Part 1

In the next posts we would like to share our thoughts on a few aspects of liquidity:

• That it makes sense to pursue illiquid investments as long as long-term investing is your approach;
• That the higher returns associated with illiquid markets can be sought in publicly traded equities; and
• That the most bothersome aspects of illiquidity can be tempered with a proper approach to investing.

First, as a recap, academics in financial disciplines have long identified liquidity as an element of expected returns. Liquidity is considered to be a most desirable quality in an investment. In theory, the more illiquid an investment, the higher the premium that must be paid to compensate for lack of liquidity. Which is simply the other side of investors willingly accepting lower returns if they are given the opportunity to sell within a moment’s notice and convert their investments into cash.

If you accept the above, then to pursue higher returns, illiquidity will be a necessary component. Indeed, money managers as renowned as David Swensen from the Yale Endowment have basically stated that serious managers and investors may occasionally find extraordinary opportunities if they are willing to accept illiquidity.

Bond traders have long provided a simple example, pointing out that in Treasury securities with the same maturity, the issue that is less heavily traded will sometimes pay a slightly higher yield than its more heavily traded sibling.

The price of illiquidity is well-known. An investor might not be able to exit the investment when he needs to, or may have to pay a penalty, which can sometimes be substantial, to exit the investment prematurely. This issue becomes less of a problem for those investing for the long-term.

If, as we believe, the whole purpose of investing is to obtain the highest possible return, then focusing on long-term investing is a necessary component which allows us to take advantage of the premium paid for accepting illiquidity in an investment.

In the next post we will share our view of why illiquidity does not have to be limited to venture capital, private equity or similar pursuits, but may sometimes be achieved through publicly traded securities.

NOTE: We are not recommending the purchase of any specific stock. Any specific stock mentioned in this forum is mentioned for illustration purposes only. Investors should always consider that the price at which a stock is bought is an essential part of the buying decision, and should consult their advisors before making an investment decision.