The importance of ‘liquidity’ in your Superannuation investments
By Nick Bruining
Grab yourself a cup of cocoa, its time for a bed-time story with Uncle Nick.
It’s October 2019 and things are a little bit hairy.
As expected, the election earlier in the year has seen a change of government and while they’re blaming the other mob for the economic problems of the day, a steady run of out-of-cycle interest rate rises, brought about by rising US interest rates, has had a major impact on the Australian housing market.
Loan defaults are on the rise, Eastern states house prices have tanked and thanks to a deepening malaise in consumer sentiment, Australia’s 25 year run of economic growth has come to an end.
We are in recession.
Consecutive rate rises in the US have finally seen some major, heavily indebted US companies go belly up. Having piled on cheap debt since the GFC, complacency took hold, making many believe that rate rises would be slow and orderly. In fact, rate rise spikes took the markets by surprise. They always do.
In the past three weeks. Some major household names have been all but wiped out as they revealed the impact of higher interest costs. A sense of panic has gripped the markets. Shares have dropped 15 percent entering “bear market territory”.
Australian super fund investors, now wise to what a bear market can do to their retirement nest eggs are remembering what happened years ago and are getting out of the more risky investments.
The Whizzbang-plus balanced fund, once the doyen of super funds, has seen a rush of people wanting to lock in their ten years of record returns by switching to cash. It’s spreading like wildfire on facebook, instagram and snapchat. The phones run hot and the website’s overloaded with switching and redemption requests adding to the frenzy. There’s more people wanting to get out of the fund than in. For the first time in years, money is pouring out.
It turns out that the fund holds just three percent of the money in cash.
That cash reserve quickly gets eaten up by the redemption requests.
Next go the shares. They’re at least liquid, but over the next 2 days the fund manager is desperately trying to work out the redemption unit price in a sea of red ink as share prices tumble by the hour. Unsure of the values they should assign, they immediately declare that redemption requests will no longer be made in 3 days, but will be pushed out to thirty days. Its allowed for in the trust deed.
The problem you see, is that a big chunk of the fund is invested in stuff that can’t be readily turned into cash. The valuation of these assets was last done 3 months ago and based on “best estimates” when things were rosy.
No one ever imagined these things would have to be sold and as it turns out, they’re not the only ones having to satisfy a massive influx of redemption requests. Every other fund loaded up with infrastructure and big buildings is in the same boat.
To ensure that those investors remaining in the fund aren’t disadvantaged, the fund declares that redemptions will be frozen until further notice.
Now of course, this is a work of fiction. It will never happen. It couldn’t happen.
The trouble is it, it did.
And not that long ago.
Around the time of the GFC, one of the more popular investments for retirees were mortgage funds. Supposedly safe investments, they pooled investor funds and on-lent the money to mums, dads and developers. Mortgages destined to run for 20 to 30 years would provide the income to pay investors a return of about 8 percent when banks were paying 6. They held about 10 percent of funds in cash to meet the redemption requests which were usually matched by new investors coming in the door.
With rumbles of interest rates rising higher, people thought it wise to get out, knowing that mortgage defaults could be on the rise. As the GFC took hold, everyone wanted out. “Give me the cash” and I can put it into a federal government guaranteed bank account. The trouble is, you can’t just ask mum and dad for the money back. It’s a 25 year mortgage. It’s a long term investment, it’s backed by property. Investors didn’t care, they wanted their money.
Funds were frozen, some took years to pay out and investors ended up with cents in the dollar. And ten years on, that type of investment is no more.
So when you look at the returns on your super fund, when some fresh-faced investment youngster with a few snappy lines recommends something to you, remember the lessons from old, bald farts like Uncle Nick.
- Valuations on unlisted assets are like property valuations on your house. You only really know it’s value when you have a signed offer.
- Efficient markets are those markets where assets are readily traded (like the share market). It might be ugly in an efficient market, but at least you know what you’ve got.
- In a tumbling market, liquidity is everything. If your fund can’t readily convert to cash, then don’t be surprised if you can’t access your money. Fund trustees are obliged to ensure all members are treated equally, sometimes the only way to ensure that happens, is to freeze.
- That’s why yours truly, keeps well clear of managed investments in unlisted assets. Call me stupid, pessimistic, doomsayer, whatever.
But above all, you can call me liquid.