Capital Markets Lag, Liquidity Dries

Terry Flanagan

Institutions have long favored the esoteric, but even the “not-your-everyday” investments are having trouble getting off the ground.

Institutions like pensions, endowments, and foundations have long-needed to strike a delicate balance between “fear and greed,” or risk and return.

The institutional asset allocation model has long included hedge funds, real estate, private equity and other “alternatives”, with a reported average target weight of 10 to 12%. Pensions, perhaps the least comfortable with alternative due to their long ties to a vanilla, straightforward portfolio, have especially grown more aware of the need for more returns.

“Everyone is searching for yield, but pensions, insurance companies and generally, public investors are somewhere in the scale of where they need to balance liquidity versus yield. The higher the returns, the more illiquid the investment. The difference is in pricing,” said Ted Koenig, chief executive and president of Monroe Capital, a middle and lower market investment manager with more than $700 million in assets under management.

Institutional investors, who bring the largest pools of assets to managers, often can afford to be choosy about their investment and handle high liquidity premiums. Yet, those looking for access to esoteric strategies through hedge funds and private equity firms will have a hard time finding deals readily available in the open capital markets.

“There is just a large lack of trades in the capital markets,” said Spencer Garfield, managing director at Hudson Realty Capital, a manager of four real estate private equity funds. “It’s hard to value assets in the secondary market, mainly because there’s confusion in the capital markets and liquidity has dried up.”

Distressed companies unable to find financing in the capital markets means financing may be more available with private equity funds.

Yet, even these practitioners of special needs financing may be offering opportunities for hedge funds, due to a lack of collateral for many of these distressed companies, according to Susanne Yoon, principal at Versa Capital Management, a private equity fund that focuses on companies with less than $300 billion in revenue.

“The biggest risk we’re concerned with in today’s markets is counterparty risk, especially that emanating out of Europe,” Yoon continued. “Our end goal is to invest these companies for long-term plays.”

The European debt crisis has certainly forced many banks in deep waters to liquidate, or be forced to liquidate.

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