The cost of liquidity
In today’s uncertain environment, investors are seeking new ways to meet their goals. Understanding what liquidity is and how it can impact portfolio returns may help investors make more informed decisions.
Understanding the liquidity spectrum
Liquidity is defined as the ease with which an investment can be bought or sold without significantly impacting the price of the security. Investments that can be easily bought or sold are said to be liquid while the inverse is true for illiquid investments.
How easily assets may be converted to cash can vary considerably. Traditional investments, including many stocks and U.S. Treasury bonds, can be easily bought and sold, so they are considered highly liquid.
Illiquid asset, such as private debt and private equity, classes typically have fewer buyers and sellers than more-liquid investments and tend to lack standardized terms, making it harder for investors to quickly analyze, value and, in turn, buy or sell them.
The asset class liquidity spectrum
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Equity |
Large-cap stocks |
Mid-cap stocks |
Small-cap/ |
Preferred stock |
Private equity real estate |
Private equity venture capital |
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Fixed income |
U.S. Treasuries |
Investment grade corporate debt |
High yield bonds Emerging market debt |
Structured products Distressed debt |
Private real estate debt |
Private corporate debt |
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Review: What is liquidity?
Benefits of less-liquid investments
Investors tend to gravitate toward more-liquid investments. But in today’s environment, a portfolio of all-liquid investments may not help them reach their long-term goals.
Combining liquid and less-liquid investments may help investors meet the following objectives:
- Potential to generate a return or yield premium. Investors typically demand a higher rate of return in exchange for giving up liquidity. This “illiquidity premium” is often a key factor for those investing in less-liquid and illiquid investments.
- Diversify a portfolio by adding low-correlated assets. Finding low-correlated assets, or assets that do not move in relation to one another, is key to building diversified portfolios. Less-liquid and illiquid investments have historically exhibited lower correlation to traditional investments.
- May improve risk-adjusted returns. Institutions have long turned to less-liquid and illiquid investments to help smooth the returns of their portfolios to drive long-term performance by reducing the impact of volatility on the portfolio.
Review: Why consider less-liquid and illiquid investments?
Incorporating less-liquid and illiquid assets into an investor portfolio
Investing through the right fund type, or structure, is critical when investing in less-liquid and illiquid assets or strategies that require a long-term investment horizon. Accessing and maximizing the return and diversification potential of less-liquid and illiquid investments takes a thoughtful approach to matching the liquidity of the asset class, management style and investment structure. A mismatch between the liquidity of assets and fund structure may limit a fund’s return potential or subject investors to unnecessary risks.
The fund structure liquidity spectrum
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Unlisted NAV REITs |
Hedge funds Venture capital funds |
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Review: Accessing less-liquid and illiquid investments
Investor considerations
Investing in less-liquid and illiquid assets is different than investing in traditional investments, such as stocks and bonds, and involves risk in addition to the normal risks associated with investing, including the risk that a shareholder may receive little or no return on their investment or that a shareholder may lose part or all of their investment. Less-liquid assets are suitable only for investors who can bear the risks associated with limited liquidity and should be viewed as a long-term investment.
Learn more
Dig deeper on the topic of liquidity to understand how to effectively match asset class and fund structures.