Willis Towers Watson : Crunch time for credit investors

LONDON, 17 May 2016 - Willis Towers Watson has warned institutional investors that the magnitude and profundity of credit market liquidity changes means that action is required if they are to protect themselves in the new regime. In a new research paper, entitled Capital Market Liquidity, the company stresses that the nature of credit market liquidity has fundamentally changed following a significant fall in the depth and breadth of liquidity.

Chris Redmond, global head of credit research at Willis Towers Watson, said: 'We worry that the supply of liquidity is no longer capable of satiating demand. This will become obvious and painful during periods of market stress where investors seek to re-position or realise cash from commingled funds offering overly generous redemption terms.'

The company points to the Taper Tantrum in 2013 and the US Treasury Flash Crash in 2014 as examples of challenging market behaviour and volatility as valuable windows into possible future scenarios. It says that while the markets in question quickly calmed after the period of elevated volatility, this should be of no comfort to investors.

Chris Redmond said: 'Both events occurred during an overall environment of generally benign economic conditions and a generally positive risk appetite amongst investors. We worry about how credit markets might behave during a period of genuine macroeconomic uncertainty where investors' asset allocations are materially changing and they are all trying to sell credit assets.'

Willis Towers Watson suggests investors take certain actions to insulate their credit portfolios against future periods of extreme credit market volatility and illiquidity, including reviewing fund and liquidity terms and assess the ongoing efficacy of different investment styles.

In another research paper, entitled Understanding Illiquidity Risk, the company observes that investors generally do not have a good understanding of what they are being paid for having their capital locked up. By referencing the principle: 'what gets measured gets managed', the company explores what investors should demand for accepting illiquidity risk and how this can be measured by using a new Illiquidity Risk Premium Index. According to Willis Towers Watson, the index enables comparison of IRPs across assets on a consistent basis, so as to make relative-value statements about the attractiveness of taking illiquidity risk across those assets.

Martin Jecks, senior investment consultant at Willis Towers Watson, said: 'This approach is a useful input in portfolio construction when determining how to spend a given illiquidity budget based on what an asset class is actually offering in compensation for its illiquidity.'

The company warns that its Illiquidity Risk Premium Index currently indicates that IRPs are at the low end of fair value and are likely to remain so for some time, unless there is a significant downside event which would push all risk premia - including IRPs - higher.

Martin Jecks said: 'While we believe there is a higher chance than normal of a downside event occurring and maintain a cautious outlook on risky assets, for many investors suited to taking illiquidity risk, certain assets still provide attractive risk premia on a highly selective basis. Moreover, if a negative event does occur and illiquidity risk premia do increase, these investors should stand ready to capture these attractive returns. Often this requires investment at a difficult time, but having a solid process and plan to estimate the illiquidity risk premia eases this decision.'

Willis Towers Watson Investment

Towers Watson's Investment business is focused on creating financial value for institutional investors through its expertise in risk assessment, strategic asset allocation, fiduciary management and investment manager selection. It has over 850 associates worldwide, assets under advisory of over US$2.2 trillion and around US$75 billion of assets under management.

About Willis Towers Watson

Willis Towers Watson (NASDAQ: WLTW) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has 39,000 employees in more than 120 territories. We design and deliver solutions that manage risk, optimize benefits, cultivate talent and expand the power of capital to protect and strengthen institutions and individuals. Our unique perspective allows us to see the critical intersections between talent, assets and ideas - the dynamic formula that drives business performance. Together, we unlock potential.