Index Allows DB Plan Sponsors to Measure Illiquidity Risk Premiums

Willis Towers Watson introduced its Illiquidity Risk Premium (IRP) Index.

In a research paper, “Understanding and Measuring the Illiquidity Risk Premium,” the company observes that investors generally do not have a good understanding of what they’re being paid for having their capital locked up. By referencing the principle “what gets measured gets managed,” the company explores what investors should demand for accepting illiquidity risk and how this can be measured by using a new IRP index.

According to Willis Towers Watson, the index enables comparison of IRPs across assets on a consistent basis, so as to make relative-value statements about the attractiveness of taking illiquidity risk across those assets.

Thierry Adant, a consultant for credit research at Willis Towers Watson in New York City, tells PLANADVISER, “We think liquidity listing is underutilized. Having a good understanding of whether [defined benefit plan sponsors] are getting paid enough is better than blind allocations. The index helps plan sponsors determine where and when it is good to take liquidity risk.”

According to Adant, the IRP Index is a proprietary offering Willis Towers Watson has been using for a number of years, but is now introducing it to investors because of a change in the market liquidity regime, not just for bonds but other assets. “If [liquidity] is managed correctly, it can make a big difference over time,” he says.

The company warns that its IRP index currently indicates that IRPs are at the low end of fair value and are likely to remain so for some time unless there is a significant downside event, which would push all risk premium—including IRPs—higher.