Asset Allocation and TAA

Allocating capital to illiquid assets - the best papers

Allocating capital to illiquid assets is the preserve of investors who are able to take a long-term view. In theory, the payback for being unable to access capital is a higher expected return. In a low-return world every such opportunity is worthy of consideration, and the papers below have been selected to help institutional investors work through the issues.

The first paper listed below helps investors to consider the price paid for illiquid assets - whether the likely additional return is sufficient to make up for the flexibility that is being given up. Other papers review the selection of asset classes available to benefit from the illiquidty risk premium, and how investors should practically tackle the implementation of allocating to illiquid assets.

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Understanding the illiquidity risk premium (Willis Towers Watson, June 2016)
Illiquidity risk is a potentially appealing means of generating additional yields in a low-return world. The authors of this 10-page document discuss three different dimensions of illiquidity risk premium that investors should demand for a given asset.

Investing in illiquid assets: A review (Robeco, September 2015)
Is it worth investing in illiquid assets? What additional return from a liquidity premium should an investor expect, after entry and exit costs are accounted for? In this paper, the authors discuss the evidence, both theoretical and empirical, on illiquid asset investments, commenting on potential diversification benefits of illiquid investments, and drawing attention to associated problems and risks.

Asset Allocation with Private Equity (Mark Anson, 2016)
Private assets such as venture capital and private equity are difficult for CIOs and asset allocators to assess. They lack liquidity, which means that it is difficult to model their return streams in a risk budget or asset allocation model. In this paper, the author seeks to correct the misspecification of these, and other, illiquid assets, showing how the parameters of the underlying distributions are commonly underestimated. A new method is presented that reveals the true distributional parameters of these illiquid asset classes.

Strategic Allocation to Less Liquid Assets
The authors of this paper propose a model by which investors can address liquidity questions when engaging in strategic asset allocation decisions. They consider both market liquidity and funding liquidity, as well as liquidity risk and return. This framework is helpful for liability-driven investors, in particular, who have a comparative advantage when investing in more illiquid assets. Any investor can use this methodology to robustly and transparently unlock the liquidity premium with no additional risk incurred.

European Infrastructure Investors Survey (Deloitte, June 2016)
This 28-page paper by Deloitte provides important insights and analysis into the current state and outlook for European infrastructure investment markets. The authors believe that the infrastructure asset class will continue with its strong performance and provide stable and secure returns.

How the Science of 'Rewarded Risk' is Redefining Diversification (BlackRock, 2015)
In this 12-page paper, the authors suggest that asset classes are a combination of six common risk factors: credit, economic, liquidity, inflation, real rates and geopolitics. They propose that these fundamental risk factors offer more precision and clarity regarding the drivers of asset class returns and their co-movements. 

Illiquid Assets: Unwrapping Alternative Returns (Credit Suisse, 2015)
This document by Credit Suisse explores different facets of liquidity and illiquidity in relation to financial markets and individual assets.

Illiquid credit: Playing the role of a (good) bank (Willis Towers Watson, Dec 2015)
Illiquid credit (or private debt) is a sector within the wider "alternative credit" asset class, and describes non-traditional investments which are difficult to dispose of before maturity. This sector allows investors to potentially enhance performance and benefit from the "illiquidity risk premium". The downside is that there may be an opportunity cost of having money tied up, and the investor must have access to sufficient liquidity elsewhere to meet any needs for immediate cash. This eight page report from Willis Towers Watson outlines the opportunities available and discusses how institutional investors should implement investments in this area. The authors argue that investors should consider illiquid credit as a meaningful allocation to either low risk or return-seeking funds.

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