Illiquid assets

Global Investor 1.15, May 2015 

Expert know-how for Credit Suisse investment clients 

INVESTMENT STRATEGY & RESEARCH 

Illiquid assets 

Unwrapping alternative returns 

Roger Ibbotson Are investors rewarded or penalized for holding illiquid stocks? 

Sven-Christian Kindt Exploring the upside of new illiquid alternatives. 

Alexander Ineichen Hedge funds overcome recent challenges. 

Carol Franklin Trees represent a growth opportunity for the patient investor.

Important information and disclosures are found in the Disclosure appendix 

Credit Suisse does and seeks to do business with companies covered in its 

research reports. As a result, investors should be aware that Credit Suisse may 

have a conflict of interest that could affect the objectivity of this report. 

Investors should consider this report as only a single factor in making their investment 

decision. For a discussion of the risks of investing in the securities mentioned in 

this report, please refer to the following Internet link: 

https://research.credit-suisse.com/riskdisclosure

GLOBAL INVESTOR 1.15 — 03 

Photos: Martin Stollenwerk, Gerry Amstutz 

Responsible for coordinating the focus 

themes in this issue: 

Oliver Adler is Head of Economic 

Research at Credit Suisse Private Banking 

and Wealth Management. He has a 

Bachelor’s degree from the London 

School of Economics, as well as a Master 

in International Affairs and a PhD in 

Economics from Columbia University 

in New York. 

Markus Stierli is Head of Fundamental 

Micro Themes Research at Credit Suisse 

Private Banking and Wealth Management. 

His team focuses on long-term investment 

strategies, including sustainable 

investment and global megatrends. Before 

joining the bank in 2010, he taught at 

the University of Zurich. He previously 

worked at UBS Investment Bank. He 

holds a PhD in International Relations 

from the University of Zurich. 

Standard financial theory tells investors to carefully assess the tradeoff 

between return and risk. Liquidity is a third key consideration. This 

Global Investor (GI) is about the liquidity and illiquidity of individual 

assets and overall financial markets. Just as risk and return are uncertain 

before the fact, so is liquidity. Some assets may appear highly 

liquid, only for their liquidity to suddenly vanish. Moreover, changes 

in liquidity often correlate with shifts in risk. As our article on fixed 

income (page 62) points out, some more exotic bonds become very 

hard to sell just as their perceived risk increases, and when less liquid 

assets are pooled in typical (open-end) funds, such difficulties can 

be amplified (see page 24). 

This does not imply at all that we would advise against investing 

in illiquid assets. In fact, assets that eventually generate high returns 

are very often highly illiquid. Those who invested in Apple, Google 

or Microsoft when they were small (unlisted!) ventures run out of 

“garages” garnered huge returns. Apart from private equity, this GI 

covers a broad range of other more or less illiquid assets – ranging 

from forests to farmland to infrastructure, and from real estate, the 

most common of illiquid assets, to the most exotic “passion” investments. 

We also look at the pros and cons of investing in hedge funds, 

which are not necessarily particularly illiquid, but where the sources 

of return are often harder to identify than those of other more visible 

illiquid assets. 

Adrian Orr, CEO of the New Zealand Superannuation Fund, known 

for its innovative investment philosophy, points out (page 26) that 

even investors with long horizons should gauge the liquidity of their 

overall portfolio carefully: investments in illiquid assets should be 

balanced by some that can be easily sold. This rule is of even greater 

importance for private investors whose investment horizon is 

typically shorter and where the potential for a drastic change in 

personal circumstance (and thus need for liquidity) is that much more 

pronounced. The temptation of abandoning such caution seems particularly 

high at a time when both nominal and real expected returns 

on the most liquid of assets are so meager. Conversely, investors 

should avoid overpaying for liquidity: Professor Ibbotson (page 10) 

argues that investors tend to overrate (and thus overpay for) the 

benefits of owning large cap stocks. The fact that these assets can 

be traded in almost any circumstance may not only render them 

more expensive but also prone to excessive price gyrations. In sum: 

make sure that the analysis of risk and return is complemented with 

a careful review and “stress test” of the liquidity of assets and 

investment vehicles. 

Giles Keating, Head of Research and Deputy Global CIO


THE ALLURE OF 

LIQUIDITY – 

CURSE OR BLESSING? 

TEXT MARKUS STIERLI Head of Fundamental Micro Themes Research 

ILLUSTRATION FRIDA BÜNZLI 

What do we know 

about liquidity? 

A particular focus of this Global 

Investor is on market liquidity. 

By this we mean the presence – 

or absence – of the ability to 

sell (liquidate) an asset quickly, 

without impacting the market 

price significantly, and without 

institutional constraints. 

Measuring market 

liquidity 

For many asset classes, bid-ask spreads are 

a convenient and straightforward way to measure 

market liquidity, with declining (tightening) 

spreads indicating greater liquidity, and 

vice versa. The spread is simply the cost that 

you would incur if you were to sell an asset 

on the market and immediately purchase it 

back. But, as we will discuss throughout this 

Global Investor, the concept of market liquidity 

is more complex than that. To start with, 

the bid-ask spread is not easy to measure for 

many assets, such as real estate. Moreover, 

market liquidity typically varies dramatically 

across the cycle. Some assets 

are highly liquid in 

the upswing or the top of the 

cycle, but become less liquid 

in a downswing. Lastly, instruments 

matter. For example, 

closed-end funds can deviate 

from the value of the underlying 

assets, which is bad in some ways, 

but may also help protect long-term 

investors. Some vehicles, such as private 

equity funds and hedge funds, may impose 

so-called “gates” on their investors to limit 

redemptions. 

Liquidity 

has many 

meanings 

In the wake of the financial 

crisis, the liquidity of the 

financial system became 

synonymous with its “lifeblood.” 

Large injections of 

liquidity by central banks (the 

ultimate creators of liquidity) 

were necessary to save those who “bled”; 

the provision of liquidity to safeguard the 

economy has remained paramount ever since. 

In this context, macroeconomic liquidity does


Investors and firms share a common problem: 

liquidity risk premiums are hard to gauge, both 

across different types of assets and over time. 

Liquidity does not manifest itself in standard 

measures of risk, such as price volatility. In 

fact, in normal times, illiquid investments are 

not necessarily more volatile than liquid ones. 

Of course, price volatility may simply be hidden 

because illiquid investments are priced 

at lower intervals – turnover is itself a definition 

of liquidity. However, even in equity markets, 

as we learn from Yale’s Roger 

Ibbotson (see page 10), lower turnover 

stocks actually proved more resilient 

(and less volatile) during the financial 

crisis in 2008 than their highly liquid peers. 

Bringing it all together 

not really refer to 

the availability of cash 

in the economy, but rather 

to the smooth functioning of financial markets 

and thus the economy as a whole. To a financial 

firm, liquidity refers to the ability to meet 

its debt obligations without becoming insolvent. 

While cash holdings (a liquid balance 

sheet) provide a buffer against losses, the 

ability to convert assets into cash to meet 

current and future cash flows – its funding 

liquidity – can prove critical for survival in the 

event of stress. Therefore, funding liquidity is 

now a key regulatory imperative. Nevertheless, 

central banks ultimately will always need 

to act as a backstop to commercial banks; as 

the role of commercial banks is typically to 

invest clients’ liquidity (deposits) in less liquid 

assets, they would structurally not have sufficient 

liquidity to withstand a bank run. 

On premiums and risk 

While the different concepts of liquidity are 

often treated in isolation, it is essential to try 

to understand how they interact. We know 

that liquidity black holes wiped out entire 

markets, such as the junk bond market in 

the mid-1990s, and the subprime mortgage 

market more recently. We understand that the 

deterioration of balance sheets forced banks 

to cease lending, resulting in a vicious liquidity 

squeeze that required significant policy 

intervention to restore confidence so that the 

financial system could fulfill its most basic 

purpose. The most challenging part of the 

liquidity discussion is that it depends heavily 

on circumstances. The financial crisis was 

such a profound event that it still has a significant 

impact on investors’ attitudes toward 

illiquid investments. Consequently, entire asset 

classes are being shunned, sometimes 

unjustifiably, and genuine opportunities will 

be exited prematurely or missed altogether. 

In other cases, investors may actually end up 

paying too much for liquidity. If history has 

taught us one thing about liquidity, it is that it 

is often self-fulfilling, and at times a mirage.

GLOBAL INVESTOR 1.15 — 06




Contents 

Global Investor 1.15 

10 

Psychology and (il)liquidity 

Liquidity has its price. But, says Roger 

Ibbotson, with equities the popular choice 

has a premium that may be too high. 

16 

Liquidity trends in illiquid 

alternatives 

Amid rising interest in less liquid alternatives, 

Sven-Christian Kindt points out the 

reward for sacrificing unneeded liquidity. 

18 

On doing your homework 

If you’ve first done your research, says 

Alexander Ineichen, hedge funds may 

bring higher end returns with less volatility. 

21 

Liquidity – a key to hedge fund 

performance 

It’s a key factor. Marina Stoop examines 

the role that liquidity plays in hedge funds 

and for their investors. 

24 

Open-end versus closed-end funds 

The right investment, say Giles Keating 

and Lars Kalbreier, is a function of the 

underlying asset type and the kind of fund. 

26 

Attractively consistent 

At the helm of the New Zealand Superannuation 

Fund, Adrian Orr talks about 

patience, opportunity and very long horizons. 

30 

Talking teak 

She has branched out. Carol Franklin has 

a diverse background including language, 

insurance and plantation ownership. 

39 

Institutional investment 

in timberland 

It’s not easy going green. Gregory Fleming 

explains why institutional investors 

see timberland as a growth opportunity. 

42 

Farmland – a fertile investment 

With dairy farming interests, and over 20 

years in asset management, Griff Williams 

knows plenty about farmland investment. 

44 

Ins and outs of real estate 

It’s an illiquid asset, but real estate is 

attracting growing interest. Philippe 

Kaufmann offers his insights and advice. 

48 

Infrastructure on the rise 

Institutional investors are flocking toward 

infrastructure. Robert Parker explains why 

building for the future is a big deal today. 

52 

Looking beyond liquidity 

Felix Baumgartner and Patrick Schwyzer 

reflect on client perspectives of the illiquid 

asset landscape. 

56 

In passion we trust 

Art, antiques and collectibles: Art Market 

Research and Development looks at 

a different kind of alternative investment. 

58 

From illiquid assets to profitable 

investments 

The European Central Bank is working 

to restore the European securitization 

market, report Christine Schmid and 

Carla Antunes da Silva. 

62 

No exit? 

There’s lower and more volatile liquidity in 

the corporate bond markets. Jan Hannappel 

outlines the causes and the implications. 

Disclaimer > Page 65


Photos: Robert Falcetti 

Roger Ibbotson, founder, chairman and CIO of Zebra Capital Management.

GLOBAL INVESTOR 1.15 — 11 > 

Liquidity premium 

Psychology 

and (il)liquidity 

Maintaining a certain amount of liquidity in a portfolio is fully justified, but investors tend 

to pay up too much for it while underestimating the extra returns from holding illiquid assets. 

The overpricing of liquidity seems to be greater in equities than in bonds, in part because 

in equities the price is strongly influenced by “stories,” whereas in bonds it is dry mathematics. 

INTERVIEW BY OLIVER ADLER Head of Economic Research, JOSÉ ANTONIO BLANCO Head Global MACS, 

SID BROWNE CIO and Head of Research Liquid Alternatives 

Sid Browne: Economic theory states that 

there should be a premium available for 

accepting illiquidity. You’ve studied premiums 

– and associated risks – attached to 

both illiquid and liquid assets. What can you 

tell us about your findings in general within 

a portfolio context? How should institutional 

and private investors invest? 

Roger Ibbotson: Let me start off by 

saying that the stocks that I study are actually 

publicly traded stocks. They may be less 

liquid than the most liquid stocks, but they’re 

all liquid stocks. There’s a strong theoretical 

reason why you’d expect less liquid stocks, 

in fact less liquid assets of any type, to be 

lower valued. People want liquidity, and 

they’re willing to pay for it. They pay a higher 

price for the most liquid assets, and therefore 

the less liquid assets sell at a discount. 

That discount means that, for the same 

cash flows, you pay a lower price and 

sub sequently you get higher returns. Now, 

what’s especially interesting in liquid markets 

is that giving up a little bit of liquid - 

ity actually can have a surprisingly big 

impact – by buying stocks that trade every 

hour, say, as opposed to every minute. 

José Antonio Blanco: From an investor’s 

perspective, could you call the effect you’ve 

just described a risk premium, or is it 

instead the result of market inefficiency in 

the sense that investors focus on certain 

companies and disregard the rest? 

Roger Ibbotson: It could be both. 

You can create a risk factor from a liquidity 

premium. But I am rather thinking of 

something I call a “popularity” premium, 

which I’ve expanded on in recent papers. 

The stocks that trade the most are the 

most popular. And those are the ones 

where there is mispricing because they get 

to be “too” popular, as measured for example 

by their heavy trading. Interestingly, our 

measures of stocks that trade less show 

lower volatility. So these stocks don’t really 

seem more risky. Therefore I don’t really 

like calling the extra return a risk premium. 

Sid Browne: What about in the event of a 

squeeze, when all of a sudden you want 

liquidity and rush to sell your illiquid stocks? 

Isn’t there that flight-to-quality risk? 

Roger Ibbotson: There could be the risk 

of having to sell quickly. In actual experience, 

though, for example in 2008 when you had 

a kind of a liquidity crisis, it was the most 

liquid stocks that were sold and dropped the 

most. So even in a financial crisis, the less 

liquid stocks do relatively well compared to 

the more liquid stocks. Now it is true that it 

is more difficult to sell the less liquid, and


people chose not to sell them. But it is still 

a fact that their prices fell much less than 

those of more liquid stocks. 

Sid Browne: So would it make sense to 

have a very large exposure in your portfolio 

to these types of stocks? 

Roger Ibbotson: If you’re a day trader, 

you don’t want to buy these kinds of stocks 

because they’re going to have higher trading 

costs. It really depends on your horizon. 

If you have a longer horizon, then buying 

less liquid stocks can make sense. 

Oliver Adler: Could you discuss the parallels 

in the bond market, or segments of the 

bond market, in terms of what those 

liquidity or illiquidity premiums would look 

like there? 

Roger Ibbotson: Well, first of all, bond 

markets are in the fortunate position of 

having yields to maturity that you can actually 

see. You know that if the bond doesn’t 

default, you’re going to get a specific return 

in that particular currency. And you know 

it in advance. 

In the equity market, you can’t see the 

forward returns in the same way. You only 

see the result. And since returns themselves 

are very volatile, it’s hard to discern 

what the result really is. Moreover, the return 

measures differ strongly over different 

periods. That’s why we can debate which 

of these premiums really exist and how high 

they are. This is quite different in bond 

markets where maturities are normally fixed. 

Oliver Adler: Would you say that the stock 

market gives rise to more irrational behavior 

in some sense than the bond market? 

Roger Ibbotson: I’m sure there is irrational 

behavior in the bond market, too. But 

yes, there is behavior in the equity market 

where essentially people are attracted to 

stocks that trade a lot. And they’ll pay more 

for them, just as you would do with brands 

in the consumer market. Consequently, 

the return structure is going to be different 

among the less popular and the more popular, 

and that leads to mispricing. Of course, 

you’re also going to see mispricings in 

the bond market, but they may be smaller 

there and they’re more visible and thus 

easier to take advantage of. 

Sid Browne: You’re saying that something 

could be more popular in the equity market 

than it would be in the bond market. 

So Apple stock, for example, could go 

“hot” and very, very liquid, but the debt, 

because it’s traded less and because 

it is a discounted flow of more certain 

“What’s 

especially 

interesting in 

liquid markets 

is that giving 

up a little 

bit of liquidity 

actually 

can have a 

surprisingly 

big impact.” 

Roger Ibbotson 

cash payments, would actually not be 

impacted by this popularity phenomenon. 

Roger Ibbotson: It could be affected, 

but it would not be affected by as much 

because you can see the pricing exactly in 

a yield spread. And so you know exactly 

what you’re paying for. 

José Antonio Blanco: Are you saying that 

we have more serious information issues 

in the equity than in the bond market? 

If you compare two bonds, it’s relatively 

easy to find the one that is paying too 

much, or too little. Whereas, for a stock, 

you might look at the past, but the future 

is much more difficult to assert. So, as 

an investor, you tend to grab things that are 

a bit easier to recognize, like brand names, 

along the lines “if something is popular, 

it’s probably better.” 

Roger Ibbotson: Yes. In the equity 

markets, you can tell stories about 

the stock. And the stories can be very interesting. 

And you can pay a lot for stories. 

That’s why, for example, value tends to 

have higher returns than growth. Growth 

gets highly priced because growth 

companies have much more interesting 

stories than value companies. In the bond 

market, all these same phenomena may 

exist, but there is more information. 

It’s much more mathematical. The spreads 

are visible. 

Oliver Adler: How about areas like private 

equity, or hedge funds, where you need 

a lot of knowledge and can’t easily 

tell stories? Might it therefore be fair to 

say that mispricing phenomena occur 

less frequently here? 

Roger Ibbotson: Well, mispricing can 

be pretty frequent in private equity as well 

because there’s actually less information 

for the buyer. You need more specialized 

expertise to understand the specific stocks. 

Also, in private equity, the presumption is 

that the private equity manager not only 

identifies undervalued stocks, but actually 

changes the company in some way to make 

it more valuable, perhaps by getting tax 

benefits, restructuring management or 

altering incentives. So there are potentially 

more possibilities for profit if you’re really 

good at doing that. 

Hedge funds typically buy publically 

traded equities or bonds – more or 

less liquid securities. When you invest in 

a hedge fund, you are essentially buying 

the manager who is buying liquid 

securities. 

continued on page 14 >


How Moody’s 

measures 

liquidity stress 

In periods of market stress, investor scrutiny 

often moves onto lower-rated financial 

instruments that have been issued 

with a premium yield level attached. 

Concerns about the ability of issuers to meet 

ongoing cash obligations for coupon payments 

can lead to investor flight from speculative 

bonds, just at the moment when those issuers 

most need to shore up their finances to remain 

in business. Classic examples might be riskier 

consumer finance companies, smaller oil and 

gas firms, and heavily leveraged property 

developers. If the stress period persists, such 

issuers are often unable to raise suffi cient 

short-term debt to maintain their trading 

activities and, if undercapitalized, they may 

even fail. 

Defaults in this riskier zone can prove contagious, 

both because of the effect on other 

parties exposed to a given sector or deal, and 

due to the psychological effect on the general 

investing public. A vicious illiquidity circle 

can develop, as occurred in real estate loans 

in 2008–2009, and may require government 

intervention and ultimately debt write-downs. 

Liquidity, a key element of credit analysis 

In order to provide additional transparency in 

its existing liquidity assessment process and 

arm investors willing to hold speculative- grade 

debt against falling foul of rapid shifts in market 

sentiment, the rating agency Moody’s 

began assigning Speculative Grade Liquidity 

(SGL) ratings in 2002. Loss of access to funding 

remains a risk criterion in any assessment. 

Defining speculative-grade liquidity 

risk as “the capacity to meet obligations,” 

SGLs describe an issuer’s intrinsic liquidity 

posi tion on a scale of 1 (very good) to 4 (weak). 

Assignment of a rating is carried out under 

detailed criteria for measuring a company’s 

ability to meet its cash obligations through 

cash, cash flow, committed sources of external 

cash, and potentially available options for 

raising emergency cash through asset sales. 

SGLs are a measure of issuers’ intrinsic 

liquidity risk – meaning Moody’s assumes 

companies do not have the ability to amend 

covenants in bank facilities or raise new cash 

that is not already committed. Such conditions 

are not typical in normal market environments, 

but can occur in periods of economic and 

credit market stress when companies need 

liquidity support the most to avoid default. 

Because Moody’s factors market access and 

the ability to amend covenants into its longterm 

ratings, the assumptions utilized in analyzing 

liquidity are more stringent. 

One proviso that Moody’s noted from the 

outset is that liquidity assessments focus on 

corporate capacity to meet obligations. Willingness 

to default remains a management 

issue that is not factored into SGL ratings, but 

is separately evaluated as part of the longterm 

ratings analysis. Ratings are dynamic and 

may be modified ad hoc, as with bond ratings. 

To date, Moody’s assigns SGL ratings to 

US and Canadian issuers alone, although 

the framework is used in most other regions 

as well. Moody’s maintains SGL ratings on 

appro ximately 840 issuers, with USD 1.8 trillion 

in rated debt. 

Index summarizes the market conditions 

Moody’s also created the Liquidity Stress 

Index (LSI) to provide a broad indication of 

speculative-grade liquidity. The LSI is the percentage 

of SGL issuers with the weakest 

(SGL-4) rating. Changes in corporate earnings, 

borrowing costs and ease of new debt 

issuance are critical drivers of changes in the 

LSI over time. Credit cycles tend to lead the 

economic cycle because willingness to leverage 

into expanding economic activity has to 

occur before the activity itself gets underway 

in the real economy. 

Speculative-grade companies do not have 

access to the commercial paper markets, so 

they are generally unable to quickly raise new 

financing in crisis moments. Measuring their 

riskiness essentially boils down to gauging 

the free cash flow from operations, cash on 

hand, and committed financing from other 

sources such as revolving credit facilities (the 

latter is not part of the SGL analysis.) 

More than 12 years after the introduction 

of SGLs, the track record now includes both 

extended periods of more-than-ample liquidity 

and phases of unprecedented risk and 

market stress. The LSI’s long-term average 

value since inception is 6.8%, with a record 

high reading of 20.9% in March 2009 at the 

height of the financial crisis in the US. The 

lowest level reached by the index was 2.8% 

in April 2013, with default and illiquidity risks 

exceptionally low. At the start of 2015, the 

index was still very benign at 3.7%, indicating 

a below-average forecast of the default rate 

of speculative-grade companies in the course 

of this year. Higher risks from falling oil prices 

were balanced against the steady earnings 

gains from US consumer spending. 

Article by 

John Puchalla, Senior Vice President, 

Corporate Finance Group at Moody’s 

Co-Author 

Gregory Fleming 

Senior Analyst 

+41 44 334 78 93 

gregory.fleming@credit-suisse.com


Oliver Adler: What sorts of issues come 

up in terms of liquidity and premiums 

with some of the more obscure asset 

classes, like infrastructure, or the 

not-so-obscure ones, like real estate? 

Roger Ibbotson: Well, of course, something 

like real estate is by its nature very 

illiquid. But there are structures that you 

can buy, like REITs (real estate investment 

trusts), that make it more liquid. If you put 

real estate into a structure that makes it 

more liquid, it tends to be more highly valued. 

A REIT is a more expensive way to buy 

real estate, but of course it has the benefit 

of being liquid. On the other hand, if by 

buying real estate you actually get involved 

in managing it, it’s a much more complicated 

thing. That’s more like private equity. 

All of these things are less liquid, and they 

all should have illiquidity premiums. I suspect 

that a lot of the return from real estate 

comes from its illiquidity premium. 

Oliver Adler: Given that the different asset 

classes seem to have different characteristics, 

how do you deal with the liquidity 

issue when you put everything together 

into a portfolio? 

Roger Ibbotson: People need a certain 

amount of liquidity. If you’re going to have 

a lot of illiquid assets, you also need some 

liquid assets to meet your liquidity needs. 

On the one hand, people should not pay 

for liquidity they don’t need. On the other 

hand, they may need more liquidity than 

they think. 

There’s a danger in going into too many 

illiquid assets, like real estate and infrastructure 

and private equity. Some of 

the universities, for example, did get into 

a bit of a squeeze in the financial crisis. 

They could not get very good prices for 

their private equity investments. One of the 

benefits of the kinds of stocks I’ve been 

talking about is that they can easily be 

sold in any crisis without paying much of 

a discount at all. 

Oliver Adler: But might it be possible 

to argue that illiquid assets could help to 

put a break on investors’ impulses 

to sell at the wrong time and save them 

from making mistakes? 

Roger Ibbotson: That’s an interesting 

argument. And, of course, there is evidence 

that overall stock market trends go in the 

opposite direction of what retail investors 

do: retail tends to sell after the crash and 

buy after the rise. So if retail investors were 

somehow prevented from overtrading, they 

might perform better. But the truth is that 

people want liquidity even though it sometimes 

leads them to take the wrong actions. 

José Antonio Blanco: Once you know 

what your liquidity needs are, is there a fair 

reward for real illiquidity? Or could you 

also achieve a higher return by structuring 

liquid assets, for example by exploiting 

anomalies or special effects, as you’ve 

described (I don’t want to call it risk 

premiums)? In other words, do you think the 

illiquidity premium is overestimated? 

Roger Ibbotson: I think one aspect 

of what you are speaking about is the ability 

to achieve “alpha” (a measure of outperformance 

relative to some asset class or 

benchmark). To get a lot of alpha, you may 

need to do a lot of trading. People are 

overconfident, of course, of their ability to 

achieve alpha. But the more you believe you 

can create alpha, the more you want liquidity 

because it is the lower-cost assets that 

may allow you to achieve alpha. 

In contrast, if you have long horizons, 

then you’re the natural type of investor 

to go after illiquidity premiums. The fact is, 

though, many people believe they can 

create alpha – some legi timately, and others 

who just think they can – and they will pay 

up for it. I don’t see that going away. So, 

the market will tend to pay too much for 

liquidity, and conversely underestimate the 

illiquidity premium. 

Roger Ibbotson 

The founder of Zebra Capital Management 

in 2001, Roger Ibbotson is also 

Professor in the Practice Emeritus 

of Finance at the Yale School of 

Management. He has written numerous 

books and articles, including “Stocks, 

Bonds, Bills and Inflation” with Rex 

Sinquefield (updated annually), which 

serves as a standard reference for 

information on capital market returns.


Private equity 

in emerging 

markets 

Markus Stierli 

Fundamental Micro Themes Research 

+41 44 334 88 57 

markus.stierli@credit-suisse.com 

Nikhil Gupta 

Fundamental Micro Themes Research 

+91 22 6607 3707 

nikhil.gupta.4@credit-suisse.com 

1 

The untapped potential 

of emerging markets 

Emerging markets make up: 

39% 

of global output 

18% 

of global stock market capitalization 

14% 

of global private equity fund-raising 

11% 

of global private equity investments 

2 

Global opportunity 

At USD 29 billion, emerging market private equity 

fund-raising has been concentrated in emerging 

Asia, but growth has been the fastest in Africa. 

USD 4 bn 

+327%* 

USD 29 bn 

+97%* 

3 

High expectations 

In the USA, private equity achieved annual returns 

of around 16% over 2009–2014. Only 39% of 

limited partners surveyed expect that the USA 

will be able to sustain that level in 2015. 57% 

of limited partners expect emerging market private 

equity portfolios to achieve net returns of 16% 

or greater in 2015. Historical annual returns for 

emerging market private equity were around 

13% over 2009–2014. Emerging market equities 

only returned around 4% over the same period. 

In comparison, US private equity trailed US equity 

markets in terms of returns. 

4 

The promise of venture capital 

Emerging market private equity investments 

increased by 60% in value between 2009 and 

2014. In the same period, venture capital investment 

value increased sevenfold, now making up 

more than 20% of total private equity investments 

in emerging markets. Technology investments 

have more than tripled in the same period. 

Emerging market private equity by strategy, USD bn 

40 

30 

20 

10 

0 

20.8 

33.8 

5 

* 2014 vs 2009 

6 7 

2009 2014 

Buyout Growth PIPE Venture capital 

Data sources used for the article: Datastream, Emerging Market Private Equity Association, Preqin 

Not all markets are equal 

Private equity investments expanded rapidly 

in China, Brazil and Nigeria, shrank slightly in 

India and collapsed dramatically in Russia 

and South Africa between 2009 and 2014. 

Private equity capital invested 

in key emerging markets, USD bn 

15.7 

6.9 

China 

5.5 

4 

India 

2.7 

1.5 

Brazil 

2 

0.1 

Russia 

2009 2014 

0.6 

0.1 

Nigeria 

1.5 

0.3 

South Africa 

In search of exit 

Asian venture capital investments have started 

to find viable exits through IPO routes. The 

aggregate value of venture capital exits quadrupled 

over 2013–2014 to reach USD 38 billion. 

Number of Asian venture capital exits 

8% 

5% 

3% 

22% 7% 

2007 

2014 

83 exits 

145 exits 

65% 

USD 9 bn 

50% 

Aggregate exit value 

Trade sale IPO 

Write-off Sale to GP 

USD 38 bn 

40% 

Moving up the value chain 

African private equity is moving up the value chain, 

away from extractive industries. 

PE investments in 2014, 

USD mn 

454 

415 

242 

119 

42 

Financials 

Telecoms 

Consumer 

goods 

Oil and gas 

Basic 

materials 

PE investments in 2009, 

USD mn 

253 

126 

63 

539 

458


Liquidity 

trends 

in illiquid 

alternatives 

Investors are increasingly showing appetite to commit to less-liquid alternatives. This includes 

investment opportunities in areas such as private equity, private debt and real assets. According 

to a recent study, shifting from liquid assets in which the primary investment return results 

from the market’s (or benchmark’s) movements to less liquid investments in which the primary 

source of the return is due to a fund manager’s skill at navigating an investment to a successful 

outcome typically results in a median return premium of 20%–27% over a fund’s life, and 

more than 3% per year. This illiquidity premium can be further enhanced by investing with the 

best-performing managers. These managers typically generate top-quartile investment returns 

and outperform the median performance benchmark by as much as 20 percentage points. 

Despite the opportunity to enhance overall portfolio returns (while reducing exposure to daily 

market volatility), individual investors tend to be under-allocated to illiquid alternatives relative to 

institutional investors. One oft-cited reason is the restriction on withdrawals of ten years or 

longer before fully returning capital and profits to investors. However, the recent growth of shorter 

duration and yield-producing investment strategies, such as direct lending to small and mediumsized 

enterprises, coupled with the emergence of a secondary market for early liquidity, 

may result in greater comfort with and more appropriate allocations to illiquid alternatives. 

AUTHOR SVEN-CHRISTIAN KINDT 

Head Private Equity Origination & Due Diligence, Credit Suisse 

Photo: Biwa Studio / Getty Images


The illiquidity premium 

The term “liquidity” refers to the ease with which 

an asset can be converted into cash. Assets 

or securities that can be easily bought and sold, 

such as bonds and publically traded stocks, are 

considered liquid. Private equity, private debt 

and real assets, in contrast, are said to be illiquid. 

Investment returns tend to increase with the 

degree of illiquidity of the asset. A recent study 

of nearly 1,400 US buyout and venture capital 

funds found that the aggregate performance 

of these funds has consistently exceeded the 

performance of the S&P 500 by 20%–27% over 

a fund’s life, and more than 3% annually. 

Investment returns generally 

increase with illiquidity 

Compound gross annual returns in % 

18 

16 

14 

12 

10 

8 

6 

4 

2 

Global 

government 

bonds 

Small equity 

US fixed 

income 

Deposits 

High yield 

Real estate 

Hedge funds 

1 2 3 4 5 

Venture capital 

Private equity 

Illiquidity estimates 

6 

The manager premium 

An increase in illiquidity shifts the primary source 

of the investment return from movements of 

the market itself (or beta) to a fund manager’s 

knowledge or skill at navigating an investment to 

a successful outcome. Manager skills influence 

the returns of illiquid alternatives primarily 

through strategic and/or operational improvements 

brought to portfolio companies. For example, 

a manager may be particularly able to increase 

portfolio company sales, reduce operating expenses, 

optimize asset utilization or exploit leverage. 

The potential for upside in illiquid alternatives is 

therefore driven not only by exposure to a specific 

illiquid category but also by investing with the 

best-performing managers. This is evident in the 

graph below, which shows that the return difference 

between top and bottom quartile managers 

can be over 30 percentage points in private equity. 

Manager dispersion 

increases as illiquidity grows 

Return differential vs median in % 

40 

30 

20 

10 

Top decile 

Median 2nd quartile 

3rd quartile 

–10 bottom decile 

–20 

Long-only Long-only 

fixed income equity 

Hedge 

funds 

Private 

equity 

Individual investor allocation 

Relative to individuals, many institutional investors 

with long investment horizons, such as 

pension plans (with their liabilities for retirees) 

and endowments (with their ongoing operating 

budgets), have built up significant allocations 

to illiquid alternatives, as shown over the last 

two decades. In 2013, the average US endowment 

held a portfolio weight of 28% in alternative 

assets, versus roughly 5% in the early 1990s. 

A similar trend is evident among pension plans. 

In the early 1990s, pension plans held less 

than 5% of their portfolios in less liquid alternatives; 

today the figure is close to 20%. 

Having a long-term investment horizon may give 

more patient investors an edge in harvesting 

the illiquidity premium. They can be rewarded for 

sacrificing liquidity that they do not need. 

Allocation to alternatives 

% of investment portfolio 

19.4% 

Pension 

28% 

Endowments 

2% 

Individual 

investor 

Source: Illiquidity estimates taken from “Expected Returns” by 

Antti Illmanen, 2011. 1994–2014 return data taken from Bloomberg, 

Citigroup, Barclays Capital, J. P. Morgan, Bank of America Merrill Lynch, 

NCREIF, Hedge Fund Research, Cambridge Associates, Russell 2000. 

Source: Taken from “Patient Capital, Private Opportunity” by The 

Blackstone Group, Private Wealth Management, 2013. Return data drawn 

from Lipper, Morningstar, Preqin and Tass. 

Source: Allocation data drawn from Cerulli Research, National 

Association of College and University Business Officers 2013/14 

Studies, Pensions & Investments 2013 Annual Plan Sponsor Survey. 

Liquidity options 

Historically, illiquid investment propositions such as venture capital and private equity funds required ten years or longer before fully returning capital 

and profits to investors. However, the growth of shorter-duration and yield-producing investment strategies and a secondary market for early liquidity may 

result in greater comfort with allocations to illiquid alternatives. The strategies outlined below are only a small subset of more liquid options available to 

the investment community. These, and others, should make it easier for individual investors to sacrifice liquidity that they do not need in order to capture 

(some of) the illiquidity premium. 

Private debt strategies 

The private debt market has seen strong growth since 2008, primarily 

driven by direct lending funds. According to alternatives data provider Preqin, 

over 200 private debt funds have raised in excess of USD 100 billion of 

new capital commitments in 2013–2014. Private debt is characterized by 

shorter investment duration relative to venture capital and private equity 

funds, and in the case of direct lending, funds can be combined with regular 

yield payouts to investors. The outlook for investing in the direct lending 

space remains positive due to persistent structural factors preventing middle 

market companies from accessing the broader traditional credit markets. 

While credit supply remains tight, demand for middle-market credit remains 

strong due to the expected deployment of committed, uninvested capital 

(also referred to as “dry powder”) and the refinancing overhang of middlemarket 

companies. 

Secondary strategies 

The secondary market in illiquid alternatives has been fueled in the recent 

past by new regulations (e. g. the Volcker Rule), by record amounts of 

dry powder and by improving economic conditions. A record USD 42 billion 

of assets have traded on the secondary market in 2014, up from USD 9 billion 

in 2009. Investors increasingly see secondaries as a viable channel to 

generate liquidity before fund lockups expire. They are using the secondary 

market to rebalance their illiquid portfolios, exit poorly performing investments, 

reduce capital costs or comply with new regulations. In order to 

increase liquidity for investors, some managers are now proactively offering 

the possibility of exiting their funds early. For example, in its latest flagship 

fund, a US buyout manager committed to selling fund stakes twice a 

year to a preselected group of preferred buyers. Other managers have 

started to provide interested sellers with a list of potential buyers.


Hedge funds 

On doing your 

homework 

TEXT BY ALEXANDER INEICHEN


Photo: Gerry Amstutz 

Recent skeptical reports in the press about 

hedge funds, and a high-profile divestment 

or two, have prompted speculation that hedge 

fund returns are in “structural” decline. Not 

so fast, says Alexander Ineichen. For investors 

willing to get off the couch, a careful study 

of hedge funds shows that they actually deliver 

higher-end returns than US equities do, 

with less volatility. 

Many seasoned investment professionals argue that liquidity 

is an illusion. It is something you think you have, and 

can measure in good times, but it vanishes immediately 

during a perfect storm. It is a bit like your path toward 

the emergency exit in a concert hall: under normal circumstances you 

can run toward the exit within seconds; when fire breaks out, you 

cannot. Liquidity is something everyone seems to require at the same 

time. The financial crisis of 2008 is a good example. Markets literally 

disappeared for a while. So-called market makers would delete their 

prices on their screens and not pick up the phone, even in markets 

that were considered liquid prior to the market disturbance. Another 

example is the more recent decision by the Swiss National Bank to 

drop its quasi-peg to the euro in January 2015. For a short time, the 

foreign exchange market – considered as the most liquid market in 

the world – stopped functioning properly. 

Hedge funds – a “quasi-liquid,” superior return profile 

Alexander Ineichen 

Alexander Ineichen started his financial 

career in derivatives brokerage and 

origination of risk management products 

at the Swiss Bank Corporation, UBS 

Investment Bank and UBS Global Asset 

Management. In 2009, he founded 

Ineichen Research and Management 

AG, a research boutique focusing 

on absolute returns, risk management 

and thematic investing. 

In his 2000 book “Pioneering Portfolio Management”, David Swenson, 

the CIO of Yale University’s endowment fund, distinguishes between 

liquid and illiquid. But, for hedge funds, he creates something 

in between that he calls “quasi-liquid.” This is a very elegant turn of 

phrase. Hedge funds are indeed not as liquid as US large-cap stocks, 

but are also not as illiquid as, say, private equity or real estate. 

In the last couple of years the gloss has come off hedge funds. 

Earlier, the high returns had turned a niche product into a flourishing 

industry. For example, an investment of USD 100 in the S&P 500 

Index at the beginning of 2000 was at USD 89 (–11%) five years later, 

including full reinvestment of the dividends. The same investment of 

USD 100 in an average hedge fund portfolio, after all the fees everyone 

complains about, stood at USD 141 (+41%) five years later. This 

is a big difference. 

Hedge funds did well in the second part of the last decade too. In 

the five years to December 2009, a long-only investment in the S&P 

500 went from USD 100 to USD 102 (+2%), whereas an investment


of USD 100 in the average hedge fund portfolio went to USD 132 

(+32%). This is still a big difference, but it had gotten smaller. In the 

five years to December 2014, a USD 100 investment in US equities 

more than doubled to USD 205 (+105%). However, USD 100 in the 

average hedge funds portfolio “only” rose to USD 125 (+25%). As an 

investor, which sequence do you prefer: –11%/+2%/+105% or 

+41%/+32%/+25%? The second sequence is superior in two ways: 

higher-end return with less volatility. I like to think of the first sequence 

of returns as “nature.” That is what you get if you do not apply 

risk management: moderate overall return with high volatility. 

Hedge funds can improve this sequence with active risk management. 

The second sequence does not appear in nature, it is man-made. 

Hence the fees. 

Challenges big and small 

The biggest challenges hedge funds face today are linked to the 

smaller managers. First, they find it very difficult to raise capital 

because the financial crisis and the Madoff incident caused private 

investors to more or less disappear. They are coming back only very 

slowly. This means the main source of capital comes from institutional 

investors who have a more sophisticated decision-making process. 

They expect a hedge fund to have at least USD 100–150 million under 

management and three years of proven real returns. Furthermore, 

institutional investors conduct due diligence with their managers, because 

a lack of it was one of the sources of disappointment in 2008. 

Institutional investors also expect various layers of operational excellence, 

adding to the cost base of hedge fund operators. This means 

that the barriers for smaller, less-established managers have risen. 

Finally, regulation has intensified. Large hedge funds can deal with 

the added bureaucracy more efficiently than smaller managers. 

But large hedge funds also face challenges, and one of them is 

related to regulation. The financial crisis, and the regulation wrath 

that it triggered, resulted in investment banks downsizing their trading 

operations. Liquidity in many markets went down. Because of the 

winner-takes-all effect that resulted in large hedge funds getting 

larger and larger, these growing hedge funds see dwindling liquidity 

as a challenge. A less liquid market means diminished opportunity 

and is more prone to gap risk. 

Are hedge funds a good/bad investment? 

“Over the last decade 

or so, the conceptual 

arguments for investing 

in hedge funds have 

not changed by much. 

However, the market 

place has changed.” 

ALEXANDER INEICHEN 

I always recommended to everyone willing to listen that they move up 

the learning curve with respect to risk management, absolute returns 

and hedge funds. Knowledge beats ignorance every time. An educated 

investment is better than an uneducated investment. And education 

compounds. At the end of the day, an investment decision is 

binary: either a position is established or it is not. This means the 

various trade-offs, the pros and cons, need to be carefully weighed 

against each other. This requires an effort, i.e. learning. Whether a 

nice chap recommends hedge funds is not that relevant for most 

investors. An investor needs to reach a level of comfort before investing, 

and a conviction once acquired requires ongoing reconfirmation. 

Both are a function of learning and effort. 

The late Peter Bernstein, author of one of the best books on the 

history of risk, once wrote that “liquidity is a function of laziness.” 

What he meant is that liquidity is an inverse function of the amount 

of research required to understand the characteristics of an investment. 

As he put it: “The less research we are required to perform, 

the more liquid the instrument.” An investment in US Treasuries requires 

less research than an investment in US equities. An investment 

in US equities requires less research than an investment in 

hedge funds and so forth. In sum, hedge funds are not for the lazy. 

Why I want hedge funds in my portfolio 

Hedge funds originally marketed themselves as absolute return products 

that deliver positive performance in any market environment. 

Now, in the wake of the financial crisis, hedge funds focus on their 

diversification benefits and risk-adjusted performance. A portfolio of 

hedge funds does not obviate any alternative or “classical” way of 

portfolio construction. However, hedge funds have properties that 

you do not find in other areas of finance. For example, trend-following 

managers have had a positive return in 17 out of 19 major corrections 

in the equity market since 1980. This is unique. There is nothing 

else in finance that has such favorable correlation characteristics. 

Among other asset classes, measured low correlation more often than 

not turns into an illusion when it is most needed, somewhat akin to 

perceived liquidity. 

Over the last decade or so, the conceptual arguments for investing 

in hedge funds have not changed much. However, the market 

place has changed. For example: hedge funds as a group are larger; 

the largest funds are larger; some trades are more crowded; liquidity 

in some market areas is lower due to Dodd-Frank; yields are lower 

and IT is more important. But again, conceptually, an intelligently 

structured portfolio comprising independent returns and cash flows 

is as worth considering by every thoughtful and diligent investor as it 

was in 1949, when the first hedge fund was launched. If you know 

the future, invest in what goes up the most. If you do not, construct 

a portfolio where the source of returns and cash flows are well balanced 

and the risk is actively managed, while not forgetting that perceived 

liquidity can turn into an illusion.


Hedge Funds 

Liquidity – 

a key to 

hedge fund 

performance 

Whether it’s related to an investor’s risk tolerance, or a 

fund manager’s decision on the appropriate trading strategy, 

the management of liquidity issues is a vital consideration 

when investing in hedge funds. And while illiquidity can be a 

source of risk, it can also be a source of additional returns. 

Annualized returns 

Liquidity is an important aspect to consider 

when investing in hedge funds. 

Liquidity issues have to be managed 

by both investors as well as hedge fund 

managers. While it is true that hedge fund 

liquidity has generally improved for investors 

since the global financial crisis, hedge funds 

are still less liquid investments than equities. 

To use Alexander Ineichen’s term, they can 

be called “quasi-liquid.” In the following, we 

take a closer look at the role liquidity plays 

for hedge funds and their investors. A key 

conclusion is that illiquidity is not only a drawback, 

but also a potential source of returns, 

which still has to be managed. 

Illiquidity as a source of return 

Hedge fund returns can be divided into three 

components: (1) returns from general market 

performance (also called beta factors), (2) 

returns from exploiting risk premia, including 

illiquidity factors (alternative beta), and (3) 

returns related to manager skills (e.g. in selecting 

securities and timing entry and exit 

into an investment, called alpha.) 

The performance of equity and fixed income 

markets to which hedge funds have 

exposure are typical beta drivers. The sensitivity 

toward these drivers varies across hedge 

fund strategies. While long/short equity strategies 

(which belong to the fundamental style, 

see box) have a relatively high sensitivity to 

equity market performance, the influence on 

managed futures (a tactical trading strategy) 

or fixed income arbitrage (a relative value 

strategy) may be minor. 

Hedge funds provide advantages 

Tactical trading 5.5% 

Relative value –1.9% 

Event driven –2.6% 

Low liquidity 

decreasing 

Directional investing –4.6% 


Directional investing 7.4% 

Event driven 7.3% 

Low liquidity 

increasing 

Relative value 5.8% 

Best trading strategy is a function of market liquidity 

In periods of low liquidity, tactical trading strategies have performed best. Particularly in an environment 

of low liquidity, this style stands out as the only one delivering positive returns. Source: Datastream, Credit Suisse 





High liquidity 

decreasing 




High liquidity 

increasing 


Generally, it is easy to gain exposure to traditional 

beta drivers. However, alternative 

sources of beta may not be as easily accessible 

through commonly traded instruments. 

Default risk and illiquidity premiums fall in 

this type of category, and hedge funds can 

be one way to access this type of return. For 

example, the distressed debt strategy in - 

vests in illiquid, distressed securities that are 

not commonly accessible to investors. In 

contrast, mutual funds have more stringent 

liquidity requirements and are usually restricted 

to invest at most in low-rated credit, 

while their structural setup allows hedge 

funds to take on such credit risk. Moreover, 

distressed debt hedge funds have a longer 

time horizon, which allows them to hold on 

to investments for longer and to wait until the 

company that issued the distressed security 

gets back on track. 

>


Glossary of liquidity provisions 

Redemption notice period Minimum period for 

advance notice prior to redemption. 

Redemption period Frequency with which 

investors can withdraw their funds. 

Lock-up Time period from the initial investment 

until it is possible to make a first withdrawal. 

Gates A gate limits withdrawals to a certain 

percentage of assets under management during 

any redemption period. 

Side pockets A provision that allows the manager 

to keep particularly illiquid holdings in a separate 

account. There is usually no liquid market for 

these holdings. It may be difficult to establish the 

holdings values and may be difficult to sell 

them. Hence, if an investor places a redemption 

request, the manager does not need to liquidate 

positions in a side pocket immediately. Pro rata 

proceeds of these holdings are only distributed to 

investors once these holdings have been sold – 

which can be long after an investor has withdrawn 

his capital. 

Investments in more illiquid securities on the 

side of hedge fund managers have implications 

for investors too. Since the forced selling 

of securities can mean selling at unfavorable 

prices, hedge fund managers can set up 

a range of provisions to avoid losses due to 

this. Liquidity provisions can take the form of 

redemption restrictions, lock-ups, gates, side 

pockets or a combination thereof (see glossary 

at the left hand side). It is no surprise 

that the strategies investing in the most liquid 

assets (managed futures and global macro) 

tend to be the strategies that offer the highest 

liquidity for investors. As a result of the bad 

experiences made during the financial crisis, 

with many investors not fully aware of such 

provisions, investors now desire a higher degree 

of liquidity. Consequently, more liquid 

strategies as well as structures like UCITS 

(undertakings for the collective investment in 

transferable securities), which are designed 

to accommodate this desire, have attracted 

more inflows. 

While barriers of withdrawal can protect 

investors from redeeming funds at the most 

unfavorable terms, there can also be arguments 

raised against such policies. Investors 

may get the impression that hedge funds are 

using such provisions as an excuse to earn 

further fee income before their capital is eventually 

returned. It is thus important that investors 

are assured that long lock-up periods are 

well justified – e.g. because the hedge fund 

is holding illiquid investments such as overthe-counter-traded 

distressed debt securities. 

Generally, investors eager to benefit from illiquidity 

premia should be prepared to take a 

longer investment horizon and be willing to 

accept more stringent liquidity provisions. In 

any case, it is important that investors clearly 

understand the fund terms in order to avoid 

unpleasant surprises later on. 

Liquidity requirements and return potential 

As Alexander Ineichen points out, hedge 

funds used to be known as an asset class that 

delivers superior returns at lower volatility. 

However, our view at this time is that lower 

expected upside from traditional asset classes 

(i.e. weaker beta drivers) in combination 

with structural changes is likely to dampen 

the return potential of hedge funds. With regard 

to structural changes, the investor base 

of hedge funds is increasingly made up of 

institutional investors, while private investors 

previously played a larger role. Tougher requirements 

regarding liquidity and transparency 

have made it easier for institutional investors 

to include hedge funds in their 

portfolios. Further, the shift toward a more 

institutional investor base has increased the 

focus on the role of hedge funds in a portfolio 

context: low correlations with other asset 

classes and more stable return patterns have 

become the key differentiating feature rather 

than the delivery of high returns. With tough- 

Hedge Fund Barometer variables: Liquidity 

Hedge funds thrive when liquidity conditions improve and are exposed to liquidity shocks 

when conditions tighten. Source: Credit Suisse/IDC 

Percentile rank value 

1.00 

0.90 

0.80 

Liquidity tight 

0.70 

0.60 

0.50 

0.40 

0.30 

0.20 

0.10 

0 

Liquidity plentiful 

Jan. 92 

Jan. 96 Jan. 00 

Jan. 04 Jan. 08 Jan. 12 

Liquidity composite 13-week moving average composite


er regulatory requirements, operating costs 

have risen, which in turn has left some smaller 

hedge funds unprofitable. Conversely, institutional 

investors have been willing to sacrifice 

high returns for lower risk as long as 

their needs for liquidity and transparency are 

fulfilled. For these structural reasons, we 

think that the return potential of hedge funds 

has generally decreased. 

Liquidity drives our hedge fund strategy 

The Credit Suisse proprietary Hedge Fund 

Barometer is our main tool to assess the 

broad investment environment for hedge 

funds. The tool is an early warning framework 

that should help avoid unnecessary risks. Besides 

volatility, the business cycle and systemic 

risk, the tool also assesses liquidity 

conditions. While we have observed a general 

increase in risk starting in late 2014, 

tightening liquidity conditions began to draw 

our attention in early 2015. As the second 

chart shows, liquidity conditions deteriorated 

around the turn of the year. While tighter liquidity 

is generally a concern for hedge funds, 

some strategies are less affected and can 

even thrive in such an environment (see first 

chart). Given the divergences in monetary 

policies between the main regions and, in 

particular, the likely approach of rate hikes by 

the US Fed, we do not expect liquidity conditions 

to improve materially in the near future. 

Therefore, we adjusted our hedge fund strategy 

in early 2015 and began to focus on 

strategies that are less sensitive to liquidity 

conditions, e.g. tactical trading strategies. At 

the same time, our outlook worsened for 

relative value strategies, particularly those 

that are active in fixed income investments. 

These strategies typically apply higher leverage 

and/or invest in more illiquid securities, 

and are thus at greater risk when liquidity 

conditions tighten. 

In sum, when investing in hedge funds, 

investors should not just take traditional market 

drivers into account, but also focus on 

liquidity considerations. Illiquidity can be a 

source of risk, but also a source of additional 

returns for investors. Careful analysis of 

the role of market liquidity in an investment 

strategy can help avoid unnecessary risks and 

lift returns. 

Marina Stoop 

Cross Asset and Alternative Investments Strategist 

+41 44 334 60 47 

marina.stoop@credit-suisse.com 

The different hedge fund styles 

and how they deal with liquidity 

Tactical trading strategies are resilient when liquidity is scarce 

Tactical trading strategies include global macro and managed futures. 

In this style, managers try to exploit trends in equity, fixed income, 

currency and commodity markets. Analysis of macroeconomic variables 

rather than corporate transactions or security-specific pricing discrepancies 

distinguishes tactical trading from other styles. 

Tactical trading strategies trade in all major markets. However, one 

major difference between managed futures and global macro is that 

managed futures focus on trading futures contracts, the most liquid instrument. 

In contrast, global macro managers have the widest investment 

universe trading a broad range of different market instruments. 

Another key aspect of the tactical trading style is that some strategies 

are purely model driven. Within managed futures, trend-following strategies 

are probably the best-known example of this strategy. A model generates 

trading signals upon which trades are executed. Human discretion and 

emotions are negated, which helps explain why tactical trading strategies 

are well positioned to navigate through crisis periods. While discretionary 

managers may rely to some degree on models, they can use their own 

judgment when making investment decisions, and may be more prone to 

making irrational decisions in a tough investment environment. 

Fundamental strategies have various degrees of sensitivity to liquidity 

Fundamental strategies focus on individual securities, mostly in the equity 

and fixed income areas. While directional strategies usually build a broader 

portfolio of more liquid securities and thus deliberately take directional 

market exposure, event-driven strategies often build a more concentrated 

portfolio of securities depending on a specific catalyst (event). Directional 

strategies tend to take positions in more liquid publicly traded securities, 

while event-driven styles often engage in illiquid securities (e.g. distressed 

debt, special situations and activist investors with longer holding periods). 

While liquidity sensitivity depends on the underlying investments, the 

leverage applied is typically lower than in the relative value segment. 

Relative value strategies depend on a favorable liquidity environment 

Relative value strategies include fixed income arbitrage, convertible 

arbitrage and equity market neutral strategies. They aim to exploit pricing 

inefficiencies between related or unrelated securities and try to avoid 

directional market exposure. Forgoing returns from beta drivers, returns 

of these strategies would naturally be lower (yet more stable and with very 

low correlation to movements in major asset classes). Leverage is a way 

to enhance returns. It can be high, particularly for fixed income strategies 

where targeted pricing inefficiencies can be small. But this makes the 

strategy sensitive to liquidity conditions. While these strategies tend to do 

well as long as markets move in their favor, volatile markets with scarce 

liquidity can mean that positions need to be sold at unfavorable prices – 

or worse, cannot be sold at all. This left many investors with large losses 

during the financial crisis. It is thus vital to keep an eye on market liquidity.


1800 

Open-end versus 

closed-end funds 

0 

Making what turns out to be the right investment 

decision can hinge upon the underlying asset 

–2 

type, and understanding the fundamental 

1600 

differences between open-end and 

closed-end funds. 

In good times 

On the upward trend, 

investors see the discount 

narrowing noticeably for 

closed-end funds as the 

economy strengthens. 

–4 

–6 

Index points 

1400 

1200 

1000 

In times of crisis 

The discount of closedend 

funds mirrors the 

development of the overall 

market. The discount 

increases as the crisis 

unfolds, but is quick to 

revert again as recovery 

begins to take hold. 

– + 

–11% 

–7% 

–8 

–10 

–12 

–14 

Discount to NAV in % 

–16 

800 

–18 

600 

–20 

01.05 07.05 01.06 07.06 01.07 07.07 01.08 07.08 01.09 07.09 

MSCI World Average discount 3m MA (rhs) 

Average discount to net asset value for US closed-end investment funds 

Through the worst of the Global Financial Crisis, the average discount on closed-end funds dipped from roughly – 7% to – 11% in January 2008 

before rebounding sharply, but briefly – after which it fell to –18% before recovery at the start of 2009. Source: Bloomberg, Credit Suisse


Investors have many choices when selecting 

a pooled investment fund: regional 

versus global, active versus passive, bonds 

versus equities, famous manager versus 

start-up, and so on. But one choice can be 

overlooked: open-end versus closed-end 

funds. On occasion, this may be the most 

important issue. 

As we will show, the practical difference 

for investment returns may not be great under 

normal market conditions, but can become 

significant at times of market stress, especially 

for funds investing in illiquid assets such 

as real estate, small caps, or specialized credits. 

In such cases, a closed-end fund may be 

the better structure. 

Key differences 

Closed-end funds have a fixed asset pool. 

This can grow (or shrink) due to good (or bad) 

investment performance, but normally no extra 

capital is added from investors or paid out. 

An existing investor who wants to exit must 

sell on the open market to another investor 

who wants to put money in. In contrast, the 

assets in open-end funds can change because 

of shifts in market prices as well as due 

to net inflows or outflows of capital from investors. 

When net new money comes in, the 

manager invests in extra underlying assets, 

while exiting investors sell units back to the 

fund manager, who disposes of underlying 

investments to meet net redemptions. 

Operation under normal market conditions 

Investors in open-end funds buy and sell units 

at a level equal to the underlying asset value 

(subject to enough liquidity, see below). By 

contrast, the price of closed-end funds is typically 

at a premium or discount to the underlying 

assets, reflecting the balance between the supply 

from exiting investors versus demand from 

those entering. Academic studies have argued 

that a premium might reflect the skill of the 

manager or the rarity of the underlying assets, 

while a discount might indicate lack of confidence 

in the manager. Morningstar data shows 

that, over the long term, closed-end US funds 

have on average traded at a slight discount. 

This tends to deepen when markets go down, 

while it narrows or moves to a premium when 

markets go up and investors become more 

optimistic. 

Some closed-end funds buy back their 

own shares to try to narrow the discount, enhancing 

value for remaining investors. Sometimes, 

external predators try to gain control 

and liquidate the fund at the market value, 

thus effectively eliminating the discount. 

Despite these measures, discounts and premiums 

rarely disappear completely, perhaps 

because demand for most closed-end funds 

is dominated by retail investors who tend to 

be procyclical. 

When money flows in or out of open-end 

funds, the dealing costs are in many cases 

spread among all investors. The impact of these 

costs may be negligible in large funds with 

little movement, but can be a noticeable burden 

on performance in small, fast-growing funds. 

Perhaps, more importantly for an open-end 

fund with specialist strategies in relatively illiquid 

assets like small-cap or frontier-market 

stocks, a good performance in the early years 

when the fund is small may be difficult to replicate 

later if large amounts of new money are 

attracted by the good results, but are not easily 

investible in the same way. So many successful 

open-end fund managers in specialist 

areas close their funds for new investments to 

protect existing investors as they approach 

capacity limits. If a manager does not do this, 

there can be style drift, making the track record 

of a fund manager less relevant. 

Operation in stressed markets 

When markets become stressed, such as during 

the financial crisis, some assets may become 

illiquid, while others remain easy to sell. 

When this happens with an open-end fund, 

the first investors to exit will tend to receive 

cash obtained by the manager from sales of 

the more liquid assets. While this is good for 

these faster-moving investors, slower-moving 

investors are left with units in an imbalanced 

fund that holds mainly illiquid assets that cannot 

be readily sold and for which the theoretical 

valuation may fall further than the more 

balanced portfolio existing before the stress 

began. Well-known examples in recent years 

include some frontier-market, real estate and 

credit funds. Fund managers may have some 

ability to restrict (“gate”) withdrawals. If this 

is done early in the stress situation, it in effect 

temporarily makes the fund closed, protecting 

remaining investors. But in a worst-case scenario, 

this closure happens after the faster 

investors have left, which leaves remaining 

investors trapped with a pool of illiquid underlying 

assets that may then eventually be sold 

as soon as some limited liquidity reappears, 

which unfortunately is likely to be near the 

bottom of the market. 

Clearly, this process simply cannot happen 

in a closed-end fund. Faster investors who 

try to exit will likely find few buyers, forcing 

the fund price down to a substantial discount 

to the apparent net asset value. In the middle 

of the financial crisis in early 2009, the average 

discount of the largest US-listed closedend 

funds rose as high as 25%. But the fund 

manager is not forced into selling the underlying 

assets to meet withdrawals. Investors 

who are prepared to hold their nerve through 

the phase of stress will still own a share in 

the balanced pool of assets selected by the 

manager, with a good chance of recovery after 

the stress has passed, and they will not 

be forcibly liquidated near the bottom of the 

market by the selling actions of other investors 

in the fund. Indeed, after the financial crisis, 

the average discount narrowed quickly as 

markets recovered, providing an additional 

return driver for these funds on top of the rise 

in price of the underlying assets. 

Conclusion: Horses for courses 

The conclusion is that investors should choose 

between open-end and closed-end funds 

largely on the basis of the underlying asset 

type. For investments in mainstream, liquid 

markets like developed economy large-cap 

equities, an established large open-end fund 

is probably the better choice in most cases. 

It avoids the fluctuating premiums/discounts 

of closed-end funds and should be large 

enough to avoid issues of dealing cost attribution, 

although it would likely not have leverage 

capability. 

In contrast, closed-end funds are likely to 

be the better choice for underlying assets 

such as real estate, frontier markets, small 

caps and low-grade credit, since these are, 

or are at risk of becoming, illiquid with all the 

potential issues described above (see article 

on Swiss real estate funds on page 47 for 

more details). 

Giles Keating 

Head of Research and 

Deputy Global Chief Investment Officer 

+41 44 332 22 33 

giles.keating@credit-suisse.com 

Lars Kalbreier 

Head of Mutual Funds & ETFs 

+41 44 333 23 94 

lars.kalbreier@credit-suisse.com


Liquidity issues in an institutional portfolio context 

Attractively 

consistent 

Patient, yet opportunistic. Those are two key characteristics 

of the New Zealand Superannuation Fund, whose very long-term 

investment horizon allows it to pursue contrarian and illiquid 

strategies if the price is right, all while managing liquidity at the 

whole-fund level. 

INTERVIEW BY OLIVER ADLER Head of Economic Research 

JOSÉ ANTONIO BLANCO Head Global MACS 

Oliver Adler: From the point of view of 

a private client, what’s special about 

the New Zealand Superannuation Fund 

(NZ Super Fund), as a national 

sovereign wealth vehicle? 

Adrian Orr: We are a “buffer” fund. 

Our aim is to smooth the increasing financial 

burdens for future generations. For 

that reason, we have a very long-term 

investment horizon: no money will come out 

of the fund until at least 2031. That provides 

us great certainty around our investment 

horizon and our liquidity needs. These 

“endowments,” as we call them, together 

with our governance and our ownership 

(i.e. our control over our capital) allow us a 

very high level of risk appetite and also 

the ability to invest in what can be called 

illiquid assets. 

Oliver Adler: How do you decide 

your investment strategies? 

Adrian Orr: We have a number of 

investment beliefs against which we continuously 

test ourselves, for example, that 

there is some concept of fair value for an 

asset, and that prices may deviate from 

fair value, but should also revert to it over 

time. These beliefs give us the confidence 

to pursue contrarian strategies, as well 

as illiquid strategies, if we think the price is 

right. All potential investments, regardless 

of asset class, are measured in terms of 

their attractiveness – either as a diversifier, 

or as a (mispriced) opportunity – and, more 

generally, their consistency with our beliefs. 

Oliver Adler: Isn’t that what the vast 

majority of funds do? 

Adrian Orr: Most funds have specific 

strategic asset allocations (SAAs) to which 

they are always rebalancing, whereas 

we are opportunistic: we are continuously 

shifting from the least attractive to the most 

attractive asset classes or assets, based 

on our confidence in our strategies. We are 

least invested in black-box hedge-fund-type 

strategies that are purely skill-based. We 

have low confidence in skill as a basis for 

adding investment value because we really 

struggle to be able to assess it, and we 

also have low confidence in its consistency. 

José Antonio Blanco: What kind of horizon 

do you use to estimate the attractiveness 

of an asset mispricing? How much do 

you want to have in illiquid assets? And how 

much in liquid ones? 

Adrian Orr: We define a long-term investor 

as someone who has command over 

the capital. So at any point in time, we >


Photos: Jamie Bowering 

Adrian Orr is CEO of the New Zealand Superannuation Fund, which has posted annualized returns between 17% and 25% over the last five years.


José Antonio Blanco 

Head Global Multi Asset Class Solutions 

+41 44 332 59 66 

jose.a.blanco@credit-suisse.com 

Managing portfolios – 

a quest for value 

Credit Suisse Private Banking follows a structured investment approach, 

which starts by defining a suitable strategic asset allocation (SAA) for its 

clients and then actively managing the mandate portfolio in a disciplined 

way around this SAA. However, the SAA is periodically checked and 

adjusted (see interview). Although financial markets in some broad sense 

tend to be efficient, there are costs to finding relevant information quickly 

and acting on it appropriately; so price movements in response to events 

are sometimes neither instantaneous nor always correct. This opens 

opportunities to improve the return and risk characteristics of portfolios 

over time by deviating from the strategic allocation in various ways. 

We therefore manage portfolios actively, generally in all dimensions 

across asset classes, markets, currencies and individual securities. 

In our quest to add value, we combine in-house insights with added 

value provided by other parties as long as their investment style fits 

with the logic and structure of the mandate portfolios and the requirements 

of the client. Unless specifically instructed to do otherwise, discretionary 

portfolios for private clients are predominantly invested in fairly liquid 

assets, in the sense that we focus on assets that are easy to trade and 

monitor, although we will take some limited liquidity risk by investing some 

of the portfolios in asset categories (like high-yield bonds) and strategies 

(hedge funds, for example) that are less readily tradable and should 

therefore generate a liquidity premium on top of their other characteristics. 

Our prudence with regard to illiquid assets is the result of regulatory 

considerations (some asset categories cannot be offered to private 

investors because they require very specialized know-how and may entail 

high and unusual risks) and the fact that investments in illiquid assets 

limit our ability to adapt the portfolios to the changing environment and 

client needs. These types of assets are therefore best managed separately 

from the liquid part of the portfolio. 

should have the ability to buy or sell on our 

own terms. When you apply that definition 

of a long-term investor, what it means is that 

we manage our liquidity at the whole-fund 

level. We want to make sure that we don’t 

suddenly find ourselves in a situation where 

we’ve got a fund full of illiquid assets and 

have to shed assets in a fire-sale. We always 

want to preserve the ability to buy assets 

at opportunistically favorable times, for 

example, when they are poorly priced by 

the markets. 

Oliver Adler: How do you price liquidity? 

Adrian Orr: We have an absolute level 

of liquidity that we wish to maintain at 

any point in time for the fund. And we have 

a pricing schedule for that liquidity as we 

approach that must-have level. The level 

for the fund as a whole is established 

through specific scenario shock analysis, 

so that we are always in a position to buy 

assets at the markets’ darkest moment, 

as opposed to having to sell assets. Having 

a moving price structure rather than a 

defined target quantity of specific illiquid 

assets tends to create the right incentives 

within the fund. 

Oliver Adler: Might it mean that, in a market 

stress period, your liquidity level actually 

falls? And could that also mean that 

you may not be able to then invest in the 

opportunities you had thought you 

might want to invest in? 

Adrian Orr: Well, we try to anticipate 

and pre-empt exactly that. We are thinking: 

what does this portfolio look like in bad 

times? And that consideration sets the price 

or the “hurdle rate” we are prepared to 

accept for making that investment. In other 

words, we have a “waterfall” of liquidity, 

starting from the highest, mostliquid investments 

through to the leastliquid asset 

structures. We have a pricing structure 

and a management structure for the whole 

fund that allows us to work our way through 

that waterfall. By the time you get down 

to the leastliquid assets, you are in a very, 

very strange world, one where liquidity 

would probably be the least of your concerns. 

José Antonio Blanco: A look at the 

current structure of your fund shows that 

the allocation to what might be called 

less liquid investments is very broad and 

relatively small (about 20%). Why do 

you diversify broadly on the illiquid side, 

while having quite significant chunks on 

the more liquid side?


Adrian Orr: You have to take your 

mind out of an SAA framework. We asked 

ourselves, how could we achieve our purpose 

in the least-cost, simplest manner? 

That means going out and buying listed, 

low-cost liquid assets to create what we 

call our reference portfolio. It ends up being 

effectively 80% equity, 20% fixed income, 

globally diversified. And we think of that 

reference portfolio as delivering a Treasury 

bill plus 2.5% return, on average, over 

20 years. We then get out of bed every 

morning and say: how can we outperform 

that reference portfolio? How can we 

add value? 

José Antonio Blanco: Adding value 

means …? 

Adrian Orr: Improving the Sharpe ratio, 

a higher return for the same risk, or the 

same return for less risk. And that is when 

we start actively investing. 

Oliver Adler: If you compared your actual 

allocations with a typical SAA for a balanced 

fund, how marked would the deviations 

be, say, in the main asset classes from any 

kind of starting or “reference” point? 

Adrian Orr: The deviation is quite big, 

and has become more visible since about 

2007, when we shifted away from our 

SAA (we had one once!) and got far more 

active and more direct in our investment 

strategies. This is also the period of 

high growth in the value-add of the fund. 

So I would compare our strategy style to 

a growth fund’s, not a balanced fund’s. 

We have performed exceptionally strongly 

over the last five years or so, with 

annualized returns anywhere between 

17% and 25%. 

Oliver Adler: What about illiquid asset 

classes such as real estate, which 

is probably very local? Or infrastructure, 

which everyone is talking about? 

Adrian Orr: Many of our illiquid assets 

have entered the portfolio as diversifiers 

(like timber) or because there was a 

significant market mispricing, or a specific 

asset mispricing (like Life Insurance Settlements). 

Infrastructure has been the real 

tough one. Infrastructure assets have been 

very sought after; so we rarely see a 

mispricing opportunity, and they aren’t as 

good a diversifier as people claim unless 

they are true infrastructure. 

José Antonio Blanco: How do you handle 

the delicate question of ethical and 

sustainable investment vis-à-vis illiquid 

assets? 

“We then get out of 

bed every morning and 

say: how can we 

outperform that reference 

portfolio? How can 

we add value?” 

Adrian Orr 

Adrian Orr 

CEO of the New Zealand Superannuation 

Fund, which he joined in February 2007, 

coming from the Reserve Bank of New 

Zealand where he was Deputy Governor. 

He has also held the positions of 

Chief Economist at Westpac Banking 

Corporation, Chief Manager of the Economics 

Department of the Reserve Bank 

of New Zealand and Chief Economist at 

The National Bank of New Zealand. 

Adrian Orr: A big part of our emphasis 

on consistency is related to environmental 

and social governance issues. We will 

not enter into an external manager contract 

if we cannot get the transparency we 

need and the behaviors and reporting and 

performance that we expect. 

Oliver Adler: Would you agree that the 

set of opportunities for you has diminished 

over the last few years generally, if you 

look across most investable assets? 

Adrian Orr: Very much so. Our big valueadd 

came from being able to be a contrarian 

investor. Now equity prices are broadly 

at fair value, globally. There are still some 

opportunities in Europe and Japan, but 

that’s where we have lower confidence. 

José Antonio Blanco: In principle, 

does the current situation favor illiquid 

assets relative to traded assets? 

Adrian Orr: I would say the illiquidity 

premium has declined. There’s so much 

global capital chasing illiquid assets, 

that we just think, why bother? Why take 

on illiquidity and all of the governance 

challenges that come with direct investing 

when you’re not being rewarded for it? 

So we can be patient and await better 

opportunities over time.


Talking 

teak


Trees are a fixture of the 

physical landscape, inspiring 

the human imagination, and 

their products are a ubiquitous 

component of everyday life. 

Small wonder that they also 

constitute a vehicle for investment. 

Teak is particularly 

prized for its beauty, spiritual 

associations, durability and ease 

of workmanship. A teak tree 

matures in about 20 years and 

is fairly easy to grow, though 

the locations where it thrives 

pose their own challenges. 

Nonetheless, in the right hands, 

teak offers an interesting 

pro position for the patient 

in vestor. 

INTERVIEW BY GISELLE WEISS 

PHOTOGRAPHY LUCA ZANETTI


Carol Franklin 

Chairman of the Board of Forests for 

Friends and of the Tree Partner Company, 

she earned her PhD in English literature 

before assuming a series of management 

positions at Swiss Re over the course 

of 20 years. She subsequently became 

the Executive Director of WWF (World 

Wide Fund for Nature) Switzerland. 

Giselle Weiss: You describe “falling into” 

the business of growing trees but finding it 

interesting. Why? 

Carol Franklin: Investing in trees 

means you give your money away for 

20 years. The concept is difficult to sell 

in the sense that if you go about it properly, 

it really is illiquid. Most of our competitors 

say that you will get a first payout after 

three to five years, and that they will 

reimburse your investment if necessary, 

which is absolute rubbish. They also 

tell you that returns are between 9% and 

15% a year, which is also rubbish. We 

compare our return to what you used to 

get on a savings account – so something 

like 6% to 7% per annum, 85% of 

which comes in after 20 years when 

the trees are harvested. 

How does it work? 

Carol Franklin: The basic concept 

is that the investor pays all the money 

up front, on a shareholding basis. In other 

words, we have enough money for the 

20 years it takes for the trees to grow. 

We buy the land, plant the trees, and maintain 

them very carefully. If all goes well, 

we have the first non-commercial thinning 

after four to five years. Then after eight, 

14, and the final harvest after 20 years. 

Let’s backtrack just a bit. Why trees, as 

opposed to vineyards or fancy cars or 

Picassos or a nice little chemical start-up? 

Carol Franklin: I personally have always 

been interested in ecology. And trees are 

vital for our survival. They help slow down 

climate change by capturing CO 2 . They 

are something that you can see and touch, 

as opposed to, say, derivatives. Why teak? 

After 20 years you can sell the wood. 

There are a lot of beautiful and interesting 

trees, but they have no international market, 

whereas there is a functioning international 

teak market. At the moment, we are selling 

all our wood to India, which could buy 

the entire worldwide harvest. Recently, the 

markets of Vietnam and China have been 

growing, and some of the wood is going 

to these countries to make very nice 

garden furniture, doors, cabinets, whatever. 

It would be nice if the US and European 

markets became stronger again in the 

near future. 

Just to be clear, we’re talking about tree 

plantations, not tropical forests, right? 

Carol Franklin: Yes. We plant the trees 

on former cattle land. Plantations are not 

ecological, although ours are all certified by 

FSC (Forest Stewardship Council). What 

plantations do is to take the pressure off 

the primary forests, as people no longer 

have to go and cut trees in the jungle. 

And the reason for doing it in Panama? 

Carol Franklin: Teak only grows in 

tropical regions, but you probably wouldn’t 

want to invest your money in many of the 

countries along the equator. Panama has a 

relatively reliable legal system and, due to 

its narrow shape between two oceans, 

there is always a port nearby. If you plant in 

Brazil, for example, and people do, the 

nearest port can be 3,000 kilo meters away. 

Getting the timber there costs a fortune. 

Unlike overland transport, sea transport is 

not very expensive. Panama also has tax 

incentives for reforestation. 

Who should invest in a teak plantation? 

Carol Franklin: It’s not about quick 

money. So patient money, possibly. People 

who have an affinity for trees. People who 

are ecologically minded and who want 

to do something to save the world. Pension 

funds would be ideal because it’s a longterm 

asset and pension funds have calculable 

long-term liabilities. It’s well suited 

to family offices: traditional families used to 

have their own woods, and some still do. 

We have many grand parents! They think 

long-term, and teak is a shorter return than 

German forests, for example. A German 

oak takes 100 years to mature. 

And who should not invest? 

Carol Franklin: Someone who might 

need the money in the next 20 years. 

I’d also never invest more than 10% of my 

available money in something like this. 

We’re not listed, which means the investment 

is even more illiquid. But this also 

means we are decoupled from the financial 

markets. So if everything goes down, 

which it will again of course, at least your 

trees will continue to grow. And if the wood 

price happens to be unattractive at any 

given moment, we can just let the trees 

stand and wait. It’s not rice or oranges or 

vineyards. 

Could you describe the planting cycle? 

Carol Franklin: You buy the land. 

You prepare the land. You plant the trees. 

You have to get the right soil and the right 

seedlings. Over the past ten years, seedlings 

have improved dramatically. Because 

our plantations are ecologically certified, 

you can’t use certain pesticides and herbicides, 

so you have to keep the grass and 

shrubs down with the machete.


“There are a 

lot of beautiful 

and interesting 

trees, but they 

have no international 

market, 

whereas there 

is a functioning 

international 

teak market.” 

Carol Franklin 

As the trees grow, you cut the branches to 

avoid knots in the wood. You usually plant 

between 800 and 1,100 trees per hectare, 

with the trees spaced about 3 meters apart. 

After four years, you thin the trees to give 

them enough room and light to grow and 

become tall, strong and straight trees. 

And you continue to thin as the trees grow? 

Carol Franklin: Yes. The next thinning 

is usually after eight years. This is the 

first commercial thinning and the wood is 

used for doorframes, tongue-and-groove 

walls, indoor floorboards or furniture. As we 

now get more money than we pay for the 

thinning, we can use the proceeds for 

the maintenance. So in the cash plan this 

is income, but we do not distribute it to 

the shareholders – unlike some companies 

who use this money to keep their shareholders 

happy and have to look for additional 

income for maintenance. There’s another 

thinning at 14 years, and the final harvest 

at 20, but it could be 18 or 22, depending 

on the growth of the trees and the state 

of the market. 

Aren’t the trees vulnerable to weather 

or natural enemies? 

Carol Franklin: For the first four or 

five years, you have to be careful about fire. 

So we have fire breaks, usually roads. 

And we have people living in the plantation 

to watch. Panama has no hurricanes. 

We do have local windhoses, and sometimes 

a bunch of young trees will fall over. 

But you can put them back up and they 

continue to grow. There’s also a type 

of fungus, but it’s fairly limited, and we 

are on the lookout for it. 

What should investors know or consider 

before they make such an investment? 

Carol Franklin: The main thing is that 

they should realize that the money is out 

of their portfolio for 20 to 24 years. And 

they should check us out because you 

invest in people and not in things. It’s like 

re-insurance. It seems very technical, but 

in the end, you underwrite the underwriter. 

Do you worry about climate change? 

Carol Franklin: Well, there are general 

concerns about the unpredictability of 

the rains. And, naturally, if the tropics were 

to become colder, that would be an issue. 

But on a day-to-day basis, I think political 

risks tend to be higher than natural risks. 

Panama is probably more stable than some 

of the other countries in the tropics. 

Do people come to see the trees? 

Carol Franklin: We organize investors’ 

trips including visits around Panama – 

to the canal, an indigenous village, the old 

fortress near Colón and our sheep and goat 

farm. We have quite a few people who 

just want to have a look and not invest, or 

who want to get a feel for who we are 

before they invest. We’re happy with that. 

If you were starting over, would you do 

this again? 

Carol Franklin: My first experience with 

this type of investment was actually sitting 

on the board of a company that failed. It’s 

a long story. My husband and I made it our 

business to rescue it – now called Forests 

for Friends – which was a huge gamble and 

the odds were against us. But if we hadn’t 

accepted the challenge, two-and-a-half 

thousand people would have lost their money. 

We succeeded, and that effort, as well 

as starting The Tree Partner Company, has 

changed my life.

GLOBAL INVESTOR 1.15 — 34 3 

1 

2


2 

Tree Partner 

Province Darién 

Shareholders’ investment 2014: CHF 4,207,407 

1 The Tree Partner Company comprises two teak plantations totaling 170 hectares, located within three hours driving distance of Panama City. 

2, 3 Engineers periodically gather statistics on how well the trees are growing. The first commercial thinning occurs at about eight to ten years, when the tree 

trunks measure 40 centimeters circumference minimum.


4 

5 

6


7 

4 Trees cut from the first thinning will be made, for example, into door frames. 5 Panama’s proximity to ports is a huge advantage in terms of cost. 6 Harvest takes place 

around 20 years after the planting, when the entire plantation is felled, or “clear-cut.” 7 The plantations provide jobs and learning opportunities to the local communities. 

8 The fruit of 10 years’ labor: the wood from thinnings is collected at the entrance to the plantation, then loaded into 12-meter containers and shipped, primarily to India.

GLOBAL INVESTOR 1.15 — 38 8


Institutional 

investment 

in timberland 

through vehicles known as “TIMOs” – timber 

investment management organizations. These 

intermediate investment funds make exposure 

to timberland simpler for non-specialist institutions, 

but the larger pools of capital often 

prefer purchasing the assets directly. Returns 

for institutions that acquired undervalued 

holdings have been strong, initially driven by 

a lower discount rate boosting long-duration 

assets like timber, and recently supported by 

better wood demand. 

Current market situation and outlook 

Land devoted to investible timber worldwide 

amounts to 165 million hectares 

(408 million acres), roughly equivalent 

to the land area of Alaska. Institution al 

investors now own timberland in Argentina, 

Australia, Brazil, Canada, Chile, New Zealand, 

South Africa, the United States and Uruguay. 

Just under half of these assets (by area) are 

in North America. There is much less harvestable 

timberland worldwide than forested land. 

In Australia, only 1% of forested land is developed 

as timber plantations. 

Broadly defined institutions, such as the 

military, universities and even royalty, have 

held exclusive property rights in forests for 

centuries. Interest in timber assets by purely 

financial institutions developed in the 1980s 

in response to both the growth of institutionally 

managed retirement accounts seeking 

diversification, and a wave of forest divestments 

by large forest-product companies. 

Institutions enter into forestry 

In the first two decades of investment by institutions 

outside the wood-products industry, 

activity was confined to large university endowment 

funds. US timber companies using 

GAAP accounting had to pay tax on forest 

owned – even when it was not being logged, 

thus incentivizing them to sell such plantations 

to US tax-free pension funds. Preferential tax 

treatments for real estate investment trusts 

(REITs) also encouraged corporate divestment. 

During a period of strong equity market 

returns and declining inflation, the motivation 

for institutional investment was limited to 

those with a long time horizon for returns and 

an unusually broad mandate on alternative 

investments, enabling direct holdings of unlisted 

assets. This led the same institutions 

interested in pioneering private equity to explore 

the scope for investing in timberland, as 

a component of natural resource portfolios. 

Front-runners were the endowment managers 

for Yale and Harvard Universities. Yale alone 

holds three million acres of forests. 

Harvard’s Head of Alternative Assets, 

Andy Wiltshire, worked in the New Zealand 

forests sector early in his career, and drove 

the 2004 purchase of a 408,000-acre New 

Zealand timber estate by the Harvard Management 

Company. Kaingaroa Forest was the 

largest commercial forest property on the 

country’s North Island. A 30% share of this 

huge forestry block was divested two years 

ago to the Canadian Public Sector Pension 

Investment Board with an additional stake 

taken up by the New Zealand Superannuation 

Fund. Broadening of interest from private institutional 

to public institutional investment is 

thus well underway. 

Timber has appealed to observers noting 

long-run real annual returns of 10%–15% on 

intensively managed, short-rotation plantations. 

Seeing the very positive returns from 

timber and its low volatility, sovereign wealth 

funds and large public pension funds have 

been acquiring exposure to commercial forest 

assets. Corporate pension plans now own 

around 10% of the asset class. 

Based on measured returns on investment, 

timber is not positively correlated with 

other assets. But, because the timber price 

is responsive to house-building cycles, the 

run-up to the credit crisis in 2008 saw timberland 

prices climb and then drop sharply. 

The sluggish recovery in US housing led to 

a multiyear opportunity for pension funds 

to acquire timberland assets at reasonable 

valuations, and most have entered the market 

The US housing market has traditionally led 

timber demand and is now in a gradual recovery. 

The Australia-New Zealand region has 

enjoyed resilient building activity that is expected 

to continue, driven by immigration. In 

China and India, continuing urbanization and 

construction means these markets are still 

growing. Chinese plantations cannot meet 

demand and are under some pressure to be 

converted into development land. 

Increasing institutional investment is a 

safe prediction due to low current allocations 

within alternative asset portfolios and since 

wood usage follows wealth development. 

Thus, there is growing orientation toward 

the Southern Hemisphere. Recent surveys 

indicate that investor interest in emergingmarket 

forests is primarily European, and 

that smaller-scale investors favor emergingmarket 

timberlands. Sustainability is a critical 

concern – particularly with indigenous 

hardwood trees – but a wide range of tools 

are at hand, including forest and manager 

certification, NGO oversight and replanting 

requirements. 


Senior Analyst 

+41 44 334 78 93 

gregory.fleming@credit-suisse.com 

Find additional details on 

our map on pages 40–41


Farming and 

forestry investment 

Timberland is the investment term for 

harvestable forests, as is farmland for agriculture 

investment. Both types of investments act 

as portfolio diversifiers, satisfy investors’ 

desire for “real” assets and have 

emotional and social resonance. 

But they do require patience. 

Canada exports USD 4 bn worth of l umber and wood pulp to China 

CANADA 

China imports USD 13.3 bn worth of soybeans from the USA 

EU28 exports USD 2.6 bn worth of paper and paperboard to the USA 

China imports USD 2.6 bn worth of cotton from the USA 

EU28 

Product mix – forestry 

Tree products include hardwoods 

such as mahogany (used for 

furniture) and softwoods such 

as pine (used for building and 

paper production). Woodchips 

may be sourced from either, 

though softwood is a cheaper 

source. South-East Asia 

produces 90% of the world’s 

natural rubber. 

Source: FAOSTAT, 

Statistics Canada, Rubber Manufacturers 

Association, New Forests Asset Management 

worth of lumber to the USA 

Canada exports USD 15.8 bn 

USA Export 10% 

10% 

90% 

USA 

China imports USD 3.7 bn worth of soybeans from Argentina 

China imports USD 19.1 bn worth of soybeans from B razil 

EU28 imports USD 2.9 bn worth of soybeans from Brazil 

100% 

SOUTH AMERICA Export 100% 

95% 

ASIA Export 100% 

5% 

ARGEN- 

TINA 

BRAZIL 

CANADA Export 87% 

10% 

7% 

80% 

3% 

35% 

15% 

50% 

50% 

50% 

NEW ZEALAND Export 50% 

Hardwood domestic 

Softwood export 

Hardwood export 

Rubber export 

A US TR ALIA E xport 65% 

Softwood domestic


NZ timber destinations 

Logs constitute New Zealand’s third-largest export 

industry. New Zealand is also now the world’s 

leading log exporter (as of 2012) and the biggest 

supplier of softwood logs to China (as of 2013). 

JAS: Standard units. Source: UN Comtrade, New Zealand MPI 

NCREIF Timberland TR Index 

Returns as measured by a diversified index of 

timberland investments. Timber serves as a good 

diversifier, remaining stable during the financial 

crisis of 2008 as shown in the index. 

Source: Bloomberg, Credit Suisse/IDC 

Volume (million JAS) 

16 

14 

12 

10 

Index 

3000 

2500 

2000 

The USA imports USD 2.9 bn worth of paper and paperboard from China 

8 

6 

4 

2 

0 

1500 

1000 

500 

0 

EU28 exports USD 2.6 bn 

worth of paper and paperboard to Russia 

03 04 05 06 07 08 09 10 11 12 13 

China India Japan 

Korea Taiwan Other 

03.87 03.95 03.03 03.11 

NCREIF Timberland TR Index 

RUSSIA 

The USA exports USD 3.3 bn worth of meat to Japan 

JAPAN 

CHINA 

Australia exports USD 1.6 bn worth of meat to Japan 

China imports USD 3.3 bn worth of dairy products from New Zealand 

AUSTRALIA 

Farmland 

Investing in farmland means 

investing in rural land along 

with specific crop and livestock 

assets. Crops may be row crops 

like soybeans or permanent 

fruit and nut crops. 

Soybeans 

Dairy products 

Meat 

Paper and paperboard 

Cotton 

Lumber 

Wood pulp 

Mature, intermediate 

and emerging timberland 

investment regions 

With most US forestry assets 

already in institutional ownership, 

investor interest has turned 

to non-US markets, e.g. Asia. In 

Europe, forests are generally in 

private hands. 

Mature 

Intermediate 

Emerging 

Australia exports USD 1.7 bn worth of cotton to China 

Excellent climate for 

agriculture, total annual 

rainfall 

Agricultural productivity is 

greatest in the world’s temperate 

zones. Nonetheless, other 

regions, such as South America 

and Africa, where water is still 

plentiful, are drawing investor 

interest. 

475–4974 millimeters rain 

Selected international 

agri-trade flows in USD 

Find more 

information in 

the articles 

on pages 

39 and 42 

NEW 

ZEALAND


Harvesting yields from agriculture 

Farmland – 

a fertile 

investment 

One doesn’t often think of institutional investors and farmland 

in the same breath. Yet, global population growth and the 

accompanying demands on our food supply have made agriculture 

an asset class worth considering. But bridging the worlds of 

farming and financial services requires rather specific expertise. 

INTERVIEW BY GREGORY FLEMING Senior Analyst 

Food demand 

is set to grow 

by over 60% 

as the world 

becomes 

wealthier 

2014 

2014 

Find additional 

details on 

our map on 

page 40 

2055 

2055 

Global 

population is 

expected 

to increase by 

some 50% 

Gregory Fleming: Griff, you have moved 

from a traditional investment career in 

pensions and investment funds into advising 

on and structuring of farmland 

investments. What motivated this move? 

Griff Williams: A desire to make agriculture 

investment accessible to institutional 

investors. Agriculture is an asset class that 

delivers real benefits to savings and retirement 

portfolios, but lamentably, it is very 

difficult to access it in a pure-play format. 

It is also an asset class that requires specific 

expertise that generally does not reside 

in the financial services sector. As a farmer 

who has spent over 20 years in the asset 

management sector, I am blending the two 

worlds to deliver this objective. 

What kind of investor considers farmland? 

Griff Williams: Investors seeking exposure 

to assets that benefit from long-term 

secular themes such as population growth, 

changing dietary habits, growing middle 

classes, water and conservation management. 

Farms offer a hedge against inflation, 

combined with an income yield. At the 

same time, investors need to be able to 

trust the farm managers, or at least the 

partner selecting them. No one really wants 

to have to go down to the farm and 

check what’s happening there in person. 

Is agriculture sufficiently exposed to 

the modern, services-based economy to 

offer good returns? 

Griff Williams: The global population 

is expected to increase by 50%, to more 

than nine billion in the next 40 years, while 

food demand is set to grow by over 60% 

as the world becomes wealthier. Shifts in 

diet preferences toward protein foods are 

well-attested in enriching societies, and this 

will increase the demand for land resources. 

So investors can potentially benefit from 

value-added gains in food or crop quality, 

but also from the very limited expected 

increase in the world’s available arable land. 

The investment time frame is important 

in illiquid assets. What is the best time 

frame for taking a stake in farming? 

Griff Williams: Farming lacks the thrills 

of daily commentaries on network television. 

The farmer is almost the archetype of 

a patient investor, and non-farmers also 

need some patience. Much depends on the 

mode of investment, but an investment 

horizon of five to ten years or a longer-term, 

strategic allocation is reasonable. For investors 

preferring the fund route to a direct 

investment, between three and five years is


the shortest time frame to see results, but 

that renders the investment rather prone to 

the fortunes of just a few growing or production 

seasons. Capital gains on farmland 

are also likely to accrue more reliably over 

longer horizons. 

What kind of return can investors expect? 

Griff Williams: A good internal rate of 

return would be around 12% to 15% per 

annum. This is likely to be split between a 

cash yield on the farm products of 6% to 

8% and a similar appreciation in the capital 

value of the farmland, as it is improved. 

Would you say that any one kind of crop 

or product is superior, from an investor’s 

point of view? 

Griff Williams: I have looked at opportunities 

in dairy, livestock, cotton, sugarcane 

and fruit, soya, grains, and other rotational 

crops. Each has unique and demanding 

characteristics that require very solid experience 

on behalf of the farm managers. 

Investors may have an affinity with a particular 

farm product, which is legitimate, but 

it shouldn’t bias the objective judgment of 

their returns and risk levels across the cycle. 

All the farm products benefit from intractable 

global demographic trends, but within 

this rising demand trend, some crops are 

considerably more volatile. Alternatively, 

some are more demanding – for instance, 

dairying requires much more investment 

and stock management than sheep farming. 

What approach should investors take? 

Griff Williams: Maximizing sustainable 

yield and minimizing environmental risks 

means that it is critical to partner with real 

farm operators. The skills the investor 

should try to access are centered on rural 

productivity, rather than on land speculation 

or investment vehicles that mainly back 

trades in the agricultural futures markets. 

These markets have quite distinct returns 

time frames and performance drivers from 

the farmland itself. 

What are the special characteristics of 

investing in farmland globally? 

Griff Williams: The key point is that 

agriculture, in many countries, remains a 

politically defined investment universe. 

Certain governments restrict direct farm 

ownership to residents, while others link 

subsidy payments to the farm’s output. A 

set of agricultural economies, however, has 

liberalized its farming sector to reflect global 

market prices, and these countries have 

seen substantial efficiency gains. New 

Zealand is the classic example here, ditching 

“Maximizing sustainable 

yield and minimizing 

environmental risks means 

that it is critical to 

partner with real farm 

operators.” 

Griff Williams 

Griff Williams 

The New Zealand national comes from 

a farming family on the North Island, 

where he continues to have dairy farming 

interests. At Milltrust he is responsible 

for designing and co-managing the 

globally diversified agricultural strategy 

with special focus on Australia and 

New Zealand. Prior to Milltrust, he was 

Head of Europe and Interim CEO of Itaú 

Asset Management. 

farm subsidies virtually overnight in the 

mid-1980s. The New Zealand dairy sector is 

now the most efficient in the world, and few 

farmers would seek a return to government 

involvement in the price-setting process. 

Australia has also largely cut out farm 

support. Other countries, such as the USA, 

have more recently and gently modified 

farming subsidies. The 2014 US Farm Bill 

took the positive, though modest, step of 

lowering direct payments and replacing them 

with crop insurance provisions. Globally, 

rich-country transfer payments to the agriculture 

sector have been a major obstacle 

to free trade agreements. It’s important 

to stress that agriculture can survive and 

thrive in a high-income country, without 

state price support. Finding those liberalized 

land opportunities, and conducting the vital 

due diligence on legal systems, security of 

title, environmental and marketing systems, 

does require a broad range of skills. 

Have you identified some best-practice 

markets, or does it vary from farm to farm? 

Griff Williams: The set of undistorted 

farm product opportunities is quite small, in 

country terms. The best operating environments 

are seen across Australasia and in 

selected Latin American countries such as 

Uruguay, Paraguay and Brazil. Once a 

number of farmers in a given country adopt 

the best technologies and practices, 

the pressure on the other farmers builds up 

rapidly. This is as true of yield-enhancement 

techniques as it is of sustainable 

farming practices. Still, there are enough 

underper forming farms in countries with sufficiently 

good investment conditions to provide 

opportunities for a portfolio approach.


Trends in real estate investment 

Ins and outs 

of real estate 

As an illiquid asset, real estate takes time to sell and the length of the selling period can 

vary heavily. For indirect investments in particular, there may be regulatory frameworks and 

the possibility of pooling properties that moderate the negative effects, but there will 

still be a certain risk of illiquidity due to the inherent hetero geneous characteristic of real 

estate. However, investors with a sufficiently long time horizon can cope with these 

risks and are compensated by a potentially higher return compared to more liquid assets. 

Photo: Gregor Schuster/Getty Images


Hints for investors 

1 / Adopt a long investment 

horizon. Transaction costs 

are best absorbed by having a 

long investment horizon. 

2 / Mind the leverage. Sufficient 

own funds help to avoid 

fire sales as price and liquidity 

cycles can be long. 

3 / Know your product. 

Legis lation is very different for 

distinct types of real estate 

funds and country-dependent. 

Some setups are more 

exposed to liquidity problems. 

4 / Take your time. Avoid 

making your decision to buy 

or sell too quickly. This could 

turn out to be very costly. 

5 / Add real estate to your 

port folio. Do not be frightened 

of illiquidity. Real estate is 

a good diversifier in portfolios. 

01_Allocation to property in 

UHNWI investment portfolios 

While residential property (main residence and 

any second homes) makes up almost 30% of 

the total net worth of UHNWIs, real estate also 

plays an important role when it comes to making 

investments. On average, property accounts 

for 24% of UHNWI investment portfolios. 

In over 40% of all cases, this share has even 

increased in recent years. 

Source: Knight Frank, The Wealth Report 2014 

in percent 

35 

30 

25 

20 

15 

10 

5 

0 

Australasia 

Asia 

Russia/CIS 

Africa 

Global 

Europe 

Middle East 

North America 

Latin America 

When talking about illiquid assets, 

real estate is at the forefront as 

it belongs to the most prominent 

of illiquid assets. In developed 

markets, real estate is the most important 

wealth contributor in household portfolios and 

adds up to enormous amounts of wealth. It is 

not surprising that regulators and central 

banks pay a lot of attention to real estate 

markets. Residential real estate accounts 

for almost 30% of net worth in portfolios of 

ultrahigh-net-worth individuals (UHNWIs) (see 

Figure 1), and pension funds also have a substantial 

share of their allocation in real estate 

(see Figure 2). 

Causes of illiquidity of real estate assets 

The illiquidity feature of real estate results 

from a combination of several characteristics. 

To begin with, real estate assets are always 

tied to a certain location. The combination of 

a particular location and a specific object 

quality creates a unique tangible asset. Consequently, 

every building requires a one-off 

analysis and, on a microlevel, prices can even 

differ heavily on the basis of, for example, 

exposure to noise or view. All this is reflected 

in the valuation of a property: there is no true 

02_Asset allocation of 

Swiss pension funds as 

of September 2014 

Swiss pension funds traditionally have a substantial 

allocation to real estate. As of September 

2014, almost 20% of their funds were invested 

in real estate. This number typically decreases to 

some degree when equity markets are doing 

particularly well and therefore make up a larger 

part of the asset allocation. 

Source: Credit Suisse Swiss Pension Fund Index, Q3 2014 

2.1% 

19.7% 

4.9% 

31.3% 

Liquidity Bonds Equities 

Alternative investments Real estate 

Mortgages Rest 

1.2% 

7.0% 

33.7% 

or objective price. Target prices depend on the 

type of valuation model used and on investorspecific 

preferences. Finding a price becomes 

even more difficult when there is only limited 

data available on similar transactions and if 

assets have rare characteristics. This often 

makes price negotiations time-consuming, and 

adds to illiquidity. Determining a fair price is 

especially important when one considers the 

large size of the transaction. 

Several other real estate characteristics 

contribute to illiquidity, mostly from a cost 

perspective. For example, the design and, to 

some degree, the location of a building predetermine 

its suitability for certain activities. 

The conversion of a big department store 

into many small retail units is relatively costly, 

and regulation must also be taken into account. 

Changing the use of a property from 

a legal point of view, such as the conversion 

of apartments into shops and vice versa, may 

be difficult or even impossible. Investors must 

bear this in mind and should therefore have a 

clear strategy when investing in real estate. 

Other costs include legal expenses and taxes 

at the transaction stage. In total, there are 

five steps in the acquisition of a commercial 

building (see Figure 3). At each step, different 

types of costs occur. Purchasing a commercial 

real estate building typically needs a 

negotiation time of about three months, plus 

several months to conclude the transaction. 

One last reason for the illiquidity of real estate 

is simply the state of the market, which can 

dry up quickly in periods of excess demand 

(when nobody wants to sell a property) or, 

more seriously, in a situation of weak demand. 

Investors are facing difficult decisions 

The main question for investors is whether it 

is worth accepting this disadvantage from 

a risk-return perspective. This depends on 

the time horizon. As high transaction costs 

associated with illiquidity are fixed costs, 

it makes sense to hold such an asset for a 

longer period. Therefore, pension funds and 

other institutional or private investors with 

a long time horizon are typical real estate investors. 

In addition, these investors need to 

accept that their real estate positions may not 

be 100% liquid at any time. For wealthy investors, 

these constraints are easier to cope with 

(a fact that is reflected in the higher real estate 

allocations of UHNWIs, see Figure 1). For 

these investors, it makes sense to accept the 

illiquidity and be compensated for it. For example, 

the historical average premium to the 

intrinsic net asset value (NAV) for listed >


03_Real estate transaction process 

A typical transaction process for commercial real estate consists of five steps and may last up to 

six months. Expenses, such as search or transaction costs, may incur at each step. Steps 2, 3 and 4 

could run simultaneously. Due diligence thus makes up most of the time and costs. 

Source: Credit Suisse 

Research 

– Search costs 

– 2–4 weeks 

Swiss real estate funds has been 7% since 

January 1990. Direct real estate investors 

can avoid this premium. In addition, although 

direct real estate cannot be traded on a daily 

basis, this may be a good thing from a behavioral 

finance perspective. Most investors tend 

to underestimate transaction costs and in turn 

reduce their performance by trading too often. 

Since the real estate transaction process 

takes time, investors are automatically prevented 

from excessive trading. 

Preliminary check and 

non-binding offer 

– Agency costs 


Negotiation and final offer 

– Negotiation costs 


Due diligence 

– Market, legal, tax, technical 

and environmental due diligence 

– 1–3 months 

Closing 

– Additional costs 

(transfer taxes) 


Implications of illiquidity on markets 

In the case of illiquid assets, the problem 

is that investor interests do not necessarily 

align with market conditions. While it may be 

highly rational for an investor to buy or sell a 

property, too many investors acting in the 

same manner at the same time can reduce 

the liquidity of the whole market. In the end, 

investors behave in a pro-cyclical manner because 

they take more extreme positions and 

trade more often when liquidity is high and 

revise their ideas if liquidity drops. From a 

long-term perspective – and this is the horizon 

of most direct real estate investors – this is 

irrational. Theoretically, there should be a 

similar number of transactions in each stage 

of the cycle. But this is clearly not the case. 

Between the peak in Q1 2007 and Q1 2009, 

quarterly commercial real estate transactions 

in the USA fell by 91% in terms of volume, 

and they increased by 691% by Q3 2014. 

Illiquidity is often amplified in abnormal 

market situations. Moreover, not all real estate 

segments are affected by illiquidity in the 

same way. Down markets trigger a flightto-quality 

effect. Most investors will focus on 

core properties in prime locations of favored 

cities such as London or New York – if they 

are still buying real estate assets at all. 

Negative consequences are not a given 

Weeks 

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 

Investment solutions to meet the illiquidity 

challenge are very different from country to 

country, but generally adhere to the same 

simple idea: pool some properties, securitize 

them and distribute the shares. Then create 

a market for these shares. This can be a stock 

exchange or not. In either case, the shares 

can be traded more or less continuously 

and the properties are thus effectively more 

liquid. Sometimes, a market maker is needed 

to make the market fully liquid. This not only 

applies to properties but also to mortgages 

that are backed by properties. The legal structure 

of such transactions can be very differ - 

ent depending on the number of owners and


properties. For all these structures, trust is of 

key importance, which implies a certain degree 

of transparency when it comes to valuation 

for instance. 

Sometimes illiquidity conflicts with certain 

investment goals. For example, one concept 

is to reduce liquidity slightly by increasing 

transaction costs in order to curb speculation. 

This may help to lock out investors that have 

a very short time horizon and are prone to 

selling assets when the first headwinds occur. 

Limits to liquidity 

Even if liquidity is enhanced by pooling properties, 

there is still no guarantee that this 

will work all the time. Sometimes pooling 

properties only results in “pseudoliquidity,” 

which works when markets are rising (see 

also “Open-end versus closed-end funds”, 

page 24). In contrast, in times of falling markets, 

the number of potential sellers surpasses 

the number of potential buyers. This can 

also happen for complex real estate-related 

financial instruments such as residential and 

commercial mortgage-backed securities 

(RMBS /CMBS) as investors learned in the 

aftermath of the financial crisis. Confidence 

could not be restored on short notice. The 

risk of moving from a liquid to an illiquid market 

environment depends on the legal framework, 

as seen in the case of German openend 

real estate funds. The announcement of 

possible regulatory changes to the corresponding 

legal framework triggered massive 

redemptions by investors who wanted to retrieve 

their capital before the new regulation 

was introduced. In contrast, listed fund structures 

with a fixed capital base such as in 

Switzerland are less exposed to such risks. 

Selling real estate may become easier 

As long as properties are tied to specific locations, 

real estate will face liquidity issues. But 

we believe that real estate properties will become 

a priority for investors in the coming 

decades. First, real estate still does not have 

the appropriate or optimal weight in many asset 

allocations. Second, interest rates may 

stay at low levels for an extended period of 

time, which makes real estate returns attractive 

and should help to improve liquidity from 

the seller’s perspective. 

Beat Schwab 

Head Real Estate Investment Management Switzerland 

+41 44 333 92 42 

beat.schwab@credit-suisse.com 

Swiss real estate funds: 

Liquidity and diversification 

Real estate funds are an interesting alternative to investing into physical 

real estate as they typically offer investors access to diversified real estate 

portfolios that are managed by experienced real estate professionals. 

However, the way the product structure deals with in- and outflows 

of investor liquidity can impact the funds’ returns. Generally, one can 

distinguish between open-end and closed-end funds. As described in the 

article by Giles Keating and Lars Kalbreier (see page 24 for more details), 

these two contrasting structures have both advantages and disadvantages 

in times of market stress. 

Swiss real estate funds aim to create a structure that captures 

advantages from both types, while limiting the disadvantages by having 

a semi-open-ended structure. This means that funds are opened up to 

investors during periods of capital-raising activity, but that shares of the 

funds are otherwise exchanged between investors on secondary markets 

(with the majority of funds being listed on the SIX Swiss Exchange). 

Whenever there is strong investor appetite for real estate funds, any 

excess demand on the secondary market leads to an increase in unit prices 

and vice versa. However, this excess liquidity does not flow directly 

into the product and, as such, can neither impact the underlying portfolio 

nor potentially affect operations, as it is fully absorbed by supply and 

demand on the secondary market. Typically, this often leads to fund units 

either trading above (agio) or below (disagio) par to the net asset value 

of the underlying real estate portfolios. If true investment opportunities 

arise in target markets, the funds can be reopened for subscription 

of fresh capital for newly issued units, which can then be put to work. 

This structure thus enables controlled and healthy organic growth, while 

also providing a certain degree of liquidity to investors. 

We also advise real estate investors to diversify internationally. 

Since real estate market cycles tend to vary between different countries, 

adding international real estate to a domestic portfolio can significantly 

enhance the risk-return profile of a real estate portfolio. There are 

several Swiss real estate funds with an international focus. While such 

products are denominated in Swiss francs and foreign currencies are 

mainly hedged, we believe the approach of globally diversified real estate 

portfolios offers value to investors beyond Switzerland. 

Philippe Kaufmann 

Head of Global Real Estate Research 

+41 44 334 32 89 

philippe.kaufmann.2@credit-suisse.com


Taking a long-term view 

Infrastructure 

on the rise 

Source: Preqin 

Transport sectors Telecommunications Energy Social infrastructure 

and technology 

Resources 

and waste 

2007 

USD 94 bn of 

infrastructure assets 

2014 

USD 282 bn of 

infrastructure assets 

90% 

of surveyed investors plan 

to invest at least USD 50 mn 

each over the year 2015 

25% 

of surveyed investors plan 

to invest over USD 400 mn 

each over the year 2015 

Illustration: -VICTOR-/Getty Images


Largely due to the current low interest rate 

environment, institutional investors such 

as insurers and pension funds are increasingly 

moving toward allocation into longer-term 

illiquid assets, in particular into infrastructure 

as an asset class. This trend has been a 

significant one. In fact, global infrastructure 

assets under management have seen a 

300% increase over the past seven years. 

Investors are increasingly putting their money 

into the transport, tele communications, 

technology, energy and resources sectors, 

and backing the large-scale construction 

projects these sectors require. While not 

without risk, such investment is supported by 

governments and supranationals alike. 

There is clear evidence that insurers and pension funds 

with long maturity liabilities are increasing their asset allocation 

to infrastructure as an asset class. Other categories 

of investors are larger family offices and sovereign wealth 

funds. The investment case is that infrastructure projects or businesses 

offer long-term yields that are theoretically fairly stable 

and normally can provide inflation protection. Typically, investors 

are taking a seven- to ten-year view on the risk / reward of investing 

in infrastructure assets, but frequently the time horizons can be 

considerably longer. According to Preqin, global infrastructure 

assets under management in unlisted funds are at a record high of 

USD 282 billion, having increased threefold since 2007. Of the investors 

surveyed by Preqin, 25% plan to invest over USD 400 million 

each over the next year in infrastructure, and 90% plan to invest at 

least USD 50 million. Preqin estimates that “dry powder”, i. e. uncalled 

capital already committed, could be USD 107 billion, while insurance 

companies are planning to increase their asset allocation to infrastructure 

to 3%. 

Infrastructure: The different components 

Infrastructure covers a range of differing assets, but can be broadly 

disaggregated into the transport sectors, telecommunications and 

technology, energy, social infrastructure, and resources and waste 

management. Examples in the transport sector will include the 

construction of new railways / mass transit systems and trains, ports 

and shipping, airports, roads, bridges and tunnels. Telecommunications 

and technology investments range from relatively simple, such 

as mobile phone masts and fiber-optic cable, to complex projects, 

such as server or other tech cluster farms. The energy sector is very 

broad, but will include conventional assets such as pipelines, storage 

facilities, refineries, support infrastructure for oil and gas fields, the 

nuclear sector, energy transmission systems and alternative energy 

assets. There has been significant investment in alternatives such as 

on- and offshore wind farms, hydroelectric systems, solar and biomass 

plants. Social investments are typically defined as the construction 

and maintenance of schools, universities, hospitals and prisons. 

Although there is some overlap with the energy sector, resources 

and waste management infrastructure includes water management 

systems, sewerage, waste collection and the recycling sector. 

Typical infrastructure investment vehicles 

In an unlisted fund, it is normal for the general partners to manage the 

infrastructure assets and to appoint management teams as relevant 

to the day-to-day management of individual assets or projects. Limited 

partners will have made an initial capital commitment, and capital 

will be called as and when funds are invested. There is typically an 

initial investment period, and if the general partner has not invested 

funds prior to the maturity of this investment period, then capital 

commitments are waived or the limited partners can vote on granting 

an extension. There will be clear guidelines on the fund’s turnover, 

on investment concentration, leverage, planned repayments to limited 

partners, and how, if necessary, the limited partners can vote on 

a change in asset manager or general partner. Leverage has to be 

carefully monitored since funding can be at the fund level or more 

normally embedded in the actual projects or assets being invested 

in. Leverage levels will typically be higher than what is normally found 

in the private equity industry on the assumption that cash flows have 

a lower degree of volatility than that in private equity. Sources of >


performance will be cash flows from projects, the improvement or 

upgrading in infrastructure assets with new management, leverage 

and over the long term the disposal of assets to new investors. 

1 

Investor demand: Existing assets versus greenfield projects 

The infrastructure industry is dominated by investment in existing 

infrastructure with a focus by general partners to improve the cash 

flows from existing assets, to improve the financing structures, 

to upgrade assets and to sell on what were originally purchased 

as undervalued assets. In some cases, publicly listed infrastructure 

companies will be taken private with a view that management change 

can be more easily effected in a private structure. One key problem 

is that although 70% of infrastructure requirements are estimated 

to be in greenfield projects, investor demand is primarily for existing 

assets. The rationale for this reluctance lies in the fact that investors 

do not want to carry the initial construction period risk where cash 

flows will be negative, and where investors have limited direct control 

over issues such as cost overruns, construction failures, environmental 

risks, supplier failures, etc. Greenfield project risks are typically 

carried out by companies with a long history of involvement in 

the construction of infrastructure, and they may be supported by 

government, bank or supranational institution guarantees. In emerging 

economies, many projects have only taken place backed by, for 

example, guarantees from the Asian Development or the Inter- 

American Development Bank. In Europe, the European Investment 

Bank has played a key role, not just in financing projects, but by 

providing guarantees. 

2 

Financing 

Financing can be divided into a variety of constituent elements – 

including equity – typically with pension funds and insurance companies 

acting as limited partners in unlisted funds, companies involved 

in the infrastructure sectors providing equity, bank financing, the 

developing infrastructure bond market and the provision of guarantees 

from banks, governments or supranational institutions. Given the 

long-term and illiquid nature of the assets, it is generally agreed that 

it is inappropriate to have infrastructure assets in mutual funds where 

short-term liquidity is provided to investors. If retail investors want 

to access the infrastructure industry, the most appropriate route is 

to purchase the equity or bonds of infrastructure construction and 

maintenance companies. 

3 

Infrastructure bonds 

Apart from equity investing on the part of long-term investors, there 

is a clear recognition among investors that the infrastructure bond 

market requires further development. Historically, infrastructure was 

financed either by bank lending or by bond issues made by supranational 

institutions, governments, or companies involved in the construction 

or maintenance of projects. Investor risk was limited to a direct 

credit risk on the issuer without any recourse to the project assets. 

With banks deleveraging and reducing maturity mismatch risk by 

focusing on floating-rate rather than fixed-rate assets and reducing 

proprietary positions, bank financing for infrastructure will decrease 

on trend, and therefore lead to greater reliance on access to funding 

from investors and the bond markets. Since investors are reluctant 

to act as equity providers in greenfield projects, they likewise will not 

be providers of longer-term financing for new projects. They will, however, 

be active participants in bond issues made by existing infrastruc- 

1 Workers laying railway track in northwest 

China. 2 Pipeline pipes at the ready with 

oil rig in background. 3 Bales of paper ready 

for recycling.


Photos: Imaginechina, Lowell Georgia, Anna Clopet/Corbis 

ture management companies such as train operators, pipeline managers, 

etc., while they will also purchase bonds where there are credit 

guarantees either by government, supranational institutions or banks. 

Risks 

While the current low interest rate environment encourages increased 

allocation into longer-term illiquid assets such as infrastructure, it is 

important to focus on the risk factors in the industry and highlight 

some examples where investor losses have been generated. For 

new projects, the obvious key risk is that projects are either not completed 

or have serious delays and / or cost overruns. Recent examples 

include escalating costs of building new nuclear plants, projected 

overruns in high-speed train lines and toll road tunneling projects. 

Political risk has to be carefully assessed; there have been a number 

of instances, notably in mining projects in higher-risk emerging markets, 

where a change of government has led to contracts / concessions 

being cancelled and assets sequestered. Another example of political 

risk is the possible change in government subsidies and / or support. 

A number of alternative energy projects and notably wind farms have 

faced deteriorating economics as government subsidies have been 

withdrawn, and likewise social infrastructure projects, which might be 

in the form of a public / private partnership, can suffer from reduced 

government funding. Environmental issues are critical, notably in the 

transport, energy and waste management sectors. Examples of problems 

have been the imposition of environmental fines on projects and 

infrastructure assets and projected cash flows being delayed because 

of disputes over environmental issues. Certainty of cash flows is 

obviously important, but in a number of cases, cash flow projections 

have been too optimistic. One example has been in toll roads where 

they have competed with toll-free roads and traffic has not switched 

to the toll roads, with a mediocre outcome for revenues and cash 

flows. Another risk is the threat from new technology. For example, 

in telecommunications, the future viability of mobile masts has to be 

questioned, while initially the excessive installation of fiber-optic 

cabling led to major losses. Market price movements can change the 

economic viability of infrastructure. At present, the sharp decline in 

oil prices is challenging a number of alternative energies, and investment 

in oil and gas fracking is becoming less attractive. 

Financial risks involve the threat of higher interest rates and / or 

wider credit spreads. Increased financing costs will challenge the 

economics of infrastructure, make alternative asset classes more 

attractive and could delay projects if refinancing needs are not met. 

Other market-related risks can be changes in foreign exchange rates 

where hedging longer-term assets can be problematic, shifts in 

yield curves (which might affect swap pricing where swaps have been 

used to hedge borrowing risks) and the use of excessive leverage. 

In 2008–09, a number of infrastructure funds had to be restructured 

since reduced cash flows could not meet increased borrowing costs 

and / or refinancing could not be successfully achieved. The final risk 

is that, in “easy” markets backed by quantitative easing, valuations 

may become stretched and there is some initial evidence of this occurring 

with current transactions in the ports and trains sectors being 

effected at values significantly higher than those that took place over 

the last five years. 

Government policies 

In the recent G20 communiques, the G20 stated “we are working 

to facilitate long-term financing from institutional investors and to 

encourage market sources of finance, including transparent securitization, 

particularly for small and medium enterprises and we endorse 

the multiyear program to lift quality public and private infrastructure 

investment.” It is obvious that at the level of individual governments 

and also the IMF, OECD and EU, accelerating infrastructure projects 

is a clear macropolicy objective. S & P has estimated that infra structure 

financing needs worldwide could total USD 3.4 trillion annually until 

2030. For governments, infrastructure investment is clearly attractive 

given the initial positive impact on employment and the longer-term 

multiplier effect on the economy. 

Trends 

There are a number of clear trends in the infrastructure sector. First, 

new investment from investors such as pension funds that need 

long-term assets and do not need liquidity will increase significantly. 

Second, investment in infrastructure will have the support of governments 

and supranational institutions given the strong economic 

multiplier effects. Third, the environment for investing in greenfield 

projects / start-ups will remain challenging and will require project and 

credit support. Fourth, investors will focus on areas where there is 

inflation protection, minimal systemic risk, and where leverage and 

financial risk is intelligently managed. Finally, the flow of equity capital 

will be matched by the development of the infrastructure bond 

market as an alternative to bank financing. 

Robert Parker 

Senior Advisor 

+44 20 7883 9864 

robert.parker@credit-suisse.com


Advising on illiquid assets 

Looking 

beyond 

liquidity 

Global Investor asked two Credit Suisse wealth managers 

to describe the illiquid asset landscape from the point of 

view of investors. Do clients feel it is worth trading liquidity 

for additional returns? How much of their portfolios do clients 

allocate to illiquid assets? Are some assets more popular 

than others? And how does culture affect asset choices? 

INTERVIEW BY MANUEL MOSER Senior Financial Editor, Credit Suisse 

Manuel Moser: What does a typical client’s 

portfolio allocation look like? 

Felix Baumgartner: My perception 

is that “this” client is invested approximately 

40% to 50% in equities and 30% in cash. 

The cash tends to come from fixed income. 

In other words, when a bond expires, the 

money goes into the cash portion of the 

account owing to the lack of opportunities 

in fixed income. Now, clients are a bit 

worried about staying in cash, and consequently 

they’re looking for other opportunities, 

including illiquid assets. 

Are some investors more open 

to illiquid assets than others? 

Patrick Schwyzer: There are different 

ways of characterizing investor preferences: 

by geography, by what stage investors are 

in in their lifecycle, by their background 

and by the country they live in. For example, 

the USA is certainly more open to illiquid 

asset investment. Switzerland not so much. 

There are a number of reasons for the difference, 

one of which could be that in the 

USA, people have to administer their own 

pension money. That means thinking through 

the range of investments for the best yield 

and return, whereas in Switzerland we 

still delegate the entire business of pensions 

to outside parties or the companies’ 

pension scheme. 

What about preferences for various kinds 

of illiquid assets, such as real estate or 

hedge funds? 

Felix Baumgartner: The order of 

pre ference that we observe is: real estate, 

then hedge funds, followed by private equity. 

Traditional Swiss investors, in particular, 

look for real estate in Switzerland. But there 

is not much left here. It’s all been bought 

up. Some traditional investors still like gold, 

which is not an illiquid asset, of course, 

but still very volatile. 

How satisfied are clients with the 

returns on their investments in illiquid 

assets? 

Felix Baumgartner: I’d say they’re 

satisfied with real estate, and with hedge 

funds. Private equity could be the next 

boom in the coming years because it offers 

a long-term investment, diversification and 

good returns. But clients are too little invested 

in it at present to reap the benefits. 

For Swiss-based investors, I would estimate 

that private equity currently represents 

only about 1% or 2% of their portfolio. 

Patrick Schwyzer: I would say it’s more 

like 0.5%!


Photos: Luca Zanetti 

Patrick Schwyzer (left) and Felix Baumgartner from Private Banking & Wealth Management, Credit Suisse, take a moment to exchange viewpoints.


What additional return would a client 

typically expect in private equity versus 

traded equity, after fees? 

Patrick Schwyzer: It’s difficult to price 

the illiquidity premium. Research shows that 

private equity does create a positive outperformance 

over the classic equity market in 

the long run. For example in a traditional 

buyout private equity fund, a client would be 

looking for annual double-digit returns over 

the lifetime of the fund. 

How realistic are those returns? 

Patrick Schwyzer: What’s key in 

private equity is to invest in what we call 

top- quartile performers. So you tend to 

go with managers who have proven that 

they can achieve the double-digit return in 

any particular strategy. Needless to say 

that expertise and knowledge of the private 

equity universe are key in identifying 

such managers. 

Where would you rank expectations for 

hedge funds compared with cash, bonds, 

equity or private equity? 

Patrick Schwyzer: Again, it’s difficult 

because hedge funds are not a homogeneous 

asset class. We group hedge funds 

into four different styles, so to speak. 

And every style has its own risk/return 

profile. For an equity long-short manager, 

for example, a rule of thumb is that you 

participate in two-thirds of the upside and 

one-third of the downside compared 

to traditional equity. There’s no such thing 

as a free lunch, as you know. There are 

other styles, e.g. managed futures, strategies 

that tend to be uncorrelated to an 

equity market. Keep in mind that any broad 

hedge fund index is just the amalgamation 

of all these different styles. 

Nobody assumes that hedge funds are fully 

liquid. But what about bonds? The financial 

industry is reporting big rushes into high 

yields and very high-risk bonds. Do you see 

a risk that clients may have bought things 

that they thought were liquid, but that may 

end up not being liquid? 

Patrick Schwyzer: Education is key. 

Absolutely key. This is one of the lessons of 

the financial crisis of 2008. Sometimes 

a product behaves just like it is designed 

to, but a different perception was linked to 

the product and therefore caused irritation 

with clients. An explanatory discussion with 

a specialist typically helps in such situations. 

Also, secondary market liquidity can be 

provided for alternative solutions. While this 

generates liquidity, it is not inherent in the 

“What I see in most 

discussions is that clients 

want to understand 

the thought process and 

how we do things.” 

Patrick Schwyzer 

Patrick Schwyzer 

is a Managing Director of Credit Suisse 

in the Private Banking & Wealth 

Management division, Zurich, and Head 

of Alternative Investments for Private 

Banking clients Switzerland and EMEA. 

He was previously with GAM Global 

Asset Management London. He graduated 

from the University of St. Gallen 

with a special focus on Finance and 

Capital Markets. 

Felix Baumgartner 

is a Managing Director of Credit Suisse 

in the Private Banking & Wealth 

Management Division, Zurich, and 

Co-Head Premium Clients Switzerland. 

He was previously a Director at Credit 

Suisse First Boston in Global Foreign 

Exchange (GFX) and a member of the 

GFX management team. He is a graduate 

of the Zurich and the London Business 

School.


product, and the liquidity provider will 

typically buy at a discount to the actual net 

asset value of the product. 

Are entrepreneurs more likely than other 

investors to favor illiquid assets? 

Felix Baumgartner: It’s a good question. 

As owners of their own company, they’re 

more open to illiquid investments. They 

probably have 80% of their total wealth invested 

in the company, and they’re comfortable 

with that because they know what 

is going on with it. Of course, if they already 

have 80% invested in their company, it 

makes no sense to put the rest in illiquid 

assets as well. So we would tend to advise 

them to maybe put 5% in private equity, 

if they really want that, and keep the rest 

in cash or in liquid assets. 

How much do clients want to know before 

they decide on an illiquid investment? 

Patrick Schwyzer: What I see in most 

discussions is that clients want to understand 

the thought process and how we 

do things. They want to understand how 

we come to the selection of a particular 

manager, be it in the private equity or the 

hedge fund space. They don’t really want 

to receive the full package on the due diligence 

report and go through it themselves. 

That’s exactly why they come to us. 

In terms of cycles, is it fair to say that 

investor appetite is back where it was 

before the financial crisis? 

Felix Baumgartner: Absolutely. Investors 

are looking for opportunities. Clients, 

and especially Swiss clients, often want to 

leverage their portfolio, also the illiquid 

parts. It’s analogous to taking out a mortgage 

on real estate. And banks are increasingly 

amenable to offering credit (assessed 

on the basis of loan to value, or LTV) on 

illiquid assets. We clearly limit the risk in the 

interests of both the client and the bank. 

Patrick Schwyzer: Another cycle- related 

example: before the 2008 financial crisis, 

there was a lot of movement into the socalled 

fund of hedge funds space, particularly 

in Switzerland. After the crisis, those 

private investors left that space. And now 

we see them coming back, as providers 

begin to offer a selection of carefully vetted 

single-manager hedge fund products or 

advisory services. 

Has the rise of family offices played 

a big role in increasing the allocation 

to illiquid assets? 

Patrick Schwyzer: It depends on the 

type of family office. The smaller ones that 

literally are a family of two or three people 

have one investment specialist who needs 

to cover everything from bonds to alternatives. 

In that case, they’re looking to us to 

help them put together their own portfolio of 

hedge funds. Bigger family offices typically 

employ their own private equity specialist 

or hedge fund specialist, but like to talk to 

us as a “sparring partner.” 

Felix Baumgartner: Investment behavior 

and interest can also change dramatically. 

We’ve seen that over the last one or 

two years. Some family offices that previously 

invested only in traded equities with no 

allocation in private equity because of 

worries over illiquidity, decided to go into it 

within the space of three or six months. 

Are fees an issue for clients? 

Patrick Schwyzer: Certainly, pre-2008, 

the predominant means of investing in 

hedge funds for the private sector was fund 

of hedge funds. And there you had a double 

layer of fees: the underlying managers 

who on average were going to charge you 

a 2% management fee and a 20% performance 

fee; and the additional level on 

the fund of hedge funds where the manager 

would pick and choose those funds. We 

have seen a clear trend toward single funds, 

which has removed one of the fee layers. 

The second layer is also under pressure. 

It comes down to performance. Good 

performance is clearly needed to justify the 

fee levels. 

“The order of preference that 

we observe is: real estate, 

then hedge funds, followed 

by private equity.” 

Felix Baumgartner


AMRD 2003 = 1000 

12,000 

10,000 

Market overview 

Indexes compare each sector’s 

growth over a ten-year period, 

using the central 80% of 

data and a 14-month moving 

average (14MMA). 

Chinese Contemporary Art 

AMRD Contemporary 100 

Jewelry 

Classic Cars 

Watches 

8,000 

6,000 

4,000 

2,000 

05 06 07 08 09 10 11 12 13 14 

In passion 

we trust 

The idea of objects of desire as investments of passion took off in the UK in the late 1970s 

with the publication of “Alternative Investment.” As an investment analyst in the City of London, 

the late Robin Duthy noticed that, while conventional investments were intensely studied for 

past performance and future potential, no systematic analysis of the markets for art, antiques 

and collectibles had been undertaken. Working with the late Sir Roy Allen at the London School 

of Economics, he devised a sophisticated methodology of trimming and smoothing mechanisms, 

which eliminated seasonal and other distortions. It is important to remember that when the 

media reports eye-catching prices for collectibles sold at auction, the prices paid by the buyer 

will be substantially higher than the cash received by the seller; transaction costs in these 

markets (e. g. auctioneers’ or agents’ commissions) can be sobering, reflecting the price paid 

to overcome the illiquidity inherent in trading high-value idiosyncratic items. 

AUTHOR ART MARKET RESEARCH & DEVELOPMENT (AMRD) 

Photo: malerapaso / Getty Images Sources: Art Market Research & Development (AMRD)


“All successful 

buying must 

be based on confidence, 

whether 

in a dealer or 

in oneself, and 

the only basis 

for confidence 

in oneself 

is knowledge.” 

Robin Duthy “Alternative Investment” – 

Founder of Art Market Research 

Drawing attention: The rise of 

Chinese contemporary art 

In 2007, art collector Howard Farber sold Wang 

Guangyi’s “Great Criticism: Coca-Cola (1993)” 

for USD 1.59 million at Philips, having claimed to 

have paid just USD 25,000 ten years earlier. 

The painting was sold in late 2007 as the market 

neared its peak for 63 times the reported acquisition 

cost. After 2005, the auction market for 

Chinese contemporary art entered a phase of rapid 

development. Two years later, Charles Saatchi 

was noted for selling off some of his younger 

German artists collection in order to fund his 

interest in Chinese contemporary art. The painting 

“1998.8.30” by Lijun sold at Sotheby’s Hong 

Kong in 2010 for over USD 1.2 million. Last year, 

his “Publication 2 No. 4” sold for over USD 7.6 

million. AMRD’s methodology enables comparison 

with other art sectors, for example, as represented 

by the AMRD Contemporary 100, a leading 

benchmark. Set against an overview of sales of 

contemporary artists across the globe, the index 

reveals that sales of top Chinese contemporary 

artists have been outperforming the competition 

for the last five years. 

Chinese Contemporary Art 

versus Contemporary 100 

The index, calculated on a 14MMA basis, shows 

that the Chinese contemporary sector has grown 

29% in the last 14 months and is back to where it 

was in early 2007. 

12,000 

10,000 

8,000 

6,000 

4,000 

2,000 

01.05 01.08 01.11 01.14 

Chinese Contemporary Art top 25% 

AMRD Contemporary 100 top 25% 

Chinese Contemporary Art bottom 25% 

AMRD Contemporary 100 bottom 25% 

Investment vehicles: 

Italian classics in pole position 

Most of us past a certain age are likely to have 

owned and subsequently lost a prized possession 

that has gone on to become a valued collectible. 

It seems that a combination of rekindling one’s 

youth and the empty nester’s disposable income 

enables enthusiasts to purchase rare items, 

and this is nowhere more obvious than in the 

classic car market. Prices for some classic cars 

are going through the roof, and it is the Italians 

that continue to lead the market. Ferrari’s 

1959–1982 models have seen a 1,350% increase 

in the last ten years. Maseratis produced between 

1958 and 1982 have also seen some action in 

the last six months, having increased in value by 

over 23%. The 1946–1977 era British Triumphs 

have almost flatlined in comparison, but have 

continued to rise slowly, with a compound growth 

rate of 3.9% over the last ten years. 

Classic Cars 

Ten years of market growth on a 14MMA basis 

shows Ferrari outperforming Maserati by 55% 

and Triumph by 84%. The Classic Car Index was 

rebalanced to 1000 in 2003. 

17,000 

15,000 

13,000 

11,000 

9,000 

7,000 

5,000 

3,000 

1,000 

01.04 01.06 01.08 01.10 01.12 01.14 

Ferrari 1959–1982 Maserati 1958–1982 

Triumph 1946–1977 

Watches 

Growth by brand from January 2004 to December 

2014 using the central 80% of data from the 

AMRD Watch Index, calculated on a 14MMA basis. 

The index was rebalanced to 1000 in 2003. 

2,000 

1,800 

1,600 

1,400 

1,200 

1,000 

800 

01.04 01.06 01.08 01.10 01.12 

Patek Philippe Cartier Rolex 

01.14 

Some watches ticking upward 

Luxury items tend to be one of the first things 

to suffer during tough economic times. The last 

financial crisis was no exception, with the highend 

watch market taking a steep plunge. The Swiss 

watch market is especially sensitive to economic 

depressions, regularly having to target new money. 

High-end wrist watches are generally a poor 

economic investment. People buy them for their 

beauty, but not because they think the watches 

will hold or increase their value. Yet Patek Philippe, 

Rolex and some Cartier watches can be exceptions, 

as they have shown solid value retention. 

A person buying a new Rolex or Patek Philippe 

watch today has a reasonable chance of losing 

little or no money on selling it in a few years. 

There is a healthy auction market for vintage Rolex 

and Patek Philippe watches, and a few rare models 

do fetch very high prices at auction, such as the 

sale of a Patek Philippe 1933 “Henry Graves 

Jr. Supercomplication” pocket watch, which sold in 

2014 at Sotheby’s in Geneva for CHF 23.2 million 

(USD 24 million). This set a new record for any 

timepiece ever sold at auction. 

Pearls are a girl’s best friend 

Jewelry has performed extremely well in recent 

years, with the emphasis being on signed pieces, 

colored gemstones, and pearls in particular. Names 

like Cartier, Van Cleef & Arpels or Boucheron are 

sought after as such a source usually ensures good 

quality design and manufacture, as well as having 

a signature and normally a unique number. This 

emphasis on signed pieces is a reaction to the large 

quantity of unsigned and recently made pieces on 

the market imitating vintage European pieces. 

Pearls have increased in value more than any other 

gemstones. Historically, the world’s best pearls 

were collected along the Persian Gulf especially 

around what is now Bahrain by breath-hold divers 

until oil exploration in the 1930s disrupted the 

oyster beds. The fact that no more natural pearls 

are being harvested, combined with strong interest 

from the Gulf States, which value the acquisition 

of heritage objects, has forced pearl jewelry prices 

up to unprecedented levels – increasing by 405% 

in the last ten years. With world records being 

set every year, the finest jewels and gemstones 

continue to be objects of desire, having the advantages 

of displaying wealth, wearability, portability 

and scarcity value. 

Jewelry 

AMRD Pearl Jewelry Index vs AMRD General 

Jewelry Index on a 14MMA basis over ten years. 

The index was rebalanced to 1000 in 2003. 

5,000 

4,000 

3,000 

2,000 

1,000 

01.04 01.06 01.08 01.10 01.12 01.14 

Jewelry (general) 

Pearls


European securitization 

From illiquid assets to 

profitable investments 

To foster economic growth, the European Central Bank needs to revive the securitization market. 

This market is currently down to 25% of precrisis volumes or only 14% of US issuance in 2013. 

Improved transparency, the clearing of bank balance sheets and improved regulatory rules are expected 

to provide a catalyst for the securitization market going into the second half of 2015, offering 

attractive yield opportunities for investors. 

Illustrations: Frida Bünzli


In the aftermath of the financial crisis, the European securitization 

market collapsed. New issuance in European securitization decreased 

by more than 75% compared to volumes in 2008 and has 

not recovered since then. Primary market activity in 2013 was below 

EUR 200 billion, corresponding to only 14% of US issuance over 

the same time period (see Figure 1). The lack of a functioning securitization 

market is a major disadvantage for European banks, the 

economy and investors. Regulatory-forced deleveraging and its negative 

impact on lending and economic growth could have been better 

mitigated, in our view. 

For the European Central Bank (ECB) to be successful in fostering 

economic growth, the current pool of assets for Quantitative Easing 

(QE) might prove to be too narrow, so that the issuance of securitized 

investment products based on high-quality assets – so-called Qualifying 

Securitization (QS) – needs to pick up in order to broaden the 

ECB’s investment base. As the ECB is pressuring interest rates and 

yields into negative territory, banks are in need of margin expansion. 

If structured correctly, this can be achieved by QS and align the banks’ 

need to earn profits with the ECB’s need for economic growth and 

the investors’ need for attractive yield opportunities. 

To make the securitization market grow in Europe, it must become 

economically attractive for banks. So far, the maths have not quite 

worked out, mainly due to regulatory rules with respect to securitization 

that result in a lack of “capital relief” for the banks (see box on the 

risk capital treatment of different loans and securitizations on p. 61). 

Given their need to remain exposed to the part of the securitized assets 

with the highest risk, to which a risk weight of 1,250% is applied, the 

transaction simply lacks economic appeal for the banks. 

ECB as an asset-backed securities buyer 

In 2014, the ECB released details of its asset-backed securities (ABS) 

purchase program, which was followed by the release of a legal act 

enabling implementation of the purchase program with actual purchases 

having started. The ECB has appointed four executing asset 

managers for the purchase program. The asset managers will conduct 

the purchases on behalf of the Eurosystem and undertake price checks 

and due diligence prior to approving the transactions. The program 

will involve the purchase of senior tranches and guaranteed mezzanine 

tranches of loans originated in the euro area. Greek and Cypriot ABS 

will also be included in the purchase, albeit with tighter provisions. 

The combined size of the ABS purchase program and covered bond 

purchase program will reach EUR 1 trillion. 

Several other measures have also been taken in the meantime 

to facilitate the development of the securitization market in Europe. 

Among them, we would highlight the changes to Solvency II > 

Turning an illiquid asset into an investment opportunity takes time 

The ECB is in the middle of a multiyear process to regain investors’ 

and market trust, as well as to foster economic growth. In our view, 

the basis for regaining investor trust – including the ECB as an investor 

– was provided by the comprehensive asset quality review (AQR) 

and the stress test carried out by the ECB and the European Banking 

Authority (EBA). 

In October 2014, following a yearlong analysis of over a million 

pieces of data, the ECB and EBA published the much-awaited results 

of the AQR and stress test. The AQR exercise covered 130 banks 

within the Eurozone’s 18 countries, with total assets of EUR 22.0 

trillion accounting for around 82% of total banking assets under the 

European Single Supervisory Mechanism (SSM). The EBA stress 

tests covered 123 banks across 22 of the 28 EU countries, including 

banks from the UK and the Nordic region. Overall, 25 of the 130 banks 

failed, with an identified capital shortfall of EUR 24.6 billion. More 

specifically, 13 banks were identified to face capital shortfalls totaling 

EUR 9.5 billion. 

We believe that the ECB/EBA announcement struck the right balance 

between being too harsh and being too lenient, notably highlighting 

areas of vulnerability for some of the examined banks. Despite not 

forcing them to take immediate action, the ECB made it very clear that 

the adjustments would become part of its ongoing supervision of capital 

requirements as it continues to forge ahead with the agenda 

of improving the quality of European banks’ balance sheets. More 

importantly, we believe that the process toward a European Banking 

Union has significantly contributed to increased disclosure and transparency, 

which is building the basis for a greater investor attraction 

toward banking assets. 

01_Primary market activity of 

European and US asset-backed securities 

New issuance of asset-backed securities (ABS) remains subdued in 

Europe compared to the US. The European market is, however, forecast 

to pick up during the course of the year following the launch of the 

ECB’s purchase program. Source: AFME, Credit Suisse 

in EUR bn 

2,500 

2,000 

1,500 

1,000 

500 

0 

2006 2007 2008 2009 2010 2011 2012 2013 2014 

Total European ABS placed Total US ABS placed 

European ABS placed in % of US ABS placed (rhs) 

100% 

80% 

60% 

40% 

20% 

0%

GLOBAL INVESTOR 1.15 — 60 The bank then bundles a number of home loans – 

How does securitization work? 

The following illustrations show how loans can be turned into tradable securities: 

1 

When a bank grants a mortgage to a borrower, 

the bank earns an interest income. 

2 

both risky and less risky – into a pool of mortgages. 

3 

The bank places these pools of mortgages 

into a trust. The trust then sells bonds, which 

are secured by the mortgages. 

4 

The return and the risk of the bonds depend on the 

riskiness of the mortgages which secure the bonds. 

To create different risk categories of bonds, the 

bank divides the mortgages into risk groups called 

tranches. Rating agencies such as Standard & 

Poor’s or Moody’s then often rate the tranches to 

reflect the risk of default. The bank is required by 

regulation to keep a tranche of the highest risk 

category. 

5 

The newly created bonds are sold to private and 

institutional investors and even central banks. 

Thus, the bank has earned a fee for originating 

mortgages, but sold the risk and rewards of these 

mortgages to investors through the process of 

converting them into tradable securities (bonds).


regulatory rules for insurance companies, which made the capital 

charges less onerous for high-quality securitization. Further, rules on 

the Liquidity Coverage Ratio (LCR) for banks have also allowed some 

high quality securitization to qualify under certain criteria. However, 

there is still considerable debate on whether the existing rules on 

securitization still make the capital treatment too onerous for the issuing 

banks and this is an area that needs to see some change to 

help revive the European securitization market. 

Securitization market with significant volume 

We believe that the data published by the EBA and ECB on banks’ 

risk exposures and risk-weighted assets should allow the market to 

better understand and quantify the eligible securities. From an issuer’s 

point of view, we conclude that there are currently situations where 

an unsecuritized portfolio may require less capital than a securitized 

portfolio (see adjacent box). As a result, the loan portfolio to be 

securitized might contain a higher proportion of assets with a higher 

risk weight attached to it. Thus, we believe that securitization may 

take place in regard to high-quality small and medium enterprise (SME) 

loans due to the higher risk weights applied. This is precisely the 

area where the ECB is trying to unlock the funding gridlock. 

With securitization accounting far from clear under International 

Financial Reporting Standards (IFRS) and a likely piecemeal 

approach to capital relief, we have tried to estimate the potential 

size of qualifying securitization assets for Europe. Depending on the 

range of assets taken into account, we have adjusted the data for 

asset encumbrance and estimate that the market could range from 

a minimum of EUR 1 trillion (including mainly SME loans) to EUR 2.4 

trillion (including lower risk-weighted asset categories such as securitized 

or collateralized lending). From the asset breakdown, we 

predict that securitization is more likely to reopen bank funding channels 

for SMEs and corporate lending as we would expect the capital 

relief to transmit into lower sustainable funding costs in these sectors. 

We therefore believe that securitization can play a key role in 

serving the macroeconomic policy objectives of the ECB to foster 

economic growth. 

Given the completion of the AQR and the launch of the ABS 

purchase program, we believe that these are supportive steps toward 

a fully fledged securitization market throughout 2015. In turn, we 

continue to believe this will provide a positive backdrop for the 

Eurozone by releasing capital pressure from banks’ balance sheets, 

reducing the cost of borrowing for SME clients and providing lending 

to the economy. In an environment of very low yields, investors 

(including the ECB) will gain access to higher-yielding assets, which 

we expect to be attractively priced at the beginning to reopen the 

securitization market. 

Christine Schmid 

Head of Global Equity & Credit Research 

+41 44 334 56 43 

christine.schmid@credit-suisse.com 

Carla Antunes da Silva 

Head of European Banks 

Investment Banking Equity Research 

+44 20 7883 0500 

carla.antunes-silva@credit-suisse.com 

The risk capital treatment 

of different forms of 

loans and securitizations 

In this box we compare the capital requirement for 

a securitized portfolio (leaving 5% on the book as 

per retention rules) with that of the underlying loan 

portfolio. In the analysis, we have assumed that 

the bank uses the standardized approach for the 

calculation of risk-weighted assets. 

A 

Capital requirements for typical loan portfolios 

We take three types of loan portfolios and apply the 

risk weights under the standardized approach. We 

take a secured residential mortgage, a commercial 

mortgage and an unsecured corporate loan, 

and present our capital charge analysis below: 

1 RESIDENTIAL MORTGAGE – RISK WEIGHT = 35% 

CAPITAL REQUIREMENT = 0.08 × 35 = 2.4% 

2 COMMERCIAL MORTGAGE – RISK WEIGHT = 100% 

CAPITAL REQUIREMENT = 0.08 × 100 = 8% 

3 UNSECURED CORPORATE LOAN – RISK WEIGHT = 150% 

CAPITAL REQUIREMENT = 0.08 × 150 = 12% 

B 

Capital requirement for a typical securitization 

For a bank that keeps 5% of the portfolio on its 

books, the maximum capital charge would be 

as follows: 

1 RISK WEIGHT = 5 × 12.5 = 62.5 

2 CAPITAL REQUIREMENT = 0.08 × 62.5 = 5% 

We can see that a bank does not always gain capital 

relief from securitization. For residential mortgages, 

for example, the capital requirement is greater for 

the securitized asset than for the underlying loan 

portfolio. This difference in capital treatment might 

encourage securitization of high risk assets, i.e. 

on a risk-based measure, a higher risk-weighted 

SME asset would generate more capital relief for a 

bank than a lower risk-weighted residential mortgage. 

Regulators thus have to address the risk weight 

applied to securitization of assets more closely 

compared to the underlying risk of the assets.


Illiquidity in corporate bond markets 

No exit? 

The efforts of regulators to strengthen the financial system 

have led to both lower and more volatile liquidity in the corporate 

bond markets. As a result, investors could potentially find 

themselves in a situation where no one will buy. To properly 

manage expectations, and to be able to plan ahead, investors 

need to understand this new landscape and what it means. 

financial crisis in 2008/2009: global market 

activity is concentrated more in the most 

liquid securities like sovereign bonds, and less 

in riskier securities such as corporate bonds. 

According to the paper, this trend suggests 

an increased fragility of the latter. As data 

availability is limited, the International Capital 

Market Association, a self-regulatory organization, 

conducted a series of interviews with 

market participants to analyze the topic from 

a market view. The study, titled “The Current 

State and Future Evolution of the European 

Investment Grade Corporate Bond Secondary 

Market,” finds that liquidity in secondary 

European corporate bond markets has declined; 

interviewees described the decline 

ranging from “significantly” to “completely.” 

Another survey of large banks published by 

the European Central Bank (ECB) in January 

2015 focused on Euro-denominated markets 

and arrived at similar results. More banks reported 

that their market-making activities for 

credit securities had decreased during 2014 

rather than increased, and a further decrease 

is expected in 2015. The study also found that 

participants’ confidence in their ability to act 

as market makers in turbulent times had 

diminished in 2014 compared to 2013. 

Since the financial crisis in 2008, 

regulators have tightened rules 

on financial institutions to improve 

the stability of the financial system. 

Banks and dealers have subsequently 

strengthened their financial profiles and 

scaled back risky capital market activities. 

This structural change is especially important 

to bond markets as they depend on intermediaries 

willing to warehouse risk and facilitate 

trading activity. As a number of studies by 

governing institutions suggest, liquidity in 

bond markets has decreased since 2008: 

investors now find it harder to enter and exit 

positions or are incurring higher transaction 

costs. This could increase the risk of more 

severe price swings. In an extreme scenario, 

investors might find themselves trapped as 

nobody is willing to buy. Here, we take a 

closer look at this structural change in bond 

markets and how it interacts with current 

market conditions, and analyze what investors 

can expect. 

Corporate bond markets 

Compared to equities, the fixed income 

market relies more on dealers and over-thecounter 

structures, which makes it more decentralized 

and dependent on functioning 

intermediaries. Further, the market for corporate 

debt is much more fragmented than 

the market for equities as companies usually 

offer very few classes of equity, but a large 

number of different debt instruments. Within 

the bond market, different classes of debt 

exhibit different liquidity characteristics. The 

market for government bonds is perceived as 

more liquid compared to the market for corporate 

bonds, partly due to the different structures 

of securities issued. Governments issue 

in larger lots, have fewer maturities and usually 

do not add exotic features to their debt. 

The corporate bond market is much more 

fragmented and thus shallower. Moreover, in 

the corporate bond market, different risk segments 

exhibit different liquidity traits. Investment-grade 

debt is usually more liquid, while 

high-yield and emerging-market debt are 

perceived as less liquid. 

Declining liquidity raises awareness 

A number of recent publications by regulatory 

institutions and think tanks suggest 

liquidity in bond markets has changed. In 

November 2014, a paper published by the 

Bank for International Settlements on marketmaking 

activities found that liquidity in debt 

markets has shown a diverging trend since the 

Regulatory tightening a driver 

We believe that the decline in corporate bond 

market liquidity can be attributed to an increase 

in regulation in the financial sector. 

This matches with the ECB survey results 

mentioned above, as banks most often cited 

regulation and balance sheet capacity as reasons 

for a decline in market-making activities. 

The financial crisis in 2008 revealed a 

number of shortcomings of financial regulation. 

Since then, governing institutions have 

been actively improving and tightening the 

regulatory framework, thus leading to a reduction 

of market-making and trading activities 

by banks. The Basel regulations for banks 

have increased the amount of equity banks 

need to hold against their risky positions. This 

makes market-making activities, which require 

sizable balance sheet capacity, less 

profitable. Additionally, the newly introduced 

Liquidity Coverage Ratio and Leverage Ratio 

are steering banks toward holding more 

liquid securities, reducing high-volume/lowmargin 

business such as trading activities, 

and limiting their reliance on short-term funding. 

Moreover, banks have cut proprietary 

trading in view of, for example, the Volcker 

Rule in the USA. Proprietary trading has 

been a source of liquidity, especially during


volatile markets. As a result, banks and dealers 

have reduced their fixed income trading 

activities since 2008 as well as their ability to 

warehouse risk and facilitate capital market 

activities. 

Conditions affecting structural changes 

The structural change stemming from financial 

regulation comes at a time of historically 

low interest rates fueled by quantitative easing 

programs adopted by central banks around 

the globe. On the one hand, we believe that 

this accommodative stance has reduced market 

uncertainty and thus eased investors’ 

concerns about liquidity. On the other hand, 

low interest rates have increased the corporate 

debt markets as companies take advantage 

of the lower funding costs. In Figure 1, we 

show the increasing gap between primary 

dealers’ inventory and the size of the US corporate 

debt market. Moreover, investors’ motivation 

to drop low-yielding government debt 

and pile into higher risk and most often less 

liquid securities has also risen due to monetary 

policy, in our view. This in turn adds to liquidity 

concerns again (see Figures 2 and 3). 

Liquidity most relevant in times of stress 

So far, the decline in bond market liquidity 

has not caused much of a headache for investors 

as corporate bonds are in good demand. 

However, it is quite easy to imagine a scenario 

of many investors exiting at the same 

time with no one willing to buy or provide 

market-making activities. In this case, liquidity 

would evaporate quickly, leaving investors 

high and dry. The modest decrease in liquidity 

in the last few years might therefore not 

be a good indicator of what to expect during 

turbulent times or in case demand for corporate 

bonds falls. This could, for example, occur 

when interest rates increase from their historic 

lows. We believe the asset management 

industry is particularly exposed to a sudden 

drop in corporate bond market liquidity. Investors’ 

expectations of their ability to redeem 

mutual fund shares or sell ETFs (exchangetraded 

funds) on a daily basis could reveal the 

low liquidity of the underlying bonds bundled 

into these funds. In case of a pronounced 

outflow from funds, many asset managers 

could be forced to sell into dry markets and 

incur significant losses. 

The Bank of England’s Financial Stability 

Report, published in June 2014, aims at extracting 

the liquidity premium inherent in bond 

prices by comparing credit derivatives and 

actual bond prices. The analysis found that 

the liquidity premium increased in European 

investment grade issues from approximately 

50 basis points in 2007 to 200 basis points 

the following year. For European high-yield 

issues, the rise was even more extreme, from 

approximately 100 basis points to almost 

1,200 basis points during the same period. 

This suggests that, in times of crises, investors 

chase liquidity and also quality. Furthermore, 

according to the study, the liquidity 

premium is fairly low at the moment. To us, 

this raises concerns that current market prices 

influenced by low volatility and low interest 

rates do not compensate investors enough 

for the ongoing decline in liquidity and a potential 

hike in turbulent times. 

Implications for investors 

We believe that investors need to recognize 

the structural change toward lower liquidity 

as well as the volatile nature of liquidity, especially 

buyers of higher-yielding corporate 

bonds. Certainly, liquidity is more relevant in 

turbulent market times, but we think investors 

should plan ahead and assess to what degree 

they rely on markets. If holding fixed income 

securities to maturity is an option, investors 

can shrug off liquidity concerns. If not, investors 

should analyze each case to see if they 

are rewarded for the risk of not being able to 

sell at their convenience. 

Investors are not alone. Supervisory institutions 

are increasingly aware of the structural 

changes in bond markets. A policy response 

to cushion abrupt movements is not 

unlikely, in our view. In the long term, we 

believe that the gap left behind by banks will 

be filled or that banks will adjust their trading 

activities to cater to their clients more specifically. 

As traded corporate debt is a substantial 

part of the financial system, new forms of 

trading are evolving quickly. Electronic platforms 

that rely on peer-to-peer trading instead 

of dealers already exist and are likely to grow. 

Another approach would be to standardize the 

corporate bond market more to reduce complexity 

and simplify trading and market making. 

A combination of both seems pragmatic to us 

as electronic trading requires standardized 

units to flourish. In the meantime, a closer look 

at how much an investor relies on liquidity 

when a security is purchased will help to avoid 

most of the concerns. 

Jan Hannappel 

Equity and Credit Research Analyst – 

European and US Banks 

+41 44 334 29 59 

jan.hannappel@credit-suisse.com 

01_Corporate debt market up 

A growing gap between primary dealers’ inventory 

and the size of the US corporate debt market is 

fueling liquidity concerns. 

Source: Credit Suisse, Federal Reserve, SIFMA 

Federal Reserve data 

8,000 

7,000 

6,000 

5,000 

4,000 

3,000 

2,000 

1,000 

0 

SIFMA data 

250 

2001 2004 2007 2010 2013 

Outstanding corporate debt USD bn (US) 

(left-hand axis) Primary dealer inventory USD bn 

(US) (right-hand axis) 

200 

150 

100 

02_Turnover ratio down 

The turnover ratio of corporate debt is much lower 

than the ratio of Treasuries and the total debt 

market. The turnover ratio of the US debt market 

has decreased on average by more than 30% 

since 2007. Source: Credit Suisse, SIFMA 

in % 

14 

12 

10 

8 

6 

4 

2 

0 

2007 2009 2011 2013 

US Treasuries US total debt 

US corporate debt 

03_Outstanding US bond 

market debt 

US debt markets have increased 14-fold from 

1980 to 2013. Source: Credit Suisse, SIFMA 

USD bn 

40,000 

35,000 

30,000 

25,000 

20,000 

15,000 

10,000 

5,000 

0 

50 

1980 1990 2000 2013 

Municipal Treasury Mortgage-related 

Corporate debt Federal Agency securities 

Money markets Asset-backed 

0


Authors 

Oliver Adler 

Head of Economic Research......................................... 

oliver.adler@credit-suisse.com...................................... 

+41 44 333 09 61....................................................... 

Oliver Adler is Head of Economic Research at Credit 

Suisse Private Banking and Wealth Management. 

He has a Bachelor’s degree from the London School of 

Economics and an MA in International Affairs and a PhD 

in Economics from Columbia University in New York. 

> Pages 10–12, 14, 26–29 

Carla Antunes da Silva 

Head of European Banks, Equity Research.................... 

carla.antunes-silva@credit-suisse.com.......................... 

+44 20 7883 0500..................................................... 

Carla Antunes da Silva is Head of the European Banks 

at Credit Suisse Investment Banking and has covered the 

European banking sector for 15 years. Previously, she 

was Associate Director of Research and lead analyst on 

UK banks at JPM. She started at Deutsche Bank in 1996, 

covering Iberian banks. She was consistently ranked a 

top analyst in the space. She has an MA in PPE from the 

University of Oxford and an MSc in Management from 

the LSE. > Pages 58–61 

José Antonio Blanco 

Head of Global Multi Asset Class Solutions................... 

+41 44 332 59 66....................................................... 

jose.a.blanco@credit-suisse.com.................................. 

José Antonio Blanco is Head of the Global Multi-Asset 

Class Solutions unit and a voting member of the 

Investment Committee. He holds a degree in economics 

and a PhD in applied econometrics from the University 

of Zurich. Mr. Blanco is a member of the Executive 

Committee of the Swiss Financial Analysts Association 

(SFAA) and the Swiss Society for Financial Market 

Research. > Pages 10–12, 14, 26–29 


Senior Analyst............................................................. 

gregory.fleming@credit-suisse.com............................... 

+41 44 334 78 93....................................................... 

Gregory Fleming joined Credit Suisse in 2006 as a senior 

analyst for the Investment Decision Cockpit and Investment 

Committee. Previously, he worked in portfolio strategy 

for Westpac and Grosvenor Financial Services Group, 

and for the International Textile Manufacturers Federation 

as a global economist. He holds an MA with Distinction 

in Economic History from the University of Canterbury, 

New Zealand. > Pages 13, 38–39, 42–43 

Nikhil Gupta 

Fundamental Micro Themes Research........................... 

nikhil.gupta.4@credit-suisse.com.................................. 

+91 22 6607 3707...................................................... 

Nikhil Gupta joined Credit Suisse Private Banking and 

Wealth Management in 2011, and is currently part of the 

Fundamental Micro Research team. Before joining 

Credit Suisse, he worked for a management consulting 

firm for four years. He has an MBA from the Indian 

School of Business, Hyderabad. > Page 15 

Jan Hannappel 

Equity and Credit Research Analyst – European 

and US banks.............................................................. 

jan.hannappel@credit-suisse.com................................. 

+41 44 334 29 59....................................................... 

Jan Hannappel is a Research Analyst in Global Equity and 

Credit Research at Credit Suisse, focusing on European 

and US banks. Before joining Credit Suisse in 2014, 

he was a corporate finance analyst. Jan Hannappel holds 

an MA in Accounting and Finance from the University of 

St. Gallen. > Pages 62–63 

Lars Kalbreier 

Head of Mutual Funds & ETFs....................................... 

lars.kalbreier@credit-suisse.com................................... 

+41 44 333 23 94....................................................... 

Lars Kalbreier, CFA, is a Managing Director and global Head 

of Mutual Funds & ETFs. In this role he is responsible for 

the fund selection and advisory process. Before taking the 

current role, Lars headed Global Equities & Alterna tives 

Research and was a member of the bank’s Investment 

Committee. He is a member of the investment committee 

of Corpus Christi College, Cambridge. > Pages 24–25 

Philippe Kaufmann 

Head of Global Real Estate Research............................ 

philippe.kaufmann.2@credit-suisse.com........................ 

+41 44 334 32 89....................................................... 

Philippe Kaufmann is Head of Global Real Estate Research 

at Credit Suisse Private Banking and Wealth Manage - 

ment, where he also worked for Swiss Real Estate Research 

for six years. Before joining Credit Suisse in 2007, 

he worked for a policy consulting firm and an economic 

research company. He holds an MA in Economics from 

the Univer sity of Fribourg, Switzerland. > Pages 44–47 

Giles Keating 

Head of Research and Deputy Global Chief 

Investment Officer........................................................ 

giles.keating@credit-suisse.com................................... 

+41 44 332 22 33....................................................... 

Giles Keating is Global Head of Research for Private 

Banking and Wealth Management, Deputy Global Chief 

Investment Officer and the Investment Committee’s 

Vice Chair. He joined Credit Suisse in 1986. He was a 

Research Fellow at the London Business School and has 

degrees from the London School of Economics and 

Oxford where he is Honorary Fellow. He chairs Tech4All 

and techfortrade, charities that use technology to reduce 

poverty. > Pages 03, 24–25 

Sven-Christian Kindt 

Head of Private Equity Origination & Due Diligence......... 

sven-christian.kindt@credit-suisse.com......................... 

+41 44 334 53 88....................................................... 

Sven-Christian Kindt is Head of Private Equity Origination 

& Due Diligence at Credit Suisse Private Banking 

and Wealth Management. Before joining Credit Suisse in 

2008, he worked for Bain & Company and A.T. Kearney 

in London. He holds degrees from ESCP Europe and the 

University of Michigan’s Ross School of Business. 

> Pages 16–17 

Robert Parker 

Senior Advisor Credit Suisse......................................... 

robert.parker@credit-suisse.com.................................. 

+44 20 7883 9864..................................................... 

Robert Parker is a Senior Advisor to Credit Suisse in 

Investment Strategy & Research. He has worked in the 

asset management industry for 42 years and joined 

Credit Suisse in 1982 as a founder of CSFB Investment 

Management. He chairs the Asset Management and 

Investors Council and is a board member of the International 

Capital Markets Association. He has a BA and MA 

in Economics from Cambridge University. > Pages 48–51 

Christine Schmid 

Head of Global Equity & Credit Research........................ 

christine.schmid@credit-suisse.com.............................. 

+41 44 334 56 43....................................................... 

Christine Schmid is Head of Global Equity & Credit 

Research at Credit Suisse Private Banking and Wealth 

Management. She has covered financials for 15 years 

and coordinates the global financial view. She holds an 

MA in Economics from the University of Zurich, and is 

a CFA charterholder. > Pages 58–61 

Beat Schwab 

Head of Real Estate Investment Management Switzerland 

beat.schwab@credit-suisse.com................................... 

+41 44 333 92 42....................................................... 

Beat Schwab has been Head of Real Estate Investment 

Management Switzerland since November 2012. From 

2006 to 2012 he was CEO of the real estate services 

group Wincasa AG. During his career he held various position 

in the construction industry and real estate markets. 

Mr. Schwab holds a PhD in Economics from the University 

of Bern and an MBA from Columbia University. > Page 47 

Markus Stierli 

Head of Fundamental Micro Themes Research............ 

markus.stierli@credit-suisse.com............................... 

+41 44 334 88 57....................................................... 

Markus Stierli is Head of Fundamental Micro Themes 

Research at Credit Suisse Private Banking and Wealth 

Management, based in Zurich. He holds a PhD in 

International Relations from the University of Zurich 

and is a Chartered Alternative Investment Analyst. 

> Pages 04–08, 15 

Marina Stoop 

Cross Asset and Alternative Investments Strategist........ 

marina.stoop@credit-suisse.com................................... 

+41 44 334 60 47....................................................... 

Marina Stoop is the Head of Risk and Flow Analysis 

within the Cross Asset Strategy and Alternative 

Investments team. She is responsible for providing input 

to the Investment Committee on financial market risks, 

liquidity and flow. Marina Stoop joined Credit Suisse 

in 2010 after graduating from ETH Zurich with an MA 

in Science. > Pages 21–23

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15C027A_R

Imprint 

Credit Suisse AG, Investment Strategy & Research, 

P.O. Box 300, CH-8070 Zurich 

Publisher 

Giles Keating 

Editors 

Oliver Adler, Markus Stierli, Gregory Fleming 

Editorial deadline 

30 April 2015 

Production management 

Markus Kleeb, Manuel Moser 

Concept 

arnold.kircherburkhardt.ch 

Design and realization 


Charis Arnold, Benno Delvai, Angélique El Morabit, 

Monika Häfliger, Samira Moschettini, Nadia Bucher, 

Rahel Schwarzentruber (project management) 

Editorial support 


Giselle Weiss, Robin Scott, Dorothée Enskog 

Printer 

GDZ print, Zurich 

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International research support is provided by Credit Suisse’s 

global network of representative offices. 

Cover photo: Dorling Kindersley/Getty Images 

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