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The two flavors
- Market liquidity risk — the price impact of selling a position into the available market. Public stocks and Treasuries have minimal market liquidity risk; thinly traded bonds, micro-caps, and private positions have meaningful market liquidity risk.
- Funding liquidity risk — the structural inability to redeem a position because of contractual gates or capacity limits. Interval funds, BDCs, and private credit vehicles all carry funding liquidity risk by design.
How liquidity risk shows up in advisory portfolios
- Daily-liquid wrappers over inherently illiquid assets (private-credit ETFs, real-estate ETFs).
- Semi-liquid funds with periodic redemption windows that can be gated under stress.
- Concentrated single positions where the size of the holding exceeds normal market depth.
- Side-pocket structures in alternative investment funds.
What examiners look for
Examiners care about the alignment between the client's expected liquidity needs and the actual liquidity of the portfolio. The defensible record connects three things:
- The client's spending horizon and emergency-cash needs in the IPS.
- The portfolio's liquidity profile, by tier (daily, periodic, gated, locked).
- Documented client acknowledgment of the trade-off when illiquid positions are added.
Liquidity tiering
A simple practice that holds up well under examination is tagging every position with a liquidity tier: daily, weekly, monthly, quarterly, gated-with-proration, locked. The portfolio's tier mix is then compared to the client's stated liquidity needs. Mismatch is flagged for review.
How StratiFi thinks about liquidity risk
Liquidity is not a feature of an asset; it is a feature of an asset under specific market conditions. The firms that defend their portfolios well are the ones that documented the conversation about liquidity at the position level — what the redemption mechanic is, what could disrupt it, and how the client would access cash if it did — and refresh the conversation as the client's needs change.
Frequently asked questions
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How is liquidity different from volatility?
Volatility is how much the price moves; liquidity is whether you can transact at the quoted price. A position can be low-volatility and illiquid (e.g., private credit), or high-volatility and highly liquid (e.g., a major-index ETF). -
Are interval funds liquid?
They are semi-liquid. They offer periodic repurchase windows (typically quarterly), but the windows can be filled pro rata if redemption requests exceed capacity. They are not equivalent to daily-liquid funds. -
How much illiquid exposure is appropriate?
It depends on the client's spending horizon and emergency-cash needs. A common practice is to set illiquid-allocation caps in the IPS and review them annually. There is no SEC-mandated number.