Important legal information

The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.

The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.

Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is Robeco Switzerland AG, Josefstrasse 218, 8005 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult for a list of FINMA registered funds.

Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/Robeco Switzerland product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/Robeco Switzerland offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.

This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.

I Disagree
Investors need a better understanding of liquidity risk

Investors need a better understanding of liquidity risk

21-02-2017 | Interview

Ronnie Sadka is a prominent academic voice on topics like liquidity in financial markets, high frequency trading and hedge funds. Having taught at a number of renowned universities, he currently chairs the finance department at the Carroll School of Management, Boston College, where he has been a professor since 2008.

Speed read

  • Investors do not take liquidity risk into account correctly
  • Liquidity level and liquidity risk must be properly differentiated
  • Rise of factor investing may help change perception on liquidity

Could you tell us about your academic path and what drove you to focus on liquidity?

“I belong to the post-LTCM generation of academics that recognizes the significant potential impact of systematic liquidity risk in financial markets. In the early 2000s, I was involved in the implementation of trading strategies exploiting market anomalies such as momentum at a large asset management firm. At the time, the difficulties in the implementation of relatively short-horizon strategies drew my attention to research on liquidity issues. The availability of intraday data for a relatively long period for a large cross-section of equities enabled a productive and impactful research agenda on liquidity risk.”

Stay informed on Quant investing with monthly mail updates
Stay informed on Quant investing with monthly mail updates

Any other major research areas you’d like to highlight?

“Almost a decade ago, I also began to work on projects that center on the independent collection of data and the possible applications in asset management, a field now known as big data or alternative data. I published a few articles and developed some commercial products in this field These are based on various proprietary datasets, from thousands of distinct media sources to millions of mobile devices.”

People often confuse liquidity level and liquidity risk

What are the main practical conclusions of your work on liquidity for equity investors?

“I think the key message is that liquidity risk should be better understood, both from a risk perspective and also as a potential alpha generator. In my view, people often confuse the average liquidity level of a security and its liquidity risk, which is what happens to the price of this asset during marketwide liquidity crunches. I also call it liquidity beta. Both liquidity level and beta have been shown to command a return premium, but they are clearly not the same.”

Do you think the liquidity issue is correctly taken into account by investors?

“No. For example, the common perspective on liquidity is that stocks with low levels of liquidity outperform and this is interpreted as a liquidity risk premium. However, this is not always true. As I show in my studies, illiquid securities, both equity and fixed income, outperform liquid assets during liquidity crises.’’
‘‘When there is a shock, investors tend to sell their most liquid assets first which turn out to be the hardest hit. Meanwhile, illiquid assets are by definition already illiquid. Therefore, the real systemic risk lies within the liquid assets, the large-cap firms whose stocks turn illiquid during crises.”

How do you explain these shortcomings?

“I think the concept of monitoring liquidity is appealing to some people. However, most still fail to differentiate properly between liquidity level and liquidity risk. One major reason for this could be measurement issues. Gauging liquidity level is already hard enough, as there are many different kinds of measures. But computing liquidity betas adds another layer of measurement considerations.”

Do you think other types of investors, such as fixed income managers or hedge fund managers, can also benefit from a better understanding of liquidity risk?

“Yes, definitely. I find similar results pertaining to liquidity level and beta applied to the universe of fixed income securities, hedge funds, mutual funds, and ETFs. For example, long-short equity funds are considered a relatively liquid asset class, and performed well prior to the financial crisis of 2008.’’

‘‘However, they also display a high liquidity beta, the premium of which can potentially explain their high returns. Indeed, this asset class suffered the most in the aftermath of the financial crisis, especially due to the mismatch between the liquidity offered to investors and the liquidity beta of the positions.”

Can the rise of factor investing in equity markets help change investor’s perception on liquidity?

“Yes, although I think it is important to recognize the role of investment horizon in this equation. One of my recent works examines the premiums of popular factors over different investment horizons. The results suggest that what looks like a beta premium to investors with a short investment horizon may look like alpha to investors with long investment horizons.’’

‘‘Long horizon investors are therefore the natural bearers of short-horizon risks. One example of such a short horizon risk factor is liquidity risk. Long-horizon investors might reap the returns of a liquidity beta factor that a short-run investor would otherwise consider risky.”

Some of the well-known factors such as size or low-risk already reflect liquidity characteristics. Isn’t that enough?

“To the best of my knowledge, most models may include some elements of an illiquidity level premium, in this case small-cap firms and high-volatility stocks are likely less liquid, and therefore such factors might include some element of liquidity, although the relationship is not completely straightforward. Nevertheless, I am not aware of any model that includes a liquidity risk/beta factor, and this is where there is some potential for added value.”

This article was initially published in our Quant Quarterly Magazine.

Subjects related to this article are: