AIMA/State Street: Let’s Talk Liquidity - Opportunities in a New Market Environment

Published: 16 November 2016

AIMA and State Street Corporation (NYSE:STT) research has found that nearly half (48 percent) of survey respondents say that decreased market liquidity is a secular shift that is here to stay. Regulations stemming from the 2008 financial crisis, coupled with historically low interest rates and slow rates of growth in the global economy, have constrained the ability of many banks to perform their traditional roles as market makers, which in turn has impacted broader market liquidity conditions.

More than three-fifths of the survey respondents say current market liquidity conditions have impacted their investment management strategy, with nearly a third rating this impact as significant, and are reassessing how they manage risk in their investment portfolios. More broadly, they are adjusting to an environment of less liquidity in which trading roles have been transformed, new market entrants are emerging, and electronic platforms and peer-to-peer lending are changing the way firms transact their business.

While there is no one-size-fits all strategy for balancing risk and return in the current market environment, investors and managers are adapting to the new environment by focusing their efforts in three areas:

·         Rationalizing the risk: The liquidity shift has serious ramifications for investors globally. They are seeking to develop the right strategies and tools to help them succeed in this complex new environment. This includes improving the way they measure and report on liquidity risk, and reassessing how they manage risk in their investment portfolios.

  • 42% of all respondents say the changed market conditions are making it more challenging than before to report their liquidity position to their board or regulators
  • 44% of respondents plan to invest to improve their risk –reporting capabilities.

·         Optimizing the portfolio: Investors and managers are shifting their allocation strategies to take account of new liquidity conditions. While more liquid fund vehicles such as ETFs, UCITS funds and 40 Act funds have been gaining ground, a holistic strategy that balances risk with return across the whole portfolio is critical.

  • 53% of asset managers and asset owners are planning to add more liquid investments to maintain exposures
  • 44% are increasing the size of their cash allocation against future liabilities or redemptions

·         New rules, new tools: The new market liquidity conditions are inspiring many players in the investment industry to invest in new solutions and platforms such as peer-to-peer lending that provide alternative sources of liquidity.

  • 49% say the role of non-bank institutions as liquidity providers will grow and 42% say that this growth will come from hedge funds
  • Nearly half (47%) say hedge funds may play an important role in providing liquidity in more volatile markets

About the research

State Street commissioned Longitude Research to conduct a global survey of 300 institutional asset owners and managers in June and July 2016. Of this number, 150 were asset owners, including pension funds, insurance companies and endowments and foundations, and 150 were asset managers. These included 50 hedge funds. In total, the respondents represented 14 countries worldwide. Approximately 35 percent of respondents were based in the Americas, 40 percent in Europe and 25 percent in Asia Pacific. In addition to the survey, a range of in depth interviews were conducted with select leaders across the industry.