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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).

Geoffrey Irving
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3 Answers3

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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.

Ganesh Sittampalam
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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.

positive_tax000
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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.

Orange Coast- reinstate Monica
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