Liquidity as a ‘Style’ of Investing

Back in November, Norway’s SWF hosted an ‘Investment Strategy Summit’ with a group of finance luminaries to ponder and opine on the future of long-term investing. One of the big themes was liquidity...

Back in November, Norway’s Government Pension Fund – Global hosted an ‘Investment Strategy Summit’ that brought together a group of finance luminaries from academia and industry to ponder and opine on the future of long-term investing (h/t Joe Light). The motivation for this Summit is clear (at least to me): the GPF-G is ostensibly the world’s largest long-term investor, but its current investment strategy seems to ignore this fact. The sovereign wealth fund is almost exclusively invested in public equities and fixed income, which are assets the WEF lists as short to medium term assets (though the SWF does have plans to add some minor positions in real estate). Anyway, here’s what Mrs. Hilde Singsaas, State Secretary of the Ministry of Finance, had to say about the Summit:

“The purpose of this summit is to discuss the further development of the investment strategy for the Government Pension Fund – Global...Today, we would like to turn the discussion slightly away from the day-to-day headlines in the financial press. Instead, we would like to focus on the longer-term aspects, which after all characterize this Fund.”

That’s why I think this Summit is so interesting: it offers some useful insights on where the GPF-G (and other long-term investors) may be positioned in ten years time. Anyway, all of the presentations are now online, and, interestingly, one of the big themes was illiquidity. So I’d like to specifically draw your attention to two presentations; one by Roger Ibbotson and another by Andrew Ang.

  • Ibbotson demonstrates that less liquid stocks trade at a discount to more liquid stocks, which means that buying the former instead of the latter allows investors to secure cash flows more cheaply. Accordingly, he finds that less liquid stocks have higher and more stable long-run returns.
  • Ang shows how an investor, such as the NBIM, can harvest illiquidity premia:
    • “By setting a static allocation to illiquid asset classes [real estate] at the aggregate level
    • By engaging in dynamic strategies at the aggregate level, by purchasing risky assets [equities] when others want to sell
    • By being a market maker, which supplies immediate liquidity by acting as an intermediary
    • By choosing securities within an asset class that are more illiquid, that is by engaging in liquidity security selection.”

Given the outperformance of illiquid assets shown below, that sounds like a sensible plan to me. However, recall that the Endowment Model basically blew up in 2008-09 because many of the funds (e.g., Harvard) simply didn’t understand what a portfolio of illiquid assets would mean for the fund in a crisis. In short, for any of the premia above to be realized, you really have to know what you’re doing. And Summits like the one the GPF-G put on is a good first step in this direction.