Liquidity is a core pillar of investment management. While often discussed in terms of market volatility or redemption pressure, effective liquidity management is a proactive discipline, especially within discretionary portfolios. It ensures that investors retain access to capital when needed, while the portfolio remains nimble enough to respond to market opportunities and risks.

For discretionary managers, liquidity must be addressed on two interconnected levels: the overall portfolio and the individual securities or funds it contains.

Managing Liquidity at the Portfolio Level

At the top level, investment managers must ensure that the portfolio can meet cash flow requirements, whether driven by client redemptions, income withdrawals, or strategic reallocation. This typically involves holding a proportion of the portfolio in highly liquid instruments such as cash or cash equivalents, daily traded funds, UK government bonds (gilts) or listed equities.

This liquidity reserve provides flexibility. It allows managers to rebalance quickly during market movements or to protect the portfolio in periods of stress without needing to sell less liquid holdings at unfavourable prices.

Assessing the Liquidity of Underlying Investments

Beneath the surface, liquidity depends on the nature and structure of the assets held. Managers must consider how easily each holding can be traded in different market conditions, and how fund structures or security types affect real-time access to capital.

Gilts and high-quality bonds: offer excellent liquidity and are widely used as defensive or cash-management tools.

UK large-cap equities: (such as FTSE 100 constituents) are typically highly liquid, while small- and mid-cap stocks may trade on thinner volumes and with wider spreads.

Investment trusts: being exchange-listed, provide daily liquidity to investors, even if their underlying assets (such as property or infrastructure) are less liquid. However, they may trade at a premium or discount to net asset value (NAV), introducing pricing risk.

Open-ended funds: vary in their liquidity depending on the underlying investments. Investors in illiquid assets may face redemption delays or suspensions during times of stress.

A key skill of the discretionary manager is navigating these nuances. This means not only selecting liquid instruments but also considering how they will react during times of market stress. They also need to understand fund redemption policies and ensure that the overall portfolio maintains a prudent liquidity profile that aligns with the client’s tolerance for investment risk, capacity for loss, plus their needs and goals.

The Value of Professional Liquidity Oversight

While retail investors may equate liquidity with ease of access, discretionary managers view it as a strategic component of risk control and operational flexibility. Effective liquidity management enables them to preserve value, maintain client confidence, and capitalise on market dislocations.

Importantly, liquidity risk is often latent, surfacing only in stressed markets or during systemic events. Professional managers are expected to mitigate this risk in advance, ensuring that the portfolio can weather volatility without compromising long-term investment goals.

Important Information

The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements. Please note that we are not tax experts, and you should seek professional advice concerning your personal tax affairs from qualified advisers, such as tax accountants.

Please also note that the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.