- This article explains what investment liquidity is, why it matters, and how to manage it within a portfolio.
- The information is intended for asset managers or financial advisors looking to optimize their clients’ strategies.
- FlexFunds offers an asset securitization program designed to enhance the investment liquidity of financial assets. For more information, feel free to contact our experts through the contact form.
When building strategies, portfolio managers must consider various factors, one of the most important being investment liquidity, which offers multiple benefits to all parties involved.
What is Liquidity in Investment Terms?
In the world of investing, liquidity, or investment liquidity, refers to the ability to convert an asset into cash (liquid capital ready to be exchanged).
A highly liquid investment can be converted into cash quickly and at a low cost in terms of time and money. In contrast, a low-liquidity investment faces challenges in doing so.
For example, shares of major tech companies, such as Apple, are highly liquid, meaning they can be converted into cash within seconds.
In contrast, real estate properties may take days, weeks, months, or even years to sell. And often involve significant fees to convert into liquid capital.
Why is Investment Liquidity Important in Uncertain Markets?
Investment liquidity is significant when building an investment portfolio. It provides several benefits:
- Covering unexpected needs.
- Taking advantage of opportunities.
- Flexibility in rebalancing.
Covering Unexpected Needs
First, investment liquidity helps cover unexpected financial needs.
For example, suppose an investor informs their asset manager or financial advisor that they need cash from their portfolio to cover an unexpected expense. In that case, specialists can select liquid assets to sell, obtaining cash quickly and at a low cost.
Taking Advantage of Opportunities
On the other hand, investment liquidity enables investors to capitalize on investment opportunities. While portfolio managers always maintain a portion of liquid capital to act on potential assets when opportunities arise, sometimes additional funds are required.
At these times, liquidity helps secure the additional amount quickly and cost-effectively.
For example, managers can sell stocks or bonds that have already met their performance goals to invest in a real estate project that is just getting started.
Rebalancing Flexibility
A similar situation applies to portfolio rebalancing, which involves buying and selling financial assets to maintain the original allocations.
In a classic 60/40 portfolio, comprising 60% stocks and 40% bonds, stocks may grow to the point where the portfolio shifts to 70/30. During these times, the high liquidity of stocks provides fast and low-cost sales to restore the original 60/40 allocation.
Balancing Liquid and Illiquid Allocations for Investors in the United States
When building a portfolio for investors in the United States, asset managers are highly aware of investment liquidity, which must be managed with consideration of three key factors:
- Risk profile.
- Time horizon.
- Expected cash flow.
Risk Profile
More conservative investors place greater value on liquidity in their investments, as it allows them to hold cash in case an unexpected event threatens their financial situation.
For example, during the 2020 pandemic stock market crash, investors holding liquid stocks and bonds were able to convert their holdings into cash within hours, helping to avoid larger losses.
Time Horizon
Portfolio managers also need to consider their clients’ time horizons. Those willing to invest for several years or even decades are better suited for illiquid but potentially higher-return investments, such as real estate or private equity.
Expected Cash Flow
Likewise, expected cash flow is a key factor for many investors in the United States and is directly related to investment liquidity.
Those who need regular income to cover various expenses should prioritize liquidity. On the other hand, investors without short-term cash flow needs can consider less liquid alternatives.
Key Takeaways for Managing Investment Liquidity
To manage investment liquidity effectively, asset managers need to understand its benefits:
- Covering unexpected needs.
- Taking advantage of opportunities.
- Flexibility in rebalancing.
They also need to know which factors to consider when building a portfolio with liquidity in mind:
- The client’s risk profile.
- Time horizon.
- Expected cash flow.
FlexFunds Perspectives: Expertise in Liquidity Solutions
Fortunately, there are tools to leverage the advantages of illiquid investments, and at the same time improve their level of investment liquidity. One such tool is asset securitization, a process carried out by FlexFunds.
Specifically, FlexFunds offers a securitization procedure that converts any asset into a bankable asset with its own ISIN/CUSIP code.
This allows asset managers to transform a strategy into an exchange-traded product (ETP) that can be traded through a standard brokerage account worldwide.
In FlexFunds’ case, this cost-effective solution is supported by a comprehensive service package that includes:
- Exchange listing.
- Fund accounting.
- Back-office services.
- Net Asset Value (NAV) calculation.
- Corporate administration services.
To learn more about FlexFunds’ ETPs and our asset securitization program, feel free to contact our team of specialists. We’re happy to assist you!
Sources:
- https://www.marcus.com/us/en/resources/saving/what-is-liquidity-and-what-are-liquid-assetss
- https://www.cqf.com/blog/liquidity-management-what-you-need-know
