Liquidity trends in the wake of COVID-19:implications for portfolio construction

Tuesday 03 November 2020

News, Investment Talks

The asset management industry has navigated this liquidity crisis and emerged mostly intact from it, despite having been hit by outflows and precipitous drops in asset prices. However, the liquidity crisis has highlighted once again the importance of a powerful and active liquidity management policy through liquidity buffers, swing prices, stress tests, and access to a wide and varied range of counterparties or instruments that may prove more liquid during market stress. This is crucial to fulfil the fiduciary duty and stand ready to meet all redemptions during liquidity squeezes while keeping the portfolio’s structure unchanged in the interest of remaining investors. By doing this, large international players with global trading organizations may ensure the best mix of connectivity to liquidity venues and relationships with counterparties. Under extreme circumstances, they could even become liquidity providers themselves.

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The Covid-19 crisis has triggered the deepest liquidity squeeze since 2008. Unlike the Great Financial Crisis (GFC), an unprecedented real economy shock led to extremely quick deterioration of financial conditions and showed that, under extreme circumstances, liquidity may dry up not only within risk assets, but also within risk free ones. The peak of this crisis hit in February/March. Market liquidity has improved noticeably since then, although it has not completely normalised yet and areas of weak liquidity remain.

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