According to a recent special report in Pensions & Investments entitled “Funds looming liquidity crisis,” public pensions will be hard pressed to directly own the alternative asset allocations that are needed to generate the returns required for looming distributions to plan participants. The reason? Not enough liquidity, given the future need for distributions, in the actual alternative asset classes. According to the article: “the need to provide liquidity to pay benefits over the next few decades will mean they (pension plans) can’t increase or even maintain existing allocations to real estate, private equity, timber, hedge funds and other alternative asset classes.”
So what will plans likely do? Move assets to public equities and/or fixed income says the article. What!?! The plans will essentially be saying good bye to the attractive returns and correlations of alternatives exactly when they will need them the most! Wake up public pension plans! Don’t abandon something you literally can’t afford to lose! Instead consider the vibrant and expanding marketplace of ETF alternative products that were built with liquidity in mind. ETFs deliver what pensions want (alternatives) AND what they need (liquidity). Here’s how…
ETFs are exchange traded securities and therefore are built with a focus on liquidity. This starts not at the fund level but on the level of the underlying holdings that comprise a fund. Minimum liquidity criteria are put in place for the underlying constituents of an ETF as the liquidity of the ETF itself depends on the liquidity of its underlying holdings. The foundational liquidity of an ETF alleviates the very issue public pension plans are concerned about from their experience accessing alternatives from a different path. Indeed, many other paths to alternatives do not consider liquidity to be a driver, let alone a foundation, of their approach.
But what kind of liquid alternatives could a public pension really obtain from the ETF world? Here’s a back of the napkin attempt at listing a single ETF option per category. In many categories there are multiple ETF options, so consider this a starting point.
Clearly ETFs, which ironically developed these alternative products based on smaller investors’ demand for access to these “institutional” asset classes, offer a compelling selection of alternatives. Critics may argue the tax efficiency or correlations may not be superior to directly owning the underlying asset class, but if access (code for amount of assets) or liquidity (code for flexibility) are requirements then I believe the ETF is superior.
Hopefully, ETF Sponsors are aware of and act on this compelling opportunity to present public pensions with what they want and also what they need. As usual for ETFs, education and awareness are the basic obstacles to overcome. Sponsors that are able to do this with the pension crowd will reap billions of AUM and rescue the retirement benefits of millions of Americans. Game on.