T&IO Liquidity Risk Management Update

“Liquidity Risk was extremely topical in 2019 following the high profile demise of Woodford IM, ultimately driven by exposure to ‘unlisted’ investments, which sent shockwaves throughout the industry.

As the economic and social implications of the Coronavirus pandemic has evolved, most financial assets have experienced a widespread sell-off, with a consequent impact on liquidity and volatility in certain asset classes. In commercial property, for example, limited transactions and lack of physical access to properties are making valuations extremely difficult, as illustrated by valuers’ recent statement of ‘material valuation uncertainty’.

Liquidity is only one component used in the broader risk-reward framework through which we evaluate asset classes. A key characteristic of our investment philosophy is to enhance  returns through capturing ‘illiquidity premium’. However, recent events have served as a reminder that all markets can face liquidity challenges during a sell-off, so we need to caution on ‘labelling’ something as liquid and therefore less risky!

The M&G Treasury & Investment Office (T&IO) has a well-established and tested approach to liquidity risk management. Liquidity is monitored on a daily basis by the portfolio managers. A Liquidity Coverage Ratio (LCR) is calculated by an independent risk team on a quarterly basis. This is designed to ensure  that redemptions are sufficiently covered  across various time periods (1,3,6 & 12 months). Assumptions around potential redemptions / ability to liquidate different assets, are stress tested and taken through appropriate committee governance.

PruFund portfolios are highly diversified across asset types and global markets, through allocating to a range of underlying fund managers. Importantly, capital is largely deployed via segregated mandates using internal managers. As a result of this internal relationship, T&IO and the underlying managers are both focused on acting in the best interests of the wider multi-asset fund, thus providing an additional element of flexibility in accessing liquidity at both an underlying asset class level and on a multi asset level. This is one of many advantages to working collaboratively with managers via segregated mandates.

A key responsibility of the Portfolio Management Team is to ensure that funds reflect the Strategic Asset Allocation (SAA), and this is managed within tight parameters to keep the ‘funds in shape’. Due to this extreme volatility, we have agreed more flexibility in terms of ‘operational limits’, allowing asset class positions more scope to ‘drift’. Ultimately, this means placing less trades than would ordinarily be required in these circumstances, avoiding extra costs that could be detrimental to overall performance.

The extraordinary response from governments & central banks globally have provided unprecedented levels of support for financial markets, restoring a level of stability to markets, and the portfolio managers continue to see sufficient liquidity to manage underlying portfolios efficiently. Also, the team hold an overweight to cash, providing another means of managing flows as efficiently as possible, dampening the effects of market volatility and being well placed for opportunities.”

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"Prudential" is a trading name of Prudential Distribution Limited. Prudential Distribution Limited is registered in Scotland. Registered Office at Craigforth, Stirling FK9 4UE. Registered number SC212640. Authorised and regulated by the Financial Conduct Authority. Prudential Distribution Limited is part of the same corporate group as the Prudential Assurance Company. The Prudential Assurance Company and Prudential Distribution Limited are direct/indirect subsidiaries of M&G plc, a company incorporated in the United Kingdom. These companies are not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America or Prudential plc, an international group incorporated in the United Kingdom.