Among the many stress points for institutional investors in recent years, greater portfolio liquidity is near the top of the list. Every institution has ongoing obligations, and when capital calls and asset manager review and rebalancing are taken into consideration, the need for improved liquidity – particularly in a “lower for longer” environment – becomes crystal clear. In fact, 2019 research by Greenwich Associates indicates that liquidity and risk management are an ongoing priority for 75% of chief investment officers.
What might be considered “traditional” ways of meeting liquidity demands, however, are often not sufficient or strategically viable. Adding to cash allocations, for example, can be a drag on overall portfolio performance, and increase tracking error relative to policy benchmark. At the same time, tactical selling of holdings in asset classes with higher trading costs can be expensive, operationally inefficient, disruptive to the underlying managers, or restricted by a lock-up period.
BlackRock has been a leader in providing solutions for what has become a persistent and rapidly growing demand by institutional investors for cost-efficient ETFs to help meet their liquidity needs. According to 2019 Greenwich Associates research, 81% of chief investment officers at institutions cited liquidity as a primary reason they use ETFs, and overall allocations to ETFs increased to 25% of total assets in 2018, a jump of 6% from one year earlier.1
A solution to help address the specific challenge
To help meet these growing institutional liquidity needs, BlackRock in 2011 created and launched its Liquid Policy Portfolio (LPP) strategy. The LPP strategies are designed to reflect the median asset allocation of pensions, foundations, and endowments. An LPP strategy consists of a portfolio of exchange-traded funds (ETFs) and seeks to deliver a typical policy benchmark allocation with exchange-traded flexibility.
LPP strategies are designed to deliver operational efficiency, cost efficiency, and investment efficiency – all based on their use of ETFs, which offer intra-day liquidity, with the possibility of T+1 settlement.2 In addition, using a liquidity sleeve to help meet cash needs can reduce disruption to actively managed mandates. Furthermore, when compared to holding excess cash, LPP strategies can potentially reduce tracking error relative to policy benchmark.
LPP strategies may also raise certain considerations related to risks and exposure. LPP strategies hold non-cash vehicles and therefore are more volatile than cash. Also, a client’s long-term investment policy may have a different risk/return profile than the LPP allocations.
Precision liquidity management and factors
Among the many new and innovative uses of ETFs that have accompanied their growth and development is increasingly precise liquidity management. This is possible thanks to the growing number of sizeable and sufficiently liquid ETFs in multiple asset classes. Transacting in ETFs may offer a reduction in implementation time and transaction costs relative to individually trading in the underlying assets.
When a tailored portfolio is under construction, various tradeoffs are considered to help determine an efficient fit for an investor, including active risk to policy benchmark, trading cost, management fees, and liquidity of the ETFs.
Factor-weighted exposures have been increasingly important in numerous customized liquidity solutions. The solutions utilize either the bottom-up or the top-down factor investing approach. Each approach has a distinct effect worth consideration by investors.
Liquid alt proxies
Most institutions regularly conduct reviews of their asset managers, and often as a result decide to reallocate among various alt strategies, resulting in disruption of exposures and benchmarking risks. But the search for new managers takes time, and as nearly everyone knows, time is money. It is in this scenario that a new use for ETFs has emerged, namely as liquid alternative proxies for short-term exposures to equitize cash during alternative manager transitions. ETFs are being similarly used for longer-term strategies where institutions are looking to reduce cash positions while maintaining liquid exposures.
To create liquid alternative proxies, BlackRock assesses the risk and return profiles of hedge funds, private equity buyout, venture capital, and private real estate and maps each of these asset classes to the combination of iShares ETFs that efficiently approximates these characteristics. The methodology used adjusts for the effects of private asset class autocorrelation to better estimate risk profiles.
These liquid public proxies can complement the allocations of four private asset classes, allowing institutions to gain flexibility in meeting liquidity needs while helping to mitigate the performance drag that can result from holding excess cash.
1 9th Annual Greenwich Associates Institutional ETF Study, 2019. Usage figures based on a survey of 181 U.S. asset managers, insurers, consultants, and institutional funds.
2 Capabilities may vary depending on the specific implementation and/or investment vehicle. For redemptions, T+1 settlement is conditioned on the ability to short settle ETF trade orders with brokers. If short settlement is not available, settlement will revert to standard T+2 settlement.
Carefully consider the Funds’ investment objectives, risk factors, and charges and expenses before investing. This and other information can be found in the Funds’ prospectuses or, if available, the summary prospectuses which may be obtained by visiting www.iShares.com or www.blackrock.com. Read the prospectus carefully before investing. Investing involves risk, including possible loss of principal.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. There is no guarantee that any of these views will come to pass. Reliance upon information in this material is at the sole discretion of the reader.
There can be no assurance that the investment objectives of any strategy referred to herein will be achieved. An investment in any strategy referred to herein involves a high degree of risk, including the risk that the entire amount invested may be lost. Strategies are not guaranteed by BlackRock or its affiliates.
An investment in ETFs is not equivalent to and involves risks not associated with an investment in cash.
T+1 settlement is conditioned on the ability to short settle ETF trade orders with brokers. If short settlement is not available, settlement will revert to standard T+2 settlement. Two-day financing cost for T+1 settlement would be incurred by the transacting client.
There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. The information provided is not intended to be a complete analysis of every material fact respecting any strategy and has been presented for educational purposes only. Asset allocation models and diversification do not promise any level of performance or guarantee against loss of principal.
Shares of ETFs are bought and sold at market price (not NAV) and are not individually redeemed from the LPP strategy.
Strategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Please contact your BlackRock representative for more information.
The iShares Funds are distributed by BlackRock Investments, LLC (together with its affiliates, “BlackRock”).
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