What Happens When Liquidity Dries Up

As liquidity in the financial system is removed, investors preserve cash to be proactive buyers from the inevitable forced sellers. But not all investors.

Oct 2022

Multi-Asset

Liquidity Presents A Dichotomy

As central bankers raise rates across the globe in their fight against inflation, institutional investors are turning their attention to liquidity. In this new chapter of global political economy, a world drained of liquidity is a world where assets are no longer priced on fundamentals.

Being short liquidity means sellers of assets will by necessity take what they can get in order to meet their commitments. Or put differently, being long liquidity facilitates the purchase of quality assets at deep discounts to intrinsic value.

This presents a dichotomy for institutional investors:

An ALM driven investor will be guided by a series of strategic asset allocation benchmarks and associated risk budgets. Which empirically provide a confidence level that their assets will generate enough returns to cover their current and future obligations. So the tendency is to sit out the storm.

But there are hard core investors who see the removal of liquidity from the global economic system, as an opportunity to pounce. Their research inside RFPnetworks is crossing all asset classes. Searching each of the 11 feeds for terms such as "cheap", "intrinsic value", "discount", and "distressed".

Global Macro

Investment Review by Jonathan Ruffer

Ruffer LLP

Ruffer multi asset research on RFPnetworks depicted by hour glass drawing.

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We see danger ahead. Markets are still too high, and protection is expensive in an increasingly nervous world; common sense suggests one should invest conservatively, and in safe assets. In a world where people find themselves without the ability to pay commitments as they arise, forced selling drives prices. Among risky assets like equities, one of the counter-intuitive things in a liquidity crisis is that securities perceived as safest and most liquid go down sharply, because investors are forced to sell what they can, not what they want to. We therefore regard plentiful liquidity in the portfolio as overwhelmingly attractive; it allows us to make the most of the opportunities that arise in the aftermath of a crisis. But first we have to get through the storm.

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