Thought Leadership

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.


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.”