TLDR:
An illiquid asset is one that cannot be easily or quickly converted to cash without a significant loss in value, such as real estate, private equity, startup equity, or collectibles.
Illiquidity Premium
Investors typically demand higher returns from illiquid investments to compensate for the inability to exit quickly.
Managing Illiquidity Risk
For investors, illiquidity risk is the possibility that an asset cannot be converted to cash when needed without taking a significant discount. In private equity and venture capital, investors willingly accept illiquidity in exchange for a premium return (the ‘illiquidity premium’). However, this creates challenges for institutions like endowments and pension funds that must meet regular cash obligations — a dynamic that became painfully evident during the 2008 financial crisis when many institutions holding illiquid alternatives couldn’t rebalance their portfolios.