The liquid crunch

— 1 minute read
Member education is critical if funds are to address the growing liquidity crisis, CIE's Frank Gullone says.
The effects of the global financial crisis will be felt long after investment markets have returned to positive growth.

Certainly that was the opinion of people from across the financial sector who attended and spoke at the recent Centre for Investment Education (CIE) International Investing Conference in the United States. Regulation of the industry, for example, will increasingly come under the eye of legislators, and much tougher regulatory regimes are likely to be the result.

But my focus in this column is liquidity, or perhaps more to the point, the lack of liquidity that trustees of superannuation funds have had to grapple with since returns have gone into negative territory.


Across the superannuation industry, trustees have reported that cash assets are increasing and on average stand around 10 per cent. In a few funds this is significantly higher as the funds' members move towards the cash investment option. Before the crisis, funds felt comfortable with a cash position of about 3 per cent.

There is no one single reason for this. What has happened is that several factors have coalesced to cause liquidity issues in the aftermath of the global financial crisis.

Some funds have hedged their Australian dollar exposures and, as a consequence of the dollar's sharp fall, they have been forced to find cash to cover these positions. Funding commitments to meet calls on assets that have fallen in value are also part of the equation.

But perhaps the most important factor has been the investment behaviour of fund members as the enormity of this crisis has unfolded.

There is no doubt fund members have been spooked by recent events; their primary goal now is not getting a positive investment return but securing their capital. This perfectly understandable phenomenon is most evident among those nearing retirement.

For these members, cash is king. So they are switching to investment options they believe best preserve their capital, and in the process they are forcing trustees to respond.

The consequences of this liquidity crisis are twofold. Right now trustees, investment committees and chief investment officers can see myriad investment opportunities in the offing. Many assets across the investment classes are undervalued. History tells us it's at this stage of the investment cycle that the strong returns are locked in.

But funds lack the liquidity to act on their investment instincts. Making them doubly cautious have been explicit utterances from the Australian Prudential Regulation Authority (APRA) that it is stepping up its focus on the liquidity risk facing superannuation funds.

APRA's response is understandable; as the industry's regulatory body, its primary function is to ensure the solvency of funds, not their investment returns. If that means lower returns in the longer term, then so be it.

The other consequence is the long-term returns for members' retirement incomes. Understandably, members nearing retirement are seeking to secure their capital. Even in the good times, that should be an investment priority.

But there is mounting evidence, as CIE chairman Melda Donnelly discussed in her last column, that fund members with many more years in the workplace are switching to more conservative investment options. Although this now seems a logical option, the reality is they will pay the price in terms of diminished income when they eventually retire.

The effects of them having less income in retirement won't stop at their individual lifestyles. It will require future governments to step into the breach via increased pension payments, placing a greater burden on the taxpayers of tomorrow.

In this environment it is absolutely critical that funds - and the federal government - begin a far more focused education program with members to explain the importance of understanding how markets work and that despite the recent implosion, long-term investment strategies across all asset classes are the best way to guarantee financial security in retirement.

Those lessons were given lip service during the good times; today member education has to be a priority for all funds.

Frank Gullone is Centre for Investment Education managing director.


The liquid crunch
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