Liquidity Premium Explained: A 2025 Guide for Australian Investors

In the ever-evolving world of investing, understanding the risks and rewards of different asset classes is more crucial than ever. One concept that often flies under the radar — yet has a profound impact on returns — is the liquidity premium. For Australian investors navigating volatile markets and tighter regulatory environments in 2025, grasping this idea could spell the difference between average and exceptional outcomes.

What Is the Liquidity Premium?

At its core, the liquidity premium is the extra return investors demand when buying assets that can’t be quickly or easily converted to cash without a significant price concession. In other words, it’s the compensation for holding investments that may take longer to sell or could be subject to wide price swings if you need to offload them in a hurry.

Here’s how it works in practice:

• Highly liquid assets (like ASX 200 shares or government bonds) trade frequently and can be sold rapidly at market price. They typically carry little or no liquidity premium.

• Illiquid assets (such as commercial property, unlisted infrastructure, or private equity) may take weeks or months to sell and could require accepting a lower price. These assets offer higher expected returns to compensate for this risk — that’s the liquidity premium in action.

Think of it as a kind of risk ‘bonus’ added to potential returns. The less liquid the asset, the larger the premium.

Liquidity Premium in Australia: 2025 Trends and Policy Shifts

Recent years have seen liquidity premium dynamics shift significantly in Australia. With the Reserve Bank of Australia (RBA) maintaining a cautious stance on interest rates in 2025 and regulators keeping a closer eye on bank and fund liquidity, the premium attached to less tradable assets has moved in response.

Key 2025 factors influencing liquidity premiums include:

• RBA’s Rate Guidance: After a period of tightening, the RBA’s pause in 2025 has stabilised some funding markets, but uncertainty around future moves keeps investors wary of illiquid bets.

• APRA’s Liquidity Stress Testing: The Australian Prudential Regulation Authority has introduced stricter liquidity risk assessments for super funds and insurers, nudging many to reevaluate their allocations to illiquid assets.

• Property and Private Debt Markets: Commercial real estate and private credit have both seen liquidity premiums widen in 2025, as some investors look to lock in higher yields amid subdued equity markets.

For example, Australian private credit funds are currently offering yields 2-3% above comparable listed bonds — a direct reflection of the market’s demand for a liquidity premium.

How Does the Liquidity Premium Affect Your Portfolio?

The liquidity premium isn’t just academic — it’s a practical tool for building robust portfolios. Here’s how it plays out for different types of investors:

• Superannuation Funds: Australia’s $3.5 trillion super sector is a major player in illiquid assets, from infrastructure to venture capital. Trustees must carefully balance the lure of higher returns with the need to meet member redemptions, especially with new APRA guidelines in play.

• SMSFs and Individual Investors: For self-managed super funds and high-net-worth individuals, understanding the liquidity premium can help justify higher allocations to assets like direct property, private equity, or alternative credit — but only if your time horizon and cash flow needs align.

• Everyday Investors: If you need ready access to your capital, it often makes sense to accept lower returns for more liquid investments. But if you can commit funds for the long haul, the liquidity premium may offer a genuine edge — provided you’re comfortable with the risks.

It’s also worth noting that liquidity can evaporate quickly in stressed markets. The COVID-19 panic in 2020 and the bond market volatility of 2023-24 are stark reminders that yesterday’s liquid asset can become tomorrow’s illiquid headache.

Real-World Example: Chasing Yield in 2025

Consider an Australian investor weighing up two options in 2025:

• A listed investment-grade bond yielding 4% per annum

• A private credit fund targeting 6.5% per annum, but with quarterly redemptions and limited liquidity

The 2.5% difference is a classic example of the liquidity premium. If you value quick access to your funds, the bond may be preferable. But if you can tolerate less flexibility, the private credit fund’s higher yield might be worth the trade-off.

How to Factor Liquidity Premium into Your Strategy

In 2025, a smart approach to liquidity premium involves:

• Assessing your true liquidity needs: Don’t tie up funds you might need in a hurry.

• Comparing yields across asset classes: Ensure the premium is enough to justify the risk and inconvenience.

• Monitoring policy and market shifts: Regulatory changes and sudden market stress can rapidly alter liquidity dynamics.

• Diversifying across both liquid and illiquid assets: This cushions your portfolio against shocks while allowing you to benefit from higher returns over time.

The Bottom Line

The liquidity premium is a powerful, often underappreciated driver of investment returns. In Australia’s complex 2025 financial landscape, understanding how it works — and when to chase it — can help you make sharper, more strategic decisions. Whether you’re building a super fund portfolio or managing your own investments, always weigh the trade-off between flexibility and return. Sometimes, patience really does pay.