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Is it possible to get a liquidity premium as a retail investor? That is, between the following two options, I would expect there to be a theoretical extra return to doing (2):

  1. Hold an index fund for 5 years.
  2. Hold the same index fund for 5 years, but without the ability to withdraw funds during that time.

However, I don't know any way to realize the benefits of (2).

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  • Far out of my experience, but the only approach I can think of would be some form of long-term futures contract.
    – keshlam
    Mar 4 at 13:34
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    #2 is commonly implemented (albeit for much shorter periods) through the funds' fee structures.
    – littleadv
    Mar 4 at 17:45
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    Interesting question! I'm not sure who would be on the other side of the trade. Who benefits in you having locked in your investment? Other owners of the same stocks/index perhaps. This would give them the first chance to sell before all the locked-in stocks get the chance to sell. But I guess there would need to be a significant amount of "locked-in" stocks for the other owners to benefit (in situations like a sell-off).
    – Kvothe
    Mar 4 at 18:54
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    Put another way - A "Liquidity Premium" is found is securities that are more liquid (investors will sometimes pay more for securities they can more easily sell). Why would reducing liquidity warrant a premium?
    – D Stanley
    Mar 4 at 20:40
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    @DStanley OP clearly said 'extra return', and mentioned that it would be a beneift. He wants to pay less for an illiquid service. How is that not apparent?
    – Brady Gilg
    Mar 5 at 1:52

3 Answers 3

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Suppose the locked-in contract will return an extra e after 5 years, and that the buy/sell spread (difference between buy and sell prices) for both the normal index fund and the locked-in contract is s.

Then I can short the locked-in contract and buy the normal contract at price s, and in 5 years I can unwind that getting back e-s, for a total risk-free return of e-2s.

So the maximum premium e for this product is 2s, no matter what the term. For a liquid index, this is tiny.

EDIT: I realised afterwards that I didn't take borrow costs into account in that calculation. Apart from the spread in the borrow costs contributing to the cost of the arbitrage transaction above, maybe the illiquid variant actually has an intrinsic difference? For example the custodian could lend out the asset with a promise that it wouldn't be recalled for a period.

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I'm not sure if you can do that. It is more common to be able to do that for fixed income because there are retail instruments with different types of grace periods.

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  • I-Bonds come to mind
    – littleadv
    Mar 4 at 16:51
  • Throw in the example of taking advantage of pricing for longer-term bonds vs shorter term [with a caveat that sometimes the shorter term bonds have a premium], and this becomes the complete answer. Mar 4 at 20:27
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Use 5-year LEAPs to create a synthetic long.

Because a synthetic long equivalent to $10,000 in stock requires less than $10k in upfront investment, park the difference in a 5-year bank CD or other fixed-income investment.

Nota bene, any liquidity premium earned, may be eaten up by your costs in entering and exiting option positions as a retail investor.

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