Alternative assets are so hot right now. And the IMF is worried.
Whether it be venture capital, private equity, real estate, hedge funds, art, jewellery, infrastructure, classic cars or music royalties, pension funds have never been more exposed to this cohort of financial assets.
From the latest edition of its Global Financial Stability Report, published Wednesday:
And the commentary:
Very low rates have prompted institutional investors like insurance companies, pension funds, and asset managers to reach for yield and take on riskier and less liquid securities to generate targeted returns. For example, pension funds have increased their exposure to alternative asset classes like private equity and real estate.
What are the possible consequences? Similarities in portfolios of investment funds could amplify a market sell-off, and illiquid investments by pension funds could constrain their traditional stabilising role in markets. In addition, cross-border investments by life insurers could provoke spillovers across markets.
The remedies, the IMF humbly suggests, include the obvious like matching investments to a fund’s liquidity, to the banklike, in the form of stress-testing.
Yet the reasoning behind why institutional money has flowed into alternatives — namely low rates pushing yield hungry investors further up the risk curve — doesn’t sit quite right with Alphaville.
For one, because we’ve had market exuberance in eras of much higher interest rates. The Nasdaq, and Beanie Babies, bubble saw rates above 5 per cent for much of its crazed price action. The mortgage bubble, and the subsequent collapse in the valuation of mortgage back securities, followed a period when interest rates rose from 1 per cent in 2004, to 5.25 per cent in 2006. Go back forty years, and during the hay-day of the “Nifty Fifty” in 1972, rates were climbing above 6 per cent. (All data from FRED.)
Sure this era is one of alternative investments getting out line, rather than publicly traded ones (bar mortgage-backed securities), but historically it seems rates are not that important when it comes to money flowing forcefully into financial assets.
Looking at the chart, it’s not as if pension funds are also drawing on cash reserves which could exasperate liquidity either. Rather they’re rotating from other assets — fixed income, equities — which, from time to time, also suffer from serious liquidity problems.
That’s not to say that this current bout of exuberance will end well for all involved. But for it to be a major concern for the IMF in a world where, as Matt Klein pointed out last week, aggregate demand is still fundamentally weak, feels a little like retrospective.
As if identifying the next 2008 is more important than now.
Calpers goes all in on private equity — FT Alphaville