Insight
Tickling the Dragon’s Tail
Many institutional investors have increasingly large allocations to less-liquid and illiquid assets. When markets become stressed, what are the added risks to portfolios and what are the added risks system-wide?
Key takeaways
- As investors have allocated more assets to illiquid investments such as private equity, the potential for market fragility has increased.
- An imbalance between the sources and uses of cash can trigger a liquidity squeeze and result in the forced selling of assets.
- Because demands of illiquid assets are first met by selling liquid public market assets, investors holding the least amount of illiquid assets are often hurt the most.
- There is a tipping point in the size of the illiquid allocation; once the tipping pint is breached, the more illiquid assets held, the worse the performance.
- This is not all bad news, as fragile markets also open up opportunities for investors in preservation of liquid capital, trend-following strategies, and liquidity analysis.