Study shows lack of liquidity leads to forced selling in distressed markets

BOSTON, November 10, 2009 — Long-term investors must plan for the short and medium term in order to avoid forced selling in distressed markets, according to a recent analysis by BNY Mellon Asset Management.

"This is exactly what happened to many university endowments during the 2008 market meltdown," said Robert A. Jaeger, senior market strategist for BNY Mellon Asset Management and co-author of the study. "Every long-term investor is also a short-term investor and a medium-term investor. We believe that endowments and other long-term investors would be well-served to explicitly divide their portfolios into long-term, medium-term, and short-term components."

The long-term component can aggressively seek out risk and give up liquidity, but the other components cannot, Jaeger said. He added, "If you don't have short-term liquidity, you can't be an effective long-term investor. You become a forced seller in distressed markets."

The co-authors of the study are Michael Rausch, assistant director of research and analysis for BNY Mellon Asset Management, and Margaret Foley, director of the endowments and foundations resource center for BNY Mellon Asset Management.

BNY Mellon Asset Management suggests that long-term investors create at least three sub-portfolios, which have different investment objectives, different expected returns, different liquidity constraints, and may even be based on different capital market expectations. The short-term sub-portfolio is designed to deliver a positive nominal return; the medium-term sub-portfolio is designed to deliver a positive return after inflation; the long-term portfolio is designed to deliver a positive return after inflation and spending. The long-term portfolio is the most aggressive and least liquid of the three. The relative size of the three portfolios is determined by the spending needs of the institution.

"The overall return of the portfolio would be a blend of the returns achieved by the three sub-portfolios," said Foley. "Although the analysis recommends a higher allocation to defensive assets, once that allocation is made the investor is in a better position to take intelligent risks in the long-term component of the portfolio."

Rausch added, "The buffer provided by the shorter-term and medium-term sub-portfolios allows investors to stay in the game and participate in the significant upside of a market cycle."

BNY Mellon Asset Management is the umbrella organization for BNY Mellon's affiliated investment management firms and global distribution companies.

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All information source BNY Mellon Asset Management as of September 30, 2009, except where noted. This press release is issued by BNY Mellon Asset Management to members of the financial press and media and the information contained herein should not be construed as investment advice. Past performance is not a guide to future performance.