Illiquidity within Industry Funds may prove problematic

Industry funds over the years have crept up their holdings in growth assets in their balanced funds in order to have increase performance during good times, that in itself is not necessarily a bad idea. Then, they also hold an increasing portion in unlisted assets, maybe infrastructure, direct property holdings or private equity and other 'alternatives', which don't get repriced daily on stock or bond markets.  This then lessens the volatility which has helped these fund experience seemly good returns, with less volatility. But, as I say, there is never a free lunch when it comes to investing and I think I can see the waiter coming with the bill.

As an example of the differences of unlisted assets not being subjected to the same volatility, as of March 30, Blackrock’s iShares Global Infrastructure ETF (Exchange Traded Fund so it is priced daily by the market) was down 28% this year. In comparison, over at super fund Hostplus, their infrastructure option was down a mere 2.8% this year, as per their valuation on March 27. That type of small write down doesn’t pass the sniff test.

These unlisted assets are now causing some panic within the superfunds themselves. The government, making another sweeping change with the stroke of a pen, saw fit to open up superannuation to unexpected withdrawals. Self-assessed, non-taxed withdrawals from members who’d lost their job or suffered a 20% income decline. The superfunds are demanding the government help to facilitate withdrawals, so they don’t need to liquidate assets in a crunch.

Some funds, led by the union-and-employer-controlled industry sector, want the government to underwrite a “liquidity backstop facility” that would provide immediate cash to pay withdrawals. For-profit funds oppose the idea. There is no suggestion any super fund is at risk of collapse. Rather, industry sources fear that the forced sale of assets would crush their value, crimping returns for people who remain in the fund.

Again, legislative risk and liquidity risk. If anyone should expect legislative risk, it’s the superannuation industry. The decision is a poor one, but we’ve warned about superfunds and their illiquid assets in the event of the worst. The worst happened. There is regular sabre rattling from one side of politics about superannuation funds. The LNP hold a decidedly dim view of superannuation. A cynic might suspect because it was a Labor creation and now the largest superannuation funds in the country have links to their mortal enemies, the unions. Liberal Senator, Andrew Bragg making an opportunistic, but relevant point.

Superannuation funds which may have overextended into illiquid assets, such as infrastructure and property and who did not retain adequate cash and other liquid holdings, did so knowing the risks they were adopting… To tout strong investment returns off the back of illiquid assets in the good years, only to come to the government cap in hand when markets inevitably turn, is simply a sign of bad management and poor investment governance.

To name super funds, it is reported that HostPlus and Rest super are potentially in the worst liquidity position because their members (hospitality and retail) are going to be the biggest proportion of people who take up the $10,000 superannuation withdrawal. Further to this, HostPlus started to liquidate some of their holdings in ISPT which is an unlisted property fund. ISPT, may now have to liquidate some of the assets within that fund, which gets back to actually testing if those valuations are correct by actually selling the asset at the moment. If the price is lower, this will have an impact on all the superannuation funds that hold these unlisted assets as the valuations across the board will have to come down.

I remain extremely satisfied with our investment philosophy and at the moment, the complete liquidity and with all assets traded and repriced daily on markets, means that whilst we feel every bump in the road with volatile markets, it also means we aren't left holding an asset that not priced correctly and potentially weighing down future returns as those mispricing's come to fruition. 

This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.

COVID19, World War 2 and a look at markets

Firstly, it's been great to see the huge reductions in new daily cases across Australia and possibly some light at the end of the tunnel.

You can see in the graph below just how quickly our curve of total infections has flattened, I don't think a result better than this could have been expected just a few weeks ago.

Graph via The Guardian

This is another positive. We might be able to enjoy some freedoms again, however, will need to remain cautious coming into winter. A second wave, as seen recently in Singapore, will do us no favours.

Markets, as always, remain unpredictable. Who knew a contract on oil might go into negative territory? Without anywhere to store oil it becomes more about the price to hold it than the actual price of the commodity.

Back to shares, and for almost the last month there has been a substantial rally. Up 20% plus on the Australian market and up 30% plus in the US. Even with these upward movements there have been some large falls, especially on the ASX. Falls of 5%, 3.5% 1.6% 1.3% and 1.2%, all within a confine of a 20% rally that occurred in less than a month. That is volatility.

Markets will be more sensitive to various pieces of economic and financial data. We should expect them to swing wildly for the foreseeable future. We’d like to hope they would at least hold their ground, but they could as equally revisit previous lows. Nothing should be discounted as a possibility. Even going upwards again.

Possibly the best way to consider the impact of COVID-19, in respect to the various curtailments and their impacts, would be akin to countries when at war. Travel is effectively off limits; various parts of the economy are shuttered, and freedoms are curtailed. In respect to a war they are generally multi-year events. Gauging the prospect of a war’s end? Hard to do. We would hope COVID-19 won’t be a multi-year affair.

In considering market movements One particularly interesting chart is the behaviour of various market factors around WW2. Across the six-year period of WW2, the S&P 500 doubled in the US, but at one point it fell 38%. What’s interesting is the behaviour of small and value stock indexes during that period. Small stocks were up over 500% during WW2 and value stocks were up nearly 300%. At one-point small stocks fell 52% and value stocks fell 48%.

The idea is being around to capture the gains when they appear. If an investor has stuck around for the risk, they may as well enjoy the reward. It is also important to keep in mind there will be various factors in the market that may outperform when a recovery eventuates.

Finally, we’re pleased to note, we have had no reports of any COVID19 cases from us, our friends or family or businesses in our little area. Also, across our clients, we’re happy we haven’t had any reports of COVID-19 exposure. We hope this continues and you all remain in good health.

Until next time.

Reproduced with permission from Mancel Finanical Group. This represents general information only. Before making any financial or investment decisions, we recommend you consult a financial planner to take into account your personal investment objectives, financial situation and individual needs.