Pension fund executives, like many investors, historically have been willing to pay a premium for liquidity. Lately, though, they've started to realize that, for many investments, liquidity can be an illusion. When the 2008 financial crisis hit, only the very highest-quality assets — such as U.S. Treasuries — proved as liquid as advertised.
Post-crisis, stricter regulations have forced banks to cut their inventories of assets, such as corporate bonds, and pare their traditional role as market makers — just as corporate bond issuance has increased dramatically. This imbalance has created illiquidity risk in the corporate bond market. And to add insult to injury, investors aren't getting much extra compensation for it: investment-grade and high-yield bond yields are near record lows.
The alternative might be increased allocations to the sort of private-credit investments that come with potentially higher returns — residential and commercial real estate, infrastructure, direct middle-market lending. This approach could be crucial if pension funds want to be able to meet benefit payments when the next generation of workers starts to retire.
The evolution of financial markets has made a growing array of less liquid but potentially higher-return investment opportunities available to institutions today. Banks, pressured by regulators to become smaller and safer, are lending less — leaving alternative credit providers such as asset managers, insurance companies and specialty-finance firms to fill the void.