Illiquid assets: Selection and strategies

Looking at the various sub-sectors of illiquids, Ryan Synnot, CFA, — Associate Director, Investment Research and Solutions at Arrow Private Wealth — finds the private debt market particularly attractive.

“The yields on private debt are getting towards the high single/low double digit return, which we view as being attractive, particularly relative to where some of the risks are within equities.

In terms of which parts of private debt we like, we prefer investments that are really safe, but we’ll also look at distressed opportunities,” says Ryan.

“We also believe venture capital is becoming quite interesting. We’ve seen a big power shift from founders to investors.

A couple of years ago, founders were able to demand their price, which meant people were investing in these companies at incredibly high multiples.

But that situation has since swung back to favour investors, where they can now access start-up businesses on quite favourable terms.”

With private market assets forming the foundation of many of Findex’s model portfolios, the business has elected not to follow the investment allocations of the likes of the Future Fund or the Yale Endowment Fund, which also allocate to private markets. Matthew says it all comes down to the business’s investment framework.

“We have a strategic allocation of 15 per cent to alternatives, and another 5 per cent to unlisted property. So, about 20 per cent of our overall exposure are in illiquid assets. However, not all of our alternatives exposure is fully illiquid. Some of it will range from monthly liquidity through to 1-2 years. For example, within some of our alternative structures, we have 23 underlying strategies. So, we ensure we have sufficient liquidity to cater for situations where liquidity is needed for clients,” says Matthew.

When it comes to accessing illiquid assets, Findex uses a methodical approach for assessing assets as part of its strategic allocation to sectors like property and alternatives. This process includes interviewing various managers — both retail and institutional.

“Once we determine which asset classes we want to invest into, we’ll meet with managers and provide them with a framework in terms of what we’re seeking. For example, we may ask them to construct a portfolio at a certain risk level in terms of standard deviation and drawdown, but also with minimum fees when minimum returns are delivered,” he says. “We don’t actually make the selection of the underlying strategies of the assets. We’ll leave that to the managers.”

By providing a framework to managers, Findex is able to find the right blend of strategies that fit the framework. This means it’s the manager who is ultimately making the determination on the underlying strategies — like long/short equities, credit, or global macro. Similarly, for unlisted property, Findex will invest with managers that make the call on the underlying properties or on the external property managers they use.

It’s a similar story at Arrow Private Wealth, where the underlying strategies of illiquid assets are also allocated to managers. However, Ryan believes it’s important for advice businesses to be adaptable in order to cater for clients who want to access illiquid assets.

“You need to assess your client base and determine which products are the best fit for your clients and their liquidity needs,” he says. “It’s also an education journey. You also need to educate your clients about why you’re looking to put illiquid investments in their portfolio, which also means talking about the liquidity premium for locking up their capital for a period of time.”

With the ever-present possibility of many developed economies falling into recession, Ryan believes the current environment does make it challenging for illiquid assets, but he also acknowledges that it also presents opportunities for investors. 

“There is always the risk of lock-up when you take an asset class that is usually illiquid and try and introduce liquidity to it. So, when you get ‘black swan’ events and downturns in particular asset classes, it’s going to present a risk,” he says. “However, because we make allocations to illiquid assets with a very long-term view, when investors do look to exit these assets, that does provide buying opportunities.”

A definite trend Ryan is seeing in this sector is the growth of illiquid asset products coming to market.

“About six years ago, when we were running strategic allocations to private equity, there were only two products that retail investors could access. But over the last couple of years, we’ve seen more illiquid products come to market that retail investors can access and advisers can use in their portfolios,” says Ryan.

According to Daniel, a recent survey of 100 private market fund managers by Russell Investments confirms the increase in the number of illiquid asset products coming to market.

However, whilst acknowledging this growth in products, Daniel also concedes that the majority of platforms in the market still can’t accommodate illiquid assets, although there are a couple of platforms currently working on their technology to enable this to occur.

Matthew agrees: “From a practitioner’s perspective, we’re being inundated with interest by managers in the illiquids space, both locally and offshore. In the last month alone, we’ve met with about six managers. This space is certainly going to increase in size.

“As we move forward, products will evolve and platforms will increasingly be able to cater for illiquid assets. That’s because there is an increasing appetite from advisers and investors to take up this investment opportunity.”