The Chinese Pension System
February 12, 2025
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Liquidity management has become an important buzzword in the pension fund industry. This is because of the fact that recessions, slowdowns, and the recent market crash caused by Covid-19 have left the pension funds exposed. Many studies have been conducted into the matter and the results from these studies are simply astonishing.
Pensions funds are supposed to be safe for long-term investors. However, in the current markets, pension funds frequently face a shortage of cash. As a result, investment managers have to become more creative to manage liquidity in such cases.
In this article, we will have a closer look at the impact that a lack of liquidity has on pension funds in general.
The fact that pension funds have to make sales of long-term assets to fund short-term liabilities raises a huge red flag on the fund management capabilities. This is because of the fact that if pension funds are selling assets to make the payroll, they are not selling at opportune moments. Instead, they are forced to sell at whatever prices are offered by the market. This is the reason that pension funds have been involved in many fire sales in the recent past and have now started paying close attention to liquidity management to avoid this situation in the future.
The 2008 crisis has spooked some of these funds. During that time, funds were not able to convert assets to cash even at deeply discounted prices. As a result, most funds prefer to hold cash to completely avoid that risk.
For instance, in many countries, pension funds take positions in the derivatives markets against the equity portfolio that they hold. This allows them to take on additional risk in order to generate additional cash flow. However, since derivatives and other such alternate assets can be highly volatile, funds need to improve their liquidity management so that they are not forced to take on additional risk.
However, the need for liquidity management has changed the pension fund industry. Earlier it was known for making less risky long-term investments. Now, it is known for excessive trading and making short-term risky investments. Pension funds are paying more attention to liquidity management so that their fund managers are not forced to take on excessive risks.
Pension funds have been making sure that they diversify their portfolio as much as possible. This includes geographic diversification as well as investing in companies of different sizes. This can be considered to be a positive effect of the increasing importance of liquidity management in the pension fund industry.
Companies often end up with very little debt on their balance sheet since bonds have much higher liquidity than other risker assets held by these funds. The end result is that at a later date, funds have to sell their illiquid investments as well in order to reinvest the money back in the original asset so that the same proportion of assets can be maintained. The end result is constant rebalancing which causes unnecessary transaction costs and brings down the efficiency of the firm.
The bottom line is that liquidity management has become extremely important in pension fund management. The lack of liquidity impacts any pension fund in multiple ways.
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