Investors tend to gravitate toward more-liquid investments, which they can buy and sell with relative ease. But in today’s environment, a portfolio of all-liquid investments may not help them reach their long-term goals.

Understanding liquidity as a spectrum

Liquidity is defined simply 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.

There are two ways liquidity applies to investing  – the liquidity of individual securities and the liquidity of the fund or investment vehicle used to invest in those securities.

Where different assets fall along the liquidity spectrum

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. On the opposite end of the spectrum are illiquid investments, such as private debt and private equity.

Illiquid asset 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

Equity

Fixed income

Large-cap stocks

U.S. Treasuries

Mid-cap stocks

Investment grade corporate debt

Small-cap/emerging market stocks

High yield bonds

Emerging market debt

Preferred stock

Structured products

Distressed debt

Private equity real estate

Private real estate debt

Private equity venture capital

Private corporate debt

Benefits of less-liquid investments

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.

Understanding liquidity as a spectrum

Liquidity is defined simply 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.

There are two ways liquidity applies to investing – the liquidity of individual securities and the liquidity of the fund or investment vehicle used to invest in those securities.

Where different assets fall along the liquidity spectrum

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. On the opposite end of the spectrum are illiquid investments, such as private debt and private equity.

Illiquid asset 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

Equity

Large-cap stocks

Mid-cap stocks

Small-cap/
emerging market stocks

Preferred stock

Private equity real estate

Private equity venture capital

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

Benefits of less-liquid investments

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.

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. 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

Exchange-traded funds

Publicly traded closed-end funds

Open-end mutual funds

Unlisted NAV REITs

Closed-end interval funds

Unlisted closed-end funds

Hedge funds

Private equity/debt funds

Venture capital funds

Achieving financial goals by investing across the liquidity spectrum

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.

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. 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

Exchange-traded funds

Publicly traded closed-end funds

Open-end mutual funds

Unlisted NAV REITs

Closed-end interval funds

Unlisted closed-end funds

Hedge funds

Private equity/debt funds

Venture capital funds

Achieving financial goals by investing across the liquidity spectrum

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.

Learn more about liquidity

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