Wealthsimple's Classic portfolio is our original managed portfolio — one we build and manage for you. It's diversified across a broad mix of asset classes and geographies, and held entirely in public markets to maximize liquidity.
However, many investors have longer term goals, like saving for retirement. For those goals, investors could have a higher returning and more efficient portfolio by taking on a measured amount of liquidity risk.
That said, liquidity risk isn’t as well understood as other types of risk, which is why I’m writing to you today. I want to explain what liquidity risk is and why it’s a complementary and diversifying exposure to the existing risks you already have in your Classic portfolio. It’s also why we built our new Summit portfolio, which you may have heard about recently; Summit lets you add liquidity risk within a managed portfolio with the same ease of use as your Classic portfolio. But let’s get back to what this is and why it matters.
A note on risk and diversification
The main goal of investing is to find sources of return, understand their fundamental drivers, and diversify across them as much as possible. Investors are traditionally familiar with the risks from investing in stock or bond markets, and have a well-founded belief that they will be compensated with higher returns than holding their money in cash for taking on these risks.
Diversification is something we have written about for years. You don't only invest in Canada; you invest in Canada, the US, and the rest of the world. You don't only hold equities; you hold equities, bonds, and other assets alongside them. Our Classic portfolio is built on these principles.
Building a strong portfolio is about identifying all of the risks out there that you could get paid to take, and packaging them together so that you're never dependent on any single one. You don't want all of your risk sitting on one factor. You want it spread across as many as you can find.
So what’s liquidity risk?
When investors start with cash, or with public markets such as listed stocks or ETFs, they have access to that money in a very short time frame. For some portion of your assets, that’s highly desirable so you can meet short-term obligations, but it’s unnecessary for most investors’ entire portfolios. Keeping your money liquid is a missed opportunity to collect an illiquidity premium.
Specifically, by giving up the right to access your money immediately, you can collect a higher return in private markets than you can in a similar public market. This applies across both private equity and credit markets, and also unlocks investing in markets where illiquidity is a fundamental requirement, like infrastructure, where the projects are by nature longer term and require constrained capital.
Pension funds have understood the appeal of private investments for decades to get access to exactly this risk factor. If you don't need the money for twenty years, you can earn a higher expected return by telling the people you invest with, "I'll come back in a decade. I don't need you to keep this available to me every single day." Individual investors have historically under-allocated to this, not because it was a bad idea, but because they had no way to access it and therefore little reason to learn about it.
Why giving up liquidity pays you
It's worth understanding why anyone would pay you for this, because it isn't always obvious.
“Getting paid for a risk” simply means that the market price where buyers and sellers can agree on a deal implies a higher expected return than the underlying fundamentals would otherwise imply. Why would the price be higher than expected? In the context of liquidity risk, it’s because:
investors demand a higher return in exchange for locking up their capital for longer, and
borrowers are happy to pay a higher cost of capital for assets that they know will be available to them to build and run their business for longer.
The investor demanding a higher return is obvious — but you need both sides to meet in the middle for the market to clear.
Here’s an example to help illustrate exactly why it makes sense for borrowers to pay a premium in the private market. If you're the CEO of a public company, you're trying to decide what your business should look like in ten years while simultaneously managing quarterly earnings calls, share issuance, and a stock price that moves every day and creates noise around your business. A private company will gladly sell you a larger share of itself at the same price in exchange for not having to do any of that. You get a better price in exchange for not being able to access the money as easily as you would if the company was publicly listed.
What we changed to make this work for individuals
Private markets, in their original form, were not built for individual investors. First you had to know where to look. Even if you found it, the investment terms were onerous. You'd show up at a private equity fund with a million dollars — that was a common minimum — and they'd buy a portfolio of private companies. In ten or twelve years, they’d sell those companies, tell you what they sold them for, and you'd get your money back.
We didn't think that was good enough, on two fronts. First, the minimum. You can't expect a regular person to have a million dollars lying around, so we brought it down to $3,500 for the Summit portfolio to get exposure to private markets. Second, the wait. Ten or twelve years is too long to be locked up unless the opportunity is extraordinary, so we pushed for earlier liquidity: the private markets portion of Summit is redeemable monthly.
It’s also critically important that we assess whether this is right for our clients. For every new managed investing account you open, we review your goals, timeline, and financial situation, to assess proper portfolio fit. It’s a feature, not a bug, that you go through this assessment every time. We pay close attention to when you say you'll need the money — and if it’s a short term time horizon, we direct you to a Classic portfolio.
Summit is suitable for investors with a time horizon of four years or longer. That isn't a hurdle for its own sake. It's how we make sure you're taking on an amount of liquidity risk that's appropriate for your situation, and not more.
The bottom line
Nothing about Summit is a departure from how we've always invested. Risk drives return. Diversify across as many compensated risks as you can rather than concentrating in one. Match the portfolio to the goal and the timeline.
Summit applies those same principles to a source of return that individual investors haven't historically been able to reach — adding another layer of diversification, and the higher expected return that comes with it.
If you have four years or more before you need this money, I think it's worth a look.
