THE DEFINED CONTRIBUTION (DC) OBSESSION WITH

LIQUIDITY

Bev Durston9th May 2014

The DC Obsession with LiquidityContents:

• Spot the difference• Using liquidity as a proxy for risk• Market Timing• Why so liquid?• “Lock-up” vehicles• Summary • Challenge

“Spot the difference”Long term investing institutions:

Who are they?

Long time horizons

Strategic Asset Allocation

External and Internal advice

What can we learn?

“Spot the difference”

Asset Class Allocation Endowment Yale Endowment SWF SWFListed Equities 40% 17% 43% 32%Fixed Income 10% 5% 12% 19%Cash 3% 0% 9% 4%Property 4% 19% 5% 10%Alternatives: Abs return, PE, Other, Infra 43% 59% 30% 35%Total Assets 100% 100% 100% 100%% in less liquid assets = Pty Plus Alts 47% 78% 36% 45%

“Spot the difference”

Asset Class Allocation Family Office UK DB scheme UK DB schemeListed Equities 33% 51% 48%Fixed Income 16% 22% 32%Cash 1% 2% 0%Property 12% 7% 10%Alternatives: Abs return, PE, Other, Infra 39% 19% 10%Total Assets 100% 100% 100%% in less liquid assets = Pty Plus Alts 51% 25% 20%

“Spot the difference”

Now spot the difference in DC:

Far greater focus on liquidity Particularly pronounced in AustraliaWhat causes this difference?

Asset Class Allocation Australian DC Australian DC Australian DC Australian DC Industry FundListed Equities 44% 71% 58% 69% 59%Fixed Income 35% 22% 28% 7% 11%Cash 16% 5% 8% 8% 5%Property 5% 0% 0% 9% 9%Alternatives: Abs return, PE, Other, Infra 0% 2% 6% 7% 16%Total Assets 100% 100% 100% 100% 100%% in less liquid assets = Pty Plus Alts 5% 2% 6% 16% 25%

“Spot the difference”

What causes this difference?

Objectives

Contributions

Draw down status

Size

The focus on liquidity is a unique DC feature

Using liquidity as a proxy for risk

Return %

Equities

Property

Bonds

Cash

Risk %

This looks a diversified portfolio….

Using liquidity as a proxy for riskMore Liquid

Equities

Cash Bonds Listed Property

Medium Liquidity

Less Liquid

Risk %

Using liquidity: A one dimensional view….

Using liquidity as a proxy for riskMore Liquid

Equities

Cash Bonds Listed Property

Medium LiquidityHigh Yield

Frontier marketsAbsolute return Loans Natural Resources

Distressed Convertibles InfrastructureDirect lending

Less Liquid

DirectProperty

Risk %

Private Debt

Private Equity

Many lost opportunities

Using liquidity as a proxy for risk

Less liquid assets provide:

1) Range of diversifying return patterns

2) Mixture of novel betas

3) Blend of different manager skills

Invest in areas where others are not herding

Using liquidity as a proxy for risk

Investors confuse liquidity with safetyFocus on the investment time horizon

Asset Class Liquidity (ability to cash in / out) Frequency of pricing Investment time horizon (years)Listed Equities High Daily 7 - 10Private Equity Low Quarterly 7 - 10Listed Bonds High Daily 1 - 7Private bonds Low - Medium Quarterly 3 - 7Listed Property Medium to High Daily 7 - 10Direct Property Low Annual 7 - 10Listed Infrastructure Medium to High Daily 7 - 10Unlisted Infrastructure Low Quarterly 7 - 20Distressed investing Low Quarterly 5 - 10Absolute return assets Medium to High Monthly 1 month - 5 yearsAlternative assets Low to Medium Monthly - Quarterly 1 - 6Cash High Daily Daily

Market Timing

Maintain a liquid portfolio if:

A short term time horizon, or

Good market timing abilities

Market Timing

Warren Buffett example:

Farm / Real Estate investment

“Don’t just sit there, do something” For many investors,

liquidity becomes a curse

Market Timing: Good market timing?

The Little Book of Common Sense Investing by John Bogel

Yesterdays winners become tomorrows losers

Investors lost 57%

Avoid performance chasing based on short term returns

• Member Choice1• Regulation2• Short termism / Historical3• Agency: Activity measure4• Funds management industry5• No illiquidity premium6• Lack of size and scale7 • Fees8

Why so liquid?

Why so liquid?

• Opportunistic draw down1• Controlled use of leverage2• No forced exits3• Performance fees on sales4

• Alignment of interest5

“Lock-up” vehicles: Advantages

“Lock-up” vehicles:Think Outside the Square

1) Distressed assets

2) Absolute return

3) Direct lending

4) Structured products

Opportunistic diversification

Summary

1. Superannuation is a long term investment

2. Is member choice suboptimal for long term investing?

Are DC members “second class” citizens?

Challenge to non traditional investors

Where are the industry’s less liquid performance track records?

Are we not much good at this?

Is it top secret?

Why not offered in member choice?

QUESTIONS?