Let's Talk Liquidity

CFA Level III Portfolio Management
#1

hey guys, so in doing all these past mocks it seems really likely that we’ll see Liquidity and Tiime Horizon. Time Horizon is fairly straight forward, but I seem to find myself questioning Liquidity at times.

I seem to be getting messed up in regards to this income offsetting expenses idea. so if the guy has 100k income and only 60k in expenses, he has no liquidity need to cover the 60k obviously. now, if he wants to contribute 10k a year to say, a muesuem or something, is that consider a liquidity need?? because he still has excess income to cover that… does it matter if it’s a one time 10k donation vs. an ongoing annual thing?

also just other questions…

Is it just liquidity needs that are within 1 year? If the dude needs 100k to fund something in 5 years, that’s not a liq requirement correct? Only when he needs 1MM to lump sum pay off a mortage at the end of the year?

are management fees included? if we have a 0.5% mgmt fee we list that correct?

living expenses if retired. so we have a 3MM portfolio, and we retire - so no income - then are our 150k annual living expenses considered liquidity needs? I would think so, but I’d just love to get some verification on some of these questions.

#2

Also, why is the current 60k expense not included in liquidity needs?

#3

Usually what I find is that liquidity needs are related to the portfolio. …that is what liquidity does the investor require from the portfolio…so if they have annual expenses that are taken care of by their current income. …then those do not qualify as a liquidity need… management fees would be included as they would most likely be paid from the portfolio as would living expenses in the absence of regular income

#4

Liquidity always loses me marks. Some rules I’m making myself some rules:

1.) Anything covered by income is not a liquidity need

2.) Tax liabilities from selling assets are not a liquidity need

3.) Creating a liquidity reserve in portfolio is a liquidity need if there’s no one already

4.)Ongoing expenses should be mentioned seperately, as there’s no consistency here (although I’ve mainly done Schweser so could be wrong )

5.) Far out expenses are irrelevant, near term expenses should be mentioned

#5

I think ongoing expenses should be mentioned if they are not already covered by income i.e. the net ongoing expense figure that you need to cover from your portfolio should be mentioned as liquidity requirement.

#6

Thanks guys, this is much clearer because liquidity has been a drain (get it ?) on my marks as well. However I’ve noticed some guideline answers say “no major liquidity needs, aside from ongoing expenses”.

#7

For liquidity we don’t mention expenses covered by income, but that last sentence says we mention it. So do we mention expenses covered by income or not in liquidity?

#8

I would say no. Unless the expenses have to be covered by the investment portfolio I would not include them.

#9

For liquidity we don’t mention expenses covered by income, but that last sentence says we mention it.

So do we mention expenses covered by income or not in liquidity?

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I would say no. Unless the expenses have to be covered by the investment portfolio I would not include them.

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Just looked back at Schweser, reading 9h under liquidity says: - clients’ needs for liquidity include: ongoing, anticipated needs for distributions such as living expenses ?

#10

“clients’ needs for liquidity include:ongoing, anticipated needs for distributions such as living expenses”

That’s a very important word. _ Distributions _ are going to come from the investable asset base.

If a client makes a $100k per year w/ living expenses of $125k and an investable asset base of $1,000,000 they will have a liquidity need of $25k per year from the portfolio. In the real world they could be maxing out a dozen credit cards to do this, but that’s out of scope for the exam.

At the end of the day the money has to come from somewhere and if it doesn’t come from income it has to come from another source, in most cases the investable assets.