Forbes


Charlotte Beyer - Contributor

Investors Learn The Hard Way That Liquidity Is King During Market Meltdowns

The first act of this tragic comedy opened as the 2008 crisis and market meltdown unfolded. One investor in our surveys said, “Investing is not fun anymore.” Quite an understatement as the stock market fell nearly 40%.

In act two came capital calls from private equity funds, not to mention a money market fund ‘breaking the buck.’

For act three, bring in other investors counted on ‘absolute return’ hedge funds that they believed would have an absolute return, no matter what the stock market did. No such luck. Several of these funds went down at a terrifyingly swift pace, far worse than the market if they were leveraged.

To add insult to injury, when seeking to withdraw from certain hedge funds, many investors were told they could not withdraw their monies. Called ‘gates’, the general partners of these funds claimed the withdrawals would jeopardize the value of other limited partners’ holdings. Perhaps they were right.

The finale in this three-act play made liquidity into a star. For investors liquidity suddenly became a vital part of any investment under consideration. Asset allocation began to use liquidity as one more overlay, stealing the spotlight from diversification and investment styles. Some investors swore never to invest in any hedge funds whose offering memorandum permitted gates, others significantly increased their allocation to cash.

Investment policies in some cases had missed the importance of the role of liquidity. Too many investors had portfolios that closely resembled the Yale Endowment with two noticeable and deadly differences. First, unlike Yale, few investors have areliable source of new funds coming in each year through fund raising or an annual fund. Second, unlike Yale, each year most investors relied on liquidity, i.e. cash, to pay taxes.

Advisors who employed Ashvin Chhabra’s Wealth Allocation Framework were more fortunate. The need for liquidity was already addressed in deciding the apportionment among personal risk, market risk and aspirational risk. The calculation directly addresses the liquidity needs of the investor in a variety of personal and market scenarios.

How do investors respond to the new star, liquidity? In a recent dialogue online one investor remarked, “Liquidity is so highly prized that illiquid assets are selling at discounts,” and in response, one investor admitted, “It is difficult to take risk when people are most concerned about it. It is also difficult to sell when everyone is making money.”