How Much Liquidity Do Investors Need?

For most individual investors, the vast majority of their investment portfolio is dedicated to funding goals with long time horizons: retirement, paying for children’s college expenses and generational wealth transfer. Even though investors do not need immediate access to these funds, their portfolios typically comprise mostly public equities, bonds and other highly liquid assets.

As astute investors know, liquidity is not free. Conversely, investors can generate a premium by investing in less liquid asset classes, such as private equity, private debt, hedge funds and structured credit. The net result is that many individual investors are paying for more liquidity than they need.

Historically, lack of access was among the biggest barriers to individuals investing in illiquid or less liquid assets.

Recent advances in product design have expanded individual investors’ access to alternatives. Closed-end funds (CEFs) may provide improved access to alternatives and have attractive features such as low investment minimums, no performance fees, and the ease of 1099 tax forms. In addition, CEFs are designed to offer purity of strategy and provide individuals the same investment opportunity as their institutional counterparts.

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Liquidity Premiums Across Asset Classes

Liquidity Premiums Across Asset Classes

Source: A. Ilmanen, “Expected Returns,” 2011. Average asset returns 1990-2009 on subjective illiquidity estimates. Bloomberg, MSCI, Barra, Ken French’s website, Citigroup, Barclays Capital, JP Morgan, Bank of America Merrill Lynch, S&P GSCI, MIT-CRE, FTSE, Global Property Research, UBS, NCREIF, Hedge Fund Research, Cambridge Associates. Performance data quoted represents past performance. Past performance does not guarantee future results. Current performance may be lower or higher than the performance data quoted.

 
Risks
The information in this article is provided as a summary of complicated topics and does not constitute legal, tax, investment or other professional advice on any subject matter. Further, the information is not all-inclusive and should not be relied upon as such. Illiquid investments are designed for long-term investors who can accept the special risks associated with such investments. An investment in illiquid investments involves risks, including loss of principal. Performance data quoted represents past performance. Past performance does not guarantee future results. Current performance may be lower or higher than the performance data quoted. Diversification does not eliminate the risk of experiencing investment losses. You should not use this paper as a substitute for your own judgment, and you should consult professional advisors before making any investment decisions. This information does not constitute a solicitation of an offer to sell and buy any specific security offering. Such an offering is made by the applicable prospectus only. A prospectus should be read carefully by an investor before investing. Investors are advised to consider investment objectives, risks, charges and expenses carefully before investing. Financial advisors should determine if the risks associated with an investment are consistent with their client’s investment objectives.

CEFs frequently trade at a discount of the fund’s net asset value (NAV). An investment in CEFs involves risks, including loss of principal. Past performance is not necessarily indicative of future results. Diversification does not eliminate the risk of experiencing investment losses.