UK and Europe at odds over illiquid assets

European investors catching up with UK counterparts who were early adopters of illiquids

More European fund selectors want to increase their holdings of illiquid assets next quarter compared with UK fund selectors who are more inclined to hold, according to recent asset allocation research from Last Word Media.

The research found that 21% of European fund selectors wanted to increase exposure to private equity compared with just 3% of UK fund selectors; 16% of European fund selectors wanted to increase holdings of private debt compared with 5% of UK fund selectors; and 17% of EU respondents wanted to increase exposure to infrastructure compared with 11% of UK respondents.

Chart 1: Fund selectors looking to increase illiquid allocation in Q2 2018 (%)

Overall, UK fund selectors holding illiquid assets expressed more inclination than their European counterparts to maintain their current position, with 35% compared with 23% looking to keep private equity holdings; 54% compared with 32% wanting to maintain infrastructure; and 14% compared with a higher 16% wanting to hold onto private debt.

Chart 2: Fund selectors looking to hold illiquid allocations in Q2 2018 (%)

Fund selectors that don’t use illiquid assets are similar across both regions for private equity and private debt at 57% of UK fund selectors compared with 53% of EU fund selectors on private equity; and 76% of UK fund selectors compared with 63% of EU on private debt. Infrastructure bucked this trend with more UK fund selectors holding some infrastructure assets (just 30% didn’t compared with 48% of European fund selectors).

Chart 3: Fund selectors that don’t hold illiquid assets (%)

Last Word Research said: “You can see that most of our respondents use infrastructure, just under half invest in private equity and only a quarter invest in private debt. In continental European, on average, there is healthy demand for more private equity and debt; while in the UK there is almost none. Infrastructure still has a few interested investors everywhere.”

Europe lags UK on illiquid take up

Head of European direct lending at Alcentra, part of BNY Mellon IM, Graeme Delaney-Smith explained that he thought the data showed that European investors were catching up with their UK counterparts who were early adopters of illiquid assets.

“UK investors are still keen to invest in illiquid assets, but took up this asset class a few years ago, and the rest of Europe is now catching up.”

He continued: “Illiquid assets can offer attractive returns particularly with regards to direct lending since it has a very attractive return profile that includes an important amount of cash yield during the lifetime of an investment. We are seeing a lot of interest in this asset class especially from Germany, France, Italy and the Scandinavian countries.”

Miton Group fund manager Gervais Williams said that this lag was likely to do with UK investors being more exposed to volatility meaning that they have sought alternative assets earlier than their European counterparts.

“European investors tend to hold less equity generally, with fixed income being the asset class of choice, and so buying alternatives to de-risk volatility will have been a priority for them.”

He added: “ However, a recent increase in demand [for private equity and debt] in Europe may be driven by a desire for higher returns in a low growth environment.”

How big is the risk of illiquidity?

Williams added that he thought the traditional way of viewing illiquid assets as high risk was misguided.

“The main risk for our clients is the risk of losing money, that of finding that if assets fall there is no recovery thereafter, and that they have seen a permanent loss of capital. Illiquidity can be an inconvenience, but much less of a driver of investor behaviour than illiquidity which is something people can manage. If you invest on a long-term basis then can’t get access to capital for a couple of months it is manageable.”

Brewin Dolphin head of fund research Ben Gutteridge said the challenge for many fund managers was that adding value in liquid sections of the market is extremely difficult, “particularly when relative value trades are being executed in the equity and bond markets”.

He added: “Some of the financial world’s greatest minds are also competing in this space, and repeatable alpha looks too much of a stretch. Instead, therefore, we are encouraged to assume a measure of ‘illiquidity risk’ within the absolute return sector, where managers and teams can add genuine alpha through stock selection. Of course the modest increase in liquidity risk requires far closer scrutiny and vicious risk-off periods are unlikely to leave such strategies unscathed.”

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