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After the economic fallout and reputational crises resulting from Autumn 2022’s failed mini-budget, led by then-Chancellor Kwasi Kwarteng and former Prime Minister Liz Truss, institutional investors are looking toward illiquid assets with renewed interest.
The growing appetite for illiquids is said to be due to good pricing and steady cashflows – as well as strong supply and demand in the market.
Another major contributing factor is pension funds vacating the illiquid market.
As a result, there is new room for insurers – especially those on the life side. With options available to these investment teams, those with the ability to deploy capital to a now more open illiquid market will likely benefit.
In the wake of gilt selloffs, a T. Rowe Price analysis advocated for an actively managed, high quality fixed income strategy, which it said could help pension funds manage their liquidity waterfall. The report added that savvier investors would draw a wide, strategic lesson from last Autumn’s situation. “An active asset manager [that is] skilled in navigating changing market conditions can help meet the two-fold objective of generating return and managing liquidity risk,” it said.
Because a large proportion of illiquid assets can limit a pension scheme’s room to manoeuvre if such assets are not acceptable to an insurer, these investments are less appealing to pension funds in search of options to better manage liquidity needs. Illiquid assets also cannot be easily disposed via secondary markets, which means that pension funds are, at the moment, exhibiting less interest in buying into these vehicles.
Historically, some pension funds were overallocated to alternatives, which may have left a distaste in their mouths, especially after the fallout from the mini-budget and the resulting loss of debt and equity risk assets.
As a result, the space is looking particularly appealing for insurers, as the only natural buyers, with notable opportunities in natural energy and renewables. Pricing considerations also factor into the equation.
“Most [investment] teams are looking to move to buy out, and therefore need to get good pricing to take those liabilities on board,” said James Lindsay, Director, Head of UK Corporate DB and Insurance at Natixis Investment Managers. He specifically referenced life insurers, adding that because they were focused on sourcing private assets with steady, long-term fixed income cashflows, illiquids were a good fit.
“I predict more in-house activity; it’s a good indication of which
way things are probably heading.”
Lindsay also noted that many life insurers were shifting to doing direct origination in-house themselves – which ultimately meant hiring changes and overall expansion in the area. “[This] will probably be one of the themes or trends in the next few years,” he said. “I predict more in-house activity, which means expanding and hiring more people. It’s a good indication of which way things are probably heading.”
Whilst a lot of the current focus is on life insurers, the shift to riskier assets is widespread. In the past few years, non-life insurers – which have significantly shorter investment cycles – are also starting to look at private assets to generate return. There is essentially nowhere to hide in public markets, which are at the moment struggling, but private evaluations did not significantly shift during the hubbub of the Autumn 2022.
This means there are opportunities for better return available to those able to take on the risk.
“You will see fewer opportunities in the corporate space as they
go to buy up all those assets.”
In turn, this could indicate there will be elevated competition amongst insurers looking to capitalise on these openings. “You will see fewer opportunities in the corporate space as they go to buy up all those assets,” Lindsay said. He predicted that in coming years the illiquid space would consolidate around the biggest insurers.
“It’s similar to what we’re seeing with local authority space for the pools with the DC and master trusts. Consolidation will be a theme, and there will be more competition,” he continued.
Within private assets, renewables and natural capital could emerge as particularly hot areas for insurance investment teams. This is because the majority of infrastructure opportunities are solid, investment-grade, long-term options – all desirable facets for life insurers.
Due to the energy transition, there is need for renewable energy as well as nature investments, which could provide other possibilities for growth going forward and are generally more innovative vehicles. A 2019 AllianceBernstein report, “Illiquid investments: Getting the formula right”, noted that attributes unique to alternatives don’t have relevant public market equivalents.
“[The opportunity] will exist until the end of the year. [There is] time to think about new assets, align internal approvals, and the perform necessary analyses.”
But the opportunity to invest in this area won’t disappear immediately, said Russell Lee, Head of Insurance Solutions at M&G. “[The opportunity] will exist until the end of the year at least. So [insurers] have time to think about new assets, align internal approvals, and perform the necessary analyses for these asset classes.”
He was quick to note that investors shouldn’t enter new markets without the research to back their decisions and that insurance investment teams should thoroughly understand their risk profiles, liquidity needs, and investment timelines – and that there was no one-size-fits-all solution. “Some investors might want to let go of infrastructure debt if it’s too long duration for their liabilities,” he said. “But the other side is that these assets are mature, and pension funds have sold off for a while.”
Lee added that illiquids and alternative assets could be secondary pieces for investment teams, but shouldn’t be the main fixture.
This sentiment was backed up by a recent Barclays analysis, aptly titled “Illiquid alternatives: A song of fire and ice”, which noted that, in the absence of cash reserves, a portfolio's overall exposure to illiquid assets should not exceed 15%. The report said that given the high changes of stagflation going forward, the “expected risk-adjusted returns of a traditional balanced portfolio can be substantially improved by incorporating illiquid assets.”
With turbulence from the LDI crisis still present in the market, H2 2023 could see the illiquids trend gaining steam for insurers who are enticed by new opportunities for growth. Still, a measured approach is always necessary – and there likely won’t be any drastic shifts in strategies from non-life investment teams in the near future.
