Cash is needed to provide portfolio liquidity, but it often carries a high opportunity cost.  While CIOs may contemplate reallocating a portion of portfolio cash into investment assets to help improve expected portfolio returns, they know that having cash on hand is beneficial to cover unexpected liquidity needs and avoid having to sell assets, especially during poor market environments.  But is there a better way to balance the costs and benefits of cash?

Perhaps the CIO can raise cash, when needed, through an external liquidity source?  For example, the CIO can have a lending arrangement (i.e., a “liquidity line” – LL) with a financial institution that allows the CIO to draw on a collateralized line of credit as portfolio cash needs arise, paying interest on the amount advanced and for the time the loan is outstanding.  Such a liquidity facility may give the CIO more flexibility in both asset allocation and liquidity management.

To help CIOs evaluate such a decision, we provide a framework to quantify the portfolio performance and liquidity consequences of using an external liquidity facility.  A CIO can use this analysis to determine whether an external liquidity facility, and what size, could help improve average portfolio return while keeping liquidity risk under control.