Wealth Strategies
A Family Office Says Avoid Getting Obsessed Over Liquidity
In this commentary the European family office addresses the risks of being overly concerned with having liquid assets.
The following commentary comes from Christian Armbruester,
chief investment officer of the European firm Blu Family
Office, who regularly airs views on topics in these pages. In
this short note, he talks about whether investors can become
overly-concerned about liquidity to the detriment of other goals.
10 years on from the financial crash, investors may remember only
too well how market liquidity can vanish, leaving even the most
cautious asset allocation decisions in trouble. A key issue is
understanding the full balance sheet of a client’s life to ensure
that liabilities are matched by available cashflow – no more and
no less. Famously, the “Yale Model” of investing, developed at
the university endowment fund that gave it the name, was built
around the idea that investors often over-pay for the ability to
have liquid assets and sacrifice returns, while in fact they
should and could hold more relatively illiquid, long-term, assets
instead. This is, as one can appreciate, a complex field.
The editors of this news service are glad to share these views
from Blu Family Office with readers and invite responses. Email
the editor at tom.burroughes@wealthbriefing.com
People seem to be obsessed with liquidity. Accordingly,
investment strategies that can offer daily liquidity have been in
high demand, particularly when wrapped into so-called UCITS
funds. It is estimated that nearly $9 trillion is now invested in
these investment structures that are also approved for retail
investors. Apparently, everyone, including the regulator, think
high liquidity is also equal to low risk. But, is this really
true and are we potentially missing out on a great part (and
returns) of the investment universe?
Surely liquidity is a risk factor - after all, the ability to get
out whenever one wants is a great way to take risk off the table,
almost immediately. But then again it isn’t the only risk factor
and just because something is liquid doesn’t necessarily mean it
is low-risk, either. For example, you could hold
crypto-currencies, high yield bonds or penny stocks, for that
matter, and although very liquid, the risk would be much higher
than a long-term, senior-secured lending strategy, for
example.
Moreover, by foregoing strategies with longer lock-ups, we are
also very plainly missing out on getting rewarded for
illiquidity. Depending on how long you choose to tie up your
capital, the premium can be as high as 5 per cent a year.
Compounded over time, that is a huge opportunity cost in missed
performance, making it very clear that only limiting yourself to
liquid strategies is too expensive a cost to bear. There are many
private equity funds, real estate, or lending strategies that
require lock-ups of more than five and even 10 years. The returns
have also been outsized and I would argue that to make double
digit returns in the current low interest rate environment is
nigh impossible, without giving up liquidity.
By only holding liquid investments we are also restricting our
investment universe to so-called “plain-vanilla” strategies. The
problem with UCITS, is that in an attempt to “reduce risk”,
strategies are extremely restricted in using many of the tools to
hedge specifics risks. There are limits to leverage, the ability
to short certain instruments and how much can be invested into
individual vehicles (products). That means most alternative
strategies simply can’t be executed effectively in a UCITS
structure. As such, we would also be missing out on much needed
diversification in a market environment where public bond and
stock markets are at historic highs.
But, by far the most important reason why you should never only
hold liquid instruments is, no one in their right mind would
actually ever choose to sell their entire portfolio in one day.
If you go back in history, when has it ever been a good idea to
get out of the markets completely? Sure, you can rebalance
opportunistically when there is an adverse market event, but that
doesn’t mean you sell your entire portfolio to buy something
else. In fact, the only reason you would ever do anything so
drastic, is if you either panicked or you were trying to time the
market. Either way, it is not something we would advise doing,
particularly for long-term investors.
Bringing it all together, liquidity is important, and it allows
us to manage our portfolio seamlessly as we naturally rebalance
our investment allocations or need to take some of our monies out
for unforeseen events.
But, given that we have the ability to plan our wealth management
strategy, there really shouldn’t be any reason to hold more than
25 per cent of our investments in daily liquidity terms. The rest
can be tied up for longer, and why shouldn’t it? After all, we
are also investing for the long term and it makes no sense to pay
for something we actually don’t need and forgo much needed
diversification.