MCNABB We are very careful to educate our clients on liquidity, especially the fact that a component of the returns we’re generating come from buying things that aren’t liquid. We’re managing expectations in this respect.

I would sound a note of caution about the market, here, in the sense that we believe there are products on the street that are offering liquidity on underlying assets that really aren’t liquid. I suspect at some point this will bite us all on the backside, unfortunately.

MOAL To operate a broad high-yield mandate you also have to tell your clients you’re not giving them daily liquidity. If you have to offer them this, you have to leave substantial cash on the balance sheet and not be fully invested. Which means you won’t achieve your objectives. We need to be fully invested, and our clients have to understand that the part of the capital structure we are investing in is less liquid.

JONES It comes down to the education piece at client level, and this takes time. We are an objectives-based investment firm, so it’s easier to have a conversation about assets being illiquid and the benefit this brings. We can say to clients that the illiquid part of their portfolio is not accessible – and that’s the trade-off.

It’s a journey for clients to accept this. Once they understand this concept, the risk of them trying to liquidate assets or panicking because they can’t liquidate them in the event of a downturn decreases. The education piece is a vital part of the investment process – if you don’t do it you start to get into the kinds of problems experienced during the financial crisis.

MCNABB We say to our clients: ‘If you as an investor want to liquidate for an idiosyncratic reason, you can at any given moment. But if you want to liquidate when everyone else is doing so, you’re going to get stuck.’ We also favour assets that self-liquidate rather than relying on the market, which is another reason we like asset-backed bonds at the moment.

KASE I agree that the problem comes when you buy something that’s illiquid but convince yourself it’s liquid and think you’re just getting a large credit-risk premium. Whereas really what you’re doing is getting some credit-risk premium and a lot of illiquidity premium. You can’t really lay off the illiquidity risk.

For us it’s a broader portfolio-construction question around how much illiquidity risk we take, how much we get paid for it and also where we allocate it from a risk perspective. We are aware, of course, that illiquid
products will have different characteristics. But the idea that everything we own needs to be highly liquid is somewhat nonsensical.

JONES Part of the issue with liquidity is the way investors are focused on short-term performance. We are asked to give quarterly, semi-annual and annual updates. The education process is around trying to explain to clients that they really need to be looking at performance over a three-year window. They need to forget what the equity index did over 12 months or what the bond-market index did over six months. We say to clients, ‘Let’s look at the three-year strategy we have in play and measure it on a three-yearly basis.’

We just want to see whether the assets are producing what they were forecast to and whether we’re on target to meet our clients’ goals. If you change the conversation away from the day-to-day performance issue it makes it a lot easier for clients to accept some illiquidity in their portfolio positions.