The trading costs of dealing in private assets are going to be materially higher than in publicly listed ones"

II: I suppose the alternative would be to seek investment advice?

Nick: Yes, indeed, and this is well possible but of course if you get advice then you are having to pay for the advice and many people can’t afford it and also the trading costs of dealing in private assets are going to be materially higher than in publicly listed ones.


Nick Dixon, investment director at AEGON UK, will be speaking at the Insurance Asset Management Summit in November. You can find out more about the event and book your place to attend here.

 

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