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Explain the tools available to manage liquidity risk in a portfolio

CFA® Level III · Portfolio Management Pathway · Case Study in Portfolio Management: Institutional (Endowment) · L3.PM.8.a

The idea

For an institution holding illiquid assets, liquidity risk is the chance of being unable to meet spending, capital calls or rebalancing without selling at a loss. Tools include sorting assets into tiers by time to cash, forecasting spending needs and private fund capital calls and distributions, setting a minimum share of liquid assets, and stress-testing a scenario in which markets fall, distributions stop and calls continue. Further tools are credit lines, derivatives overlays that adjust exposure without selling illiquid holdings, secondary sales of fund interests and slower new commitments. The trap is the denominator effect: when public markets fall, private assets become a larger share of the portfolio, breaching limits and squeezing liquidity when calls keep arriving.

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