Investor Corner/The asset classes/Debt Concepts
2.2.9 Liquidity Risk
Liquidity risk is the risk that you cannot sell an investment quickly without accepting a meaningful price concession. It matters most for less-traded bonds and thinly traded smaller companies.
The gap between value and sellable price
An asset can have a perfectly reasonable fair value while still being hard to sell quickly at that value, if there are few buyers actively interested at any given moment. Trying to sell in a hurry under those conditions often means accepting a lower price than the asset would otherwise be worth, simply to find a willing buyer fast enough.
Where it shows up in debt markets
Government securities and large, frequently traded corporate bonds are generally easy to buy and sell at a fair price on short notice. Smaller corporate bond issues, and bonds from less well-known companies, can trade rarely, sometimes days or weeks apart, which means a seller in a hurry may have to accept a real discount to find a buyer at all.
Why it matters for fund investors
A debt fund holding illiquid bonds can run into serious trouble if many investors ask to redeem at the same time, since the fund manager may be forced to sell those bonds quickly, at unfavourable prices, to meet redemptions. This is precisely the scenario that fund-level liquidity management, and mechanisms like side-pocketing, exist to address.
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