Problems We See: Liquidity Risk During Market Stress

Many of the most difficult investment problems do not appear during calm markets. They emerge during periods of stress - precisely when asset owners have the least flexibility to respond.

One issue we see repeatedly is liquidity risk.

Investors often discover weaknesses in their liquidity planning when markets are falling but grant commitments still need to be met. At that point, trustees may face uncomfortable decisions: selling assets into falling markets, drawing down reserves earlier than planned, or delaying important charitable activity.

The underlying challenge is often misunderstood. Liquidity risk is not simply about whether a portfolio contains illiquid assets. It is about whether the portfolio can reliably meet spending needs under difficult market conditions.

Liquidity versus volatility

A common scenario arises when asset owners invest through pooled multi-asset funds. These funds often provide diversification across equities, bonds and alternative assets, which is beneficial from a long-term investment perspective.

However, the structure can create a practical challenge.

When liquidity is needed, trustees may have little choice but to redeem units in the fund. This redemption effectively forces the sale of a slice of the entire portfolio - often dominated by equities - regardless of whether that is the most appropriate asset to sell at that moment.

In other words, diversification at the portfolio level does not necessarily translate into flexibility when liquidity is required.

This can turn short-term volatility into a real loss if assets must be sold during market downturns.

The risk of becoming a forced seller

Markets move in cycles. Periods of strong returns are inevitably followed by weaker phases.

If liquidity has not been carefully planned, a charity can become a forced seller of long-term assets during those downturns. Selling growth assets at depressed valuations may permanently impair the portfolio’s ability to support future beneficiaries.

This is particularly relevant for organisations with:

• Permanently endowed capital

• Long-term grant commitments

• Significant exposure to growth assets

A robust investment strategy should aim to avoid these situations wherever possible.

Practical solutions

In our experience, effective liquidity planning is rarely complicated, but it does require deliberate design.

At PMCL, we typically work with trustees to review several areas, including:

• Cashflow modelling: Understanding when cash will be required is the starting point. Grant commitments, operational costs and capital projects can often be forecast several years ahead.

• Liquidity stress testing: Portfolios should be tested under adverse scenarios - for example, a major equity market decline combined with higher grant demand.

• Private market commitments: Illiquid investments can play a valuable role in portfolios, but their capital calls and distributions must be carefully integrated into liquidity planning.

• Liquidity frameworks: Many institutions benefit from explicitly separating assets intended for long-term growth from those designed to meet shorter-term spending needs.

  
  

In some situations, creative solutions may also be appropriate. For example, temporary portfolio-backed lending or property-backed facilities can provide short-term liquidity without forcing the sale of long-term investments.

Designing portfolios to withstand volatility

A well-designed portfolio should be able to continue supporting the charity’s mission through different market conditions. This means thinking about liquidity during good times - not only when markets become difficult. In our experience, the most resilient investors treat liquidity as a strategic decision rather than an operational afterthought.

This article is the first in our “Problems We See” series, where we explore common investment challenges faced by asset owners.

For many organisations, a liquidity review is most valuable when undertaken periodically rather than in response to market stress. If your charity has not reviewed its liquidity framework in recent years, it may be worth revisiting how grant commitments, portfolio structure and liquidity interact.

PMCL regularly works with trustees to stress-test liquidity under adverse market scenarios and design portfolios that remain resilient during periods of volatility.