Liquidity buckets are shaping up to be a key investment management trend in 2010. But to fully appreciate them, a historical context may prove helpful.
The market meltdown of 2008 and early 2009 was a difficult period for all investors. No one was immune. Everyone suffered, even the Yale University endowment, whose strategic allocation had been highly praised before then. Pension funds, in particular, suffered large setbacks.
The Center for Retirement Research at Boston College estimates that a total return of around 52% cumulative over the next three years will be needed for the average pension fund to return to its pre-meltdown fund status. Even with a good return in the Standard & Poor's 500 in 2009 of 26.47%, including dividends reinvested, we still have a ways to go.
To bail ourselves out of this hole, it will take time. The key is to stay the course. We need to recognize that the meltdown was not a normal occurrence. It was a panic driven by a credit and liquidity crisis.
However, looking back at 2008-2009 and looking forward to 2010, pension funds and other institutional investors have begun to consider “macro buckets” of risk exposure that take into account liquidity. These buckets are defined broadly as:
• A liquidity bucket consisting of U.S. Treasury bonds, U.S. agency bonds (not mortgage-backed securities), short-duration funds based on the London interbank offered rate, and investment-grade corporate bonds.
• A market-risk bucket consisting of developed and emerging markets equities, high-yield and other credit-sensitive bonds, mortgage-backed securities and asset-backed securities.
• An inflation hedging/natural resources bucket consisting of Treasury inflation-protected securities, commodities, energy-related equities, real estate investment trusts and infrastructure investments.
• An illiquid bucket consisting of private equity, venture capital, mezzanine financing, collateralized debt obligations, direct real estate, timber and hedge funds.
The four macro buckets are really a consolidation of the major asset classes used in most strategic asset allocation models by institutional investors. The difference is the emphasis on a liquidity bucket. In prior years this was not a concern, but liquidity contingencies will likely be built into the asset allocation models for pension funds and other institutional investors.