Illiquidity and returns: making the trade-off

Large not-for-profit superannuation funds tend to allocate more of their portfolio to illiquid assets than their retail counterparts, according to a new paper by the Australian Prudential Regulation Authority (APRA).

The research paper looked into 146 large APRA-regulated superannuation funds with total assets of at least $200 million.

Illiquid assets can pose problems for superannuation funds as members seek to withdraw and transfer their balances, according to APRA. However, this liquidity risk is mitigated for not-for-profit funds because of their large size, their young membership base, and their high net cash inflows, according to the paper.

To compensate for the unfavourable aspects of illiquid assets, large not-for-profit funds tend to experience higher risk-adjusted returns between September 2004 and June 2010.

"However, this result does not guarantee that funds with illiquid portfolios will always outperform funds with more liquid portfolios, and nor does it obscure the risks of investing in illiquid assets," said APRA.

It is the responsibility of fund trustees to appropriately manage the transaction and valuation risks associated with illiquid investments, said APRA.