Institutionals will reduce illiquid assets
Posted January 10, 2023, 6:53 am
Welcome to the world of high returns! This paradigm shift fundamentally redistributes the parameters of investment choices. The big institutional players understood this well. According to the latest Institutional Barometer 2023 published by the consulting firm Indefi for management companies, French institutional investors are preparing to reduce their wing, especially in alternative assets (real estate, private debt, private equity, etc.).
In recent years, an environment of zero or even negative interest rates has driven investors to these asset classes, which offer performance growth. Like stocks, they benefited from the TINA (“No Alternative”, “No Alternative”) phenomenon due to the almost non-existent yields of bonds. Increasingly, it’s time to step back.
Real estate, which accounts for half of institutional illiquid investments, is particularly affected by this turnaround. According to the major players surveyed, about 60% now want to reduce their investments in this asset class. As a result of rising interest rates and inflation reducing household purchasing power, major players such as Fnaim or Century expect property prices in France to fall by an average of 5% to 10% over the year.
Falling real estate
Outside of France, the adjustment is often even more pronounced. “Rising interest rates automatically lower property prices in Sweden, the US and the UK, which have suffered serious setbacks; investors are looking for better opportunities,” notes Kevin Thozet, member of Carmignac’s investment committee.
Many institutional investors are also looking to reduce their investments in private equity and private debt. This caution can be explained above all by the deterioration of the economic environment with the approaching recession in Europe as a result of the European Central Bank raising key interest rates. “SMEs and ETIs will be mainly affected by the economic downturn, it makes sense to reconsider the exposure to these companies,” explains Agnès Lossi, Deputy Director of Indefi.
The only exception to this picture is that infrastructure continues to rise. The share of illiquid assets of institutional investors has already increased from 8% to 12%. Two-thirds of the latter intend to further increase this pocket in their allocations in the coming months. Of course, the energy transition is a strong driving force of this development.
Rising interest rates, falling asset prices and a worsening economy are not the only reasons institutional investors are emptying their illiquid pockets: they also want to rebalance their portfolios towards more liquid and less risky assets in an uncertain economic environment.
Alternative investments actually became more important last year, from 12% to 16% of their allocation. A change explained half by net placements (investment flows occur on average 2-5 years after committed liabilities) and half by the denominator effect: falling equity and bond markets mechanically increased the ratio of other assets.
Thus, institutions will shift to liquid assets (stocks, bonds, and cash investments) and reduce their future liabilities for illiquid investments. Agnès Lossi emphasizes: “This will be especially the case for large institutions that invest too early in the alternative and reach the limit of illiquidity in the portfolio”. Small institutional investors still have room to build their portfolios in such investments, and some are subject to accounting rules that are less tied to the market value of assets in their allocations.
Regulators such as the Financial Stability Board have repeatedly warned non-bank financial players about liquidity risks in recent months. The mini-earthquake in the UK government bond market in September proves them right: the rise of “golden” has been supported by British pension funds, players synonymous with stability and resilience.
Management companies were forced to freeze withdrawal requests from real estate funds
These are only epiphenomena at the moment, but they are indicative of the movement of discontent at work in real estate assets. In the UK, BlackRock, M&G, CBRE, Schroders and Columbia Threadneedle have restricted withdrawals from their property funds for several months. They were unable to meet the strong demands of pension funds, were eager to exit real estate assets due to falling prices and rebalanced their portfolios towards more liquid assets. Across the Atlantic, Blackstone was also forced to place limits in early September as its clients worried about the future of commercial real estate in Las Vegas and sought to restore liquidity in a tougher economic environment.