Pension fund s illiquid assets allocation under liquidity and capital constraints

Transcription

1 Pension fund s illiquid assets allocation under liquidity and capital constraints Dirk Broeders a,b, Kristy Jansen b,c,d, and Bas Werker c,d Maastricht University a De Nederlandsche Bank b Tilburg University c Netspar d October 17, /22

2 Motivation - pension funds are important investors in illiquid assets This is shown by several studies Average illiquid assets allocation of large pension funds in 34 countries was 15 percent in 2014 (OECD (2015)) Average illiquid assets allocation of 16 largest pension markets in the world was 20 percent in 2015 (Towers Watson (2015)) 2/22

3 Benefits for pension funds to invest in illiquid assets Liquidity premium Portfolio diversification Liability hedging 3/22

4 Lack of liquidity may reveal itself in Restrictions on the price at which an asset can be traded Restrictions on the amount of an asset that can be traded Restrictions on the trading time of an asset 4/22

5 We chose the following asset classes to be illiquid as these are typically not traded on regulated markets Direct and non-listed real estate Mortgages Private equity Hedge funds Infrastructure Note: There are no quantitative investment restrictions for Dutch pension funds 5/22

6 ALLOCATION TO ILLIQUID ASSETS Conventional wisdom says that a longer investment horizon allows to invest more in illiquid assets 40% 35% 30% 25% 20% 15% 10% 5% 0% LIABILITY DURATION 6/22

7 ALLOCATION TO ILLIQUID ASSETS Research question - why do pension funds with a very long investment horizon not invest more in illiquid assets? 40% 35% 30% 25% 20% 15% 10% 5% 0% LIABILITY DURATION 7/22

8 Answer: Pension funds may be constrained to invest in illiquid assets Liquidity constraints (Ang et al. (2014)) Pension funds require sufficient cash and highly liquid assets for short-term pension payments collateral on interest rate and currency derivatives Capital constraints (Sias (2004), Andonov et al. (2016)) Pension funds need to have sufficient capital to manage market-, interest rate-, exchange rate- and longevity risk capital is the difference between assets and liabilities required capital 2 x funding rate volatility 8/22

9 Two key drivers of the liquidity and capital constraints Liability duration Hedging using derivatives 9/22

10 Liability duration affects both the liquidity and the capital constraint Higher liability duration implies fewer short term pension payments (less liquidity constrained) Higher liability duration implies a higher interest rate risk exposure (more capital constrained) 10/22

11 Hedging also affects both liquidity and capital constraint Hedging interest rate and currency risk increases collateral requirements (more liquidity constrained) Hedging interest rate and currency risk decreases the exposure to interest rate and currency risk (less capital constrained) 11/22

12 Testable hypotheses Liquidity constraint Illiquid asset allocation Duration Capital constraint Illiquid asset allocation Pension fund Liquidity constraint Illiquid asset allocation Hedging Capital constraint Illiquid asset allocation 12/22

13 Supervisory data from De Nederlandsche Bank Sample period , quarterly data 220 Dutch defined benefit pension funds Strategic asset allocations Liability duration Market value interest rate and currency derivatives Other controls: size, pension fund type, required funding ratio 13/22

14 Summary statistics Variables mean std. dev p10 p90 obs. Allocation to illiquid assets ,652 Allocation to liquid risky assets ,652 Allocation to risky assets ,652 Log of total AUM ,693 Liability duration ,664 Convexity ,664 CR on interest rate derivatives ,690 CR on currency derivatives ,690 Required funding ratio ,690 The summary statistics are computed as the equally weighted average over all pension funds and all quarters 14/22

15 The model Regression model (Tobit): w ILLIQ it = β 0 + β 1 D L,it + β 2 C L,it + β 3 CRr it + β 4 CRcurr it (1) + β 5 Size it + β 6 Type i + β 7 Rfr it + λ t + ɛ it where Convexity = Duration 2 Collateral requirement = stressed MV MV AUM 15/22

16 Duration and convexity affect the allocation to illiquid assets dependent variable allocation to illiquid assets allocation to liquid risky assets Liability duration *** Liability convexity *** p < 0.10, p < 0.05, p < 0.01 Explanation For long durations the non-linear nature of interest rate risk (convexity) dominates the lower liquidity constraint The allocation to liquid risky asset is independent of investment horizon (Merton (1969)) 16/22

17 ALLOCATION ILLIQUID ASSETS Hump-shaped effect liability duration on illiquid asset allocation Hump-shaped effect liability duration 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% LIABILITY DURATION The marginal benefit of a higher liability duration (lower liquidity constraint) is equal to the marginal cost (higher capital constraint) at a liability duration equal to 17.5 years. 17/22

18 Interest rate hedging does not affect the illiquid asset allocation, whereas currency hedging affects the illiquid asset allocation positively (capital constraint) dependent variable allocation to illiquid assets allocation to liquid risky assets CR on interest rate derivatives *** CR on currency derivatives *** *** p < 0.10, p < 0.05, p < 0.01 Potential explanations Interest rate swaps have an average maturity of 30 years whereas currency forwards are rolled over every 3 months Currency derivatives do not always require day-to-day collateral management (liquidity constraint absent) 18/22

19 Larger pension funds invest more in illiquid assets and corporate pension funds invest less in illiquid assets dependent variable allocation to illiquid assets allocation to liquid risky assets Log of total AUM *** Corporate pension fund *** p < 0.10, p < 0.05, p < 0.01 Potential explanations Size Complex nature illiquid asset classes Economies of scale (Broeders, van Oord and Rijsbergen (2017)) Pension fund type Pension fund s risk reflects on corporate s balance sheet (additional constraint) 19/22

20 Robustness checks The findings are robust if we Do separate regressions per illiquid assets class Use an alternative measure of maturity Use an alternative measure of collateral requirements 20/22

21 Key findings Young pension funds are highly exposed to interest rate risk which limits opportunities to invest in illiquid assets Pension funds that hedge interest rate risk prefer to have higher allocations to liquid risky assets Pension funds that hedge currency risk have higher allocations to both liquid and illiquid risky assets Large pension funds invest more in illiquid assets 21/22

22 Policy considerations Changing the nature of pension promises from DB to DC does not take away interest rate risk Liquidity management is key for pension funds (liquidity is low when you need it most) 22/22