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How one fund manager is preparing for the market liquidity crisis

·Former Correspondent
Cracked earth is seen at the almost empty Itaim dam, which is responsible for providing water to the Itu metropolitan area in Itu, Brazil. (AP Photo)

North Carolina-based fund manager Mark Yusko, the CIO of $4 billion fund-of-funds Morgan Creek Capital, has a solution for those investors who are worried about liquidity in the market — or lack of it.

Think like an endowment.

"We think if you’re going to not get the liquidity of the public markets, why not accept the illiquidity of the private markets?" Yusko said in an interview with Real Vision Television.

Yusko, the former CIO of The University of North Carolina at Chapel Hill Endowment, explained that endowments take a portion of their assets and place them in illiquid assets. The average person can do this too with their assets.

The key to thinking like an endowment is to understand you're not going to spend that money, but instead you'll spend the gains and the income. You also have to have the mindset that you don't need to liquidate it all tomorrow, so why not get paid for holding it, he explained.

The way to think about it is that your personal assets should be divided into three buckets.

“Everyone should have three buckets. Every investor needs three buckets— the 'liquidity bucket’ to fund their lifestyle. That’s two times your spending. If you spend 5% a year that 10, you spend 7% a year, that’s 14," he told Real Vision.

Morgan Creek Capital's Mark Yusko encourages investors to think like an endowment in this low liquidity environment in an interview on Real Vision TV.
Morgan Creek Capital's Mark Yusko encourages investors to think like an endowment in this low liquidity environment in an interview on Real Vision TV.

Basically, the average investor needs two years of whatever they spend to be in very liquid assets to fund their lifestyle expenses.

"Then, you need the 'get rich bucket,’ that’s 10 to 15% to do the crazy stuff like your friend’s condo deal, your brother-in-law’s venture deal. You’re going to ‘lose’ all that. So keep it small," he said.

The "get rich bucket" could be anything from a partner's share in a business to a landlord's share in an apartment building. It's the thing that generates cash, and in some ways excess income. It's how you get rich. That bucket is going to be filled up with whatever you do to get rich.

"And that leaves 70% in the middle, maybe up to 80%, for the 'stay rich bucket.’ And the 'stay rich bucket,' you’re never going to touch... Most of that money is going to go to your kids, your grandkids, your philanthropy. So you don’t need it. So take advantage of the illiquidity premium in the private markets and do the things we talked about that make sense today.”

The "stay rich bucket" has to be diversified and should be run like an endowment or a foundation with broad diversification. It can't be too heavy in one asset because then you run the risk of volatility or a loss and it can't be purely illiquid.

'Liquidity is a coward'

The lack of liquidity is viewed as one of those unintended consequences of regulations following the financial crisis, specifically Dodd-Frank.

Basically, the worry is that if the market sells off, there simply won't be enough participants to take the other side of the trade, exacerbating the falling prices.

"One of the things about liquidity I think that people don’t understand is liquidity is a coward. It only exists when you don’t need it," Yukso said on Real Vision. "You think you have something liquid, particularly in the stock market, and then suddenly there’s a crisis and you try to sell it, you can’t sell it."

The lack of liquidity in the bond market as been "unbelievable," he added.

"One of my manager friends just showed me ‘no bids’ for any bond in his book. So, in the equity market it happens too."

He continued: "The other thing that happens in the equity market is when people get so concentrated. This is the most concentrated mutual funds and hedge funds have ever been in terms of their top ten holdings. And when you get so concentrated and you own a huge percentage of something, you try to tell it, that last price for a hundred shares, you don’t get that price. You don’t even get the price down 5% or 10%. You own a million shares of something, tough to get out. So, liquidity is a little bit of a myth sometimes."

Yusko joins a number of hedge fund managers who have been sounding the alarm about liquidity.

Just last month, Texan hedge fund manager Kyle Bass, the CEO of Hayman Capital, told attendees at the SALT Conference that it took “much longer” to close some positions last year than he had expected. Billionaire hedge fund manager Leon Cooperman of Omega Advisors also told the conference attendees that it’s been “very hard” to get out of positions.

“I tell my people they should charge a million dollars for a marriage license and get divorced for free,” Cooperman said, “So before we do anything and buy anything we’ve got to really know what we’re doing because it can be very hard to get out. It’s a different environment.”

The full interview with Yusko is available on Real Vision Television, a subscription investor video service.

Julia La Roche is a finance reporter at Yahoo Finance.

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