Focus: Liquidity is essential

Indeed, there is plenty of evidence to show that investors have often been caught in liquidity traps, where they are forced to meet liabilities, but are unable to sell certain assets because buyer interest has dried up.

If one is too exposed to illiquid holdings, investors often end up having to sell other preferred and more liquid assets that still attract buyers. This was seen in the liquidity crisis of 2008, when many defensive assets were sold down, simply because forced sellers had to get rid of whatever they could. In the managed fund world this can lead to the suspension of the vehicle, as the manager can no longer meet redemptions without compromising the interests of remaining shareholders. No one needs reminding of the chaos surrounding property funds since the start of the crisis.

Indeed, the importance of liquidity is often overlooked. Irrespective of the asset class involved, there are several important factors to consider in terms of ensuring ample liquidity. Some are mentioned below.

Determine your investment horizon

Investors need to clearly define their horizons, which should affect their decisions accordingly. Indeed, each asset class has its own appropriate horizon, although this is obviously subjective. For example, listed equity investors could have a horizon measured in weeks, months or years, depending how speculative their approach is.

But investors in private equity would almost certainly have a horizon measured in years. Similarly, physical real estate investing would probably be measured in years. These horizons should inform investors’ expectations about the ease of getting their money back when they need to.

Develop your view of the market

It is important to develop an original view of the world and investment markets to try to determine when liquidity is likely to be more or less in demand. Naturally this is difficult, but it makes sense to try and be more liquid ahead of tougher times and put cash to work before markets rise.

For example, in terms of fixed interest markets, it became increasingly clear during the course of 2007 - and even more so in early 2008 - that there were headwinds facing non-government fixed interest. Having this view could have prompted investors to react accordingly, by reducing exposure to emerging market debt, high yield and corporate bonds, while increasing exposure to developed government bonds. Indeed, taking such action would have preserved significant capital during the credit squeeze, given developed government bonds were one of the few asset classes to perform well during this period.

Understand your asset classes

It is vital to have a thorough understanding of the characteristics of the asset classes in which you are investing. Dedicated specialists are better placed to understand the distinctions between asset classes. It follows that managers with dedicated teams look at these classes day in and day out and have the expert knowledge to make such calls.