Ever noticed how much easier it is to buy a car than sell a car? There always seems to be plenty of offers and plenty of salespeople to find you that perfect purchase but never enough to help you sell at the right price when it’s time to upgrade.
That’s pretty much how it is at times in financial markets as well.
Certainly when it’s business as usual traders know the spread they can buy and sell at, and the banks and other investors they are dealing with, are usually happy to honour those bids and offers to trade.
But that appearance of liquidity can sometimes be an illusion according to Darren Langer, a Senior Portfolio Manager at Nikko Asset management.
Langer said it’s time for investors to rethink their approach to liquidity which is an “ongoing concern for fixed income participants and market regulators globally”.
Things have changed since the GFC, Langer says, and “despite the expectations of some market participants, it is not always possible to quickly and cheaply exit an asset class”.
That means “investors, borrowers, banks and asset consultants may need to adjust their expectations for what will be achievable in a more highly regulated market and one with a different level of liquidity than experienced over the past 20 years”, he said.
Langer says that “as an industry, and more broadly as investors, we need to better acknowledge that liquidity is not instantaneous, free and continuously available. Instead, we may have to start moving towards a model where investment horizons and liquidity expectations are more appropriately matched to the asset classes being invested in”.
This is a really important concept in a world of low-interest rates.
That’s because increasingly investors are using non-cash products as reservoirs of savings and assuming they can then convert them back into cash.
It’s a clear message to investors that only cash is really cash and any pretence that other products may hold to cash-like is just that – a pretence.
“It may no longer be possible to offer daily liquidity to clients and redemption periods may need to be extended to weekly or monthly windows,” Langer says. “Another option may be to adopt liquidity windows that allow redemption of a certain percentage of an investment, rather than the whole sum. Even if instant liquidity were possible, it is often not in the best interests of investors to achieve it at ‘fire sale’ prices”.
But that’s not a bad thing as the answer is simply to match product offering and investor time horizons with actual long term market liquidity.
It won’t be a costless exercise for the product issuer or market however.
But by finding a system which can stand up to the rigors of liquidity calls in times of stress, Langer says investors may be able to earn “a return that is greater than the risk-free rate” if they are willing to accept “a longer investment horizon and with this the potential for reduced liquidity or longer asset disposal timeframes”.