Thought Leadership (Professional Only)
The illiquidity conundrum: does the illiquidity premium really exist?
Locking your money up for a longer period of time can be a risk, particularly in times of market stress. However, some believe that long-term investors should be able to stomach illiquidity and will receive higher returns as a result.
3 September 2015
In this paper we examine the illiquidity premium and its place in a UK defined benefit pension scheme portfolio. We consider:
- To what extent pension schemes can tolerate illiquidity
- Approaches to identifying, isolating and quantifying the illiquidity premium
- To what extent illiquidity is a rewarded risk
- An illiquidity premium does appear to exist for some alternative asset classes (in particular property). Furthermore, being able to tolerate a degree of illiquidity enables pension schemes to access a wider range of asset classes for return generation and diversification purposes. However:
– There are a number of difficulties with measuring illiquidity risk. A key difficulty is isolating asset specific illiquidity risks from systematic or market risk
– Returns may not fully compensate investors for the risks embedded in illiquid assets, such as tail risk
– Higher returns may be the result of other underlying risk factors which can be exploited in other ways, without locking up assets for a long period of time.
Although illiquid assets may (and arguably should) play a role in a pension scheme’s investment strategy, given the challenges above, pension funds should be wary of investing in illiquidity “for illiquidity’s sake.”
Important Information: The views and opinions contained herein are those of the author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. To the extent that you are in North America, this content is issued by Schroder Investment Management North America Inc., an indirect wholly owned subsidiary of Schroders plc and SEC registered adviser providing asset management products and services to clients in the US and Canada. For all other users, this content is issued by Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA. Registered No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.