The manager also began separating capital from investment exposure by using derivatives to keep strategies in place, while unleashing capital and putting it to work elsewhere. “Cash isn’t the same as liquidity. [The aim is] not to assess which liquid funds we have available, but to think of every asset, and how long it would take to sell it. To provide the assurance that you can lay your hands on the money when you need to.” This separation of capital from investment positions can be achieved by using exchangetraded derivatives.

However, the collateral required to place these bets can be large, sometimes as much as 10 per cent of the synthetic exposure, and involve counterparty risk. “But move it to the over-the-counter world, and the pricing can be attractive,” Rieck says. “Our job as investors isn’t to eliminate risk. It’s to smartly and efficiently trade off some risks against others.” But buying options often adds leverage and counterparty risks to the portfolio. “It’s cheap to get in the market with an option.

But you have to back it up with sufficient cash, otherwise you’re leveraging the portfolio,” Fok says. And since leverage essentially amplifies investment risk, incurring losses through such exposures is extremely risky and can result in the losses exceeding the collateral behind the positions. “If you have exposure to a leveraged asset that decreases in value you have to post margin to cover it,” says Dallas of

Cambridge Associates. But if it works, you have freed some cash for use elsewhere.

Assessing the networks of counterparties in service provider relationships can also pinpoint threats to a fund’s liquidity profile. Checking up on the futures clearers used by custodians, and the brokers used by managers, and judging whether any providers face capital pressures or are exposed to a weak counterparty, can help detect potential threats to cashflows or the liquidity of investments.

Fok says that managers with liquidity problems can sometimes influence member investment options. “Some retail platforms have been impacted [by] over-reliance on one or two managers, whose funds have frozen,” he says. “If you’re going to have 50 investment managers, 12 asset classes and investment options, you better find a way to coordinate those activities, otherwise you don’t know the risks that you have.” Ultimately, comprehensive analysis of liquidity risks, and effective actions taken to counteract them, should prevent funds from being forced-sellers of assets in declining markets. “If you’re a forced-seller, you’re going to get screwed,” Rieck says.