The events of the past two weeks have quickly fostered memories of the Spring of 2009, the collapse of Lehman and unprecedented action in fixed income markets. Secondary market liquidity conditions have deteriorated significantly across fixed income sectors following concerns about the health of the banking sector. While actions by regulators have helped to restore public confidence, this banking sector shake-up remains fluid, with the outcome still very uncertain. Bid/offer spreads have widened meaningfully, and it has become more challenging to source liquidity.
We just participated in an industry event that took place as the SVB crisis was unfolding. A large number of insurance-CIOs attended this year’s roundtable. Our conversations with these CIOs understandably centered on liquidity in the fixed income market and in their reserve portfolios. Liquidity is a topic that all of us are well-versed in. Liquidity is a topic that is critical to monitor. Oddly, despite all the focus on liquidity the quantifying of what is adequate liquidity has always proven to be a challenge. A number of years ago now, our firm sought to solve this frustrating problem. We are pleased to shared that after considerable time and effort we have designed and built an analytical tool to “define” or “quantify” the liquidity of our clients’ bond portfolios. We have used the tool long enough now to have confidence in this methodology and output.
In light of the current market concerns about liquidity fostered by the banking crisis, we are pleased to share the details of this tool with you. If you are interested in having us run your portfolio through our Liquidity Evaluation Framework (LiEF), please reach out to us. We regularly hear from insurance company investors how this is a different tool in the marketplace. To be clear, we believe most insurers have plenty of liquidity in their investment portfolio, so our offer to analyze your portfolio with LiEF is more about offering you and your board a way to measure it. What can be measured is often better managed, as they say.
What is LiEF?
Liquidity Evaluation Framework (LiEF®) was developed by Wellington Management to evaluate the liquidity and liquidity risk in fixed income portfolios. At its core, LiEF® is a simulation of trading patterns that when analyzed leads to a prediction of the time it would take to liquidate a portfolio as well as the costs involved. Because it is simulation based, LiEF® not only estimates expected outcomes, but it also determines a range of possible outcomes. LiEF® reports the timeline of expected liquidation, as well as the best and worst cases. LiEF® shows how the composition of the portfolio will change over time as the remaining securities become more highly skewed towards those that are less liquid. It also shows the impact of urgency on transaction costs by highlighting how much it would cost to divest the portfolio immediately versus trading it patiently. Together, these reports provide a comprehensive picture of portfolio liquidity.
LiEF® is also useful for comparing the relative liquidity of two portfolios or a portfolio relative to its benchmark. Finally, it can also be used to monitor a portfolio over time indicating how changing portfolio composition or changing market conditions affect liquidity.
The LiEF results are based on historical market conditions, and may not represent real time liquidity. In addition, LiEF results do not include the impact on markets of any trading activity in other portfolios, which could decrease realized liquidity. Actual results may differ significantly from the LiEF analysis.