The 2022 tightening cycle to combat high interest rates exposed something that had been largely ignored, which is that many portfolios had been structured as if markets would always provide an orderly exit. In fact, the opposite proved to be true. Now, for investors with complex balance sheets, the question of when money can be accessed matters as much as how it is invested.

Liquidity buckets are one of the oldest disciplines in portfolio construction and, while the conditions that made it seem unnecessary have changed, the framework itself has evolved to deal with the developments currently occurring in the markets.

The case for liquidity segmentation – dividing cash into certain "buckets" according to a strategy or purpose – is not primarily about last year’s drawdowns, but a progression how portfolios face stress.

During the periods of low rates, correlations between asset classes were sufficiently stable that diversification continued to function as expected. When inflation forced central banks to tighten at pace, that relationship and correlation disintegrated. Bonds and equities fell together, with the most synchronised and intense monetary policy tightening in recent memory. It produced a simultaneous sell-off across asset classes that invalidated the rebalancing logic that most portfolios depended on. The natural hedge most portfolio models assumed was themn unavailable to investors who needed to sell anything at all.

Another development is the scale of private market exposure. As allocations to illiquid strategies have grown across family offices and UHNW portfolios, so too has the probability of a timing mismatch. Capital calls often arrive when public market conditions make recognising liquidity in other parts of the portfolio expensive. The Bank for International Settlement’s (BIS) 2023 Annual Economic Report noted that the financial system is under stress precisely because strategies adopted during the era of low-for-long rates are now proving ill-suited to this new environment, which includes the leverage and liquidity mismatches that accumulated in non-bank financial intermediaries during that period.

One of the most overlooked changes is that liquidity now pays. Front-end yields have normalised, as we see cash and short-duration instruments no longer as a drag to be minimised, but instead as something that carries income and preserves optionality. The opportunity cost of holding a liquidity buffer has now fallen materially.

Liquidity risk is often seen as a volatility problem, but that view is now up for debate. Temporary repricing is recoverable given sufficient time and capital, but what causes permanent damage is the need to sell growth assets at the wrong moment to meet a near-term liability.

When an investor must liquidate to fund a tax bill, a capital call, or a property transaction, they crystallise a loss that would otherwise have been on paper, and the portfolio never recaptures that compounding. This is the precise mechanism by which liquidity risk is enshrined in permanent impairment. It is also why the IMF’s April 2023 Global Financial Stability Report identified elevated leverage, liquidity mismatches, and high interconnectedness as the conditions under which non-bank financial stress tends to emerge, while flagging the complex trade-offs that arise when those stresses interact with a tightening cycle.

For investors with significant illiquid exposure, the risk has become asymmetric, as investing fully offers incremental benefits. Being caught without accessible capital at the wrong moment now carries real risk.

A bucket approach organises capital by time horizon and purpose rather than asset class. The starting question is not what the allocation should be, but rather when the money will be needed and what happens to long-term positions if markets are dislocated at that moment.

Near-term capital covers essential spending and known near-term liabilities, and is usually held in instruments where value is stable and access is immediate. This isn't because cash offers significant returns, but because this capital must never be at risk of a timing problem. In the current rate environment, this bucket can be held in money market instruments or short-duration credit without sacrificing meaningful yield.

Intermediate capital funds obligations that are anticipated but not imminent: planned capital calls; a property transaction; a business funding need within a two-to-five year window. This segment can take some duration and credit risk, but liquidity remains constraint throughout. The goal is to ensure these commitments are never funded by selling long-duration growth assets at inopportune prices.

Long-duration capital is genuinely ring-fenced because near-term obligations are funded elsewhere. This pool can ride full cycles, including extended drawdowns, without the investor facing pressure to liquidate, and it's that protection which is the point, and allows a growth mandate to behave as one.

There is a quantitative case for bucket architecture, and then there is a more concrete and stronger one: a portfolio structure that reduces the probability of panic selling during a drawdown, and can deliver more value across a full cycle than marginal optimisation of returns.

William Sharpe’s work on retirement income and the sequencing of capital under uncertainty, and Kahneman and Tversky’s foundational research on how people evaluate gains and losses asymmetrically, converge on the same point, exploring how people manage money differently depending on which mental account a loss hits. Bucket architecture exploits that tendency in a productive way, creating a clear separation between capital that must be safe, and capital that is free to grow.

The approach that made liquidity feel like a drag has not changed inherently, and the low rates, stable correlations and abundant exit conditions, etc. haven't evolved, but instead have been expunged. In its place is an environment where, as the FSB’s Global Monitoring Report on Non-Bank Financial Intermediation has documented, leverage and liquidity mismatches interact with bouts of volatility to amplify stress in ways that are difficult to anticipate in advance.

In situation such as these, Arbra understand that how a portfolio is funded matters just as much as how it is constructed and invested, because while volatility is survivable, forced selling is not.