Illiquid assets

GLOBAL INVESTOR 1.15 — 03
Photos: Martin Stollenwerk, Gerry Amstutz
Responsible for coordinating the focus
themes in this issue:
Oliver Adler is Head of Economic
Research at Credit Suisse Private Banking
and Wealth Management. He has a
Bachelor’s degree from the London
School of Economics, as well as a Master
in International Affairs and a PhD in
Economics from Columbia University
in New York.
Markus Stierli is Head of Fundamental
Micro Themes Research at Credit Suisse
Private Banking and Wealth Management.
His team focuses on long-term investment
strategies, including sustainable
investment and global megatrends. Before
joining the bank in 2010, he taught at
the University of Zurich. He previously
worked at UBS Investment Bank. He
holds a PhD in International Relations
from the University of Zurich.
Standard financial theory tells investors to carefully assess the tradeoff
between return and risk. Liquidity is a third key consideration. This
Global Investor (GI) is about the liquidity and illiquidity of individual
assets and overall financial markets. Just as risk and return are uncertain
before the fact, so is liquidity. Some assets may appear highly
liquid, only for their liquidity to suddenly vanish. Moreover, changes
in liquidity often correlate with shifts in risk. As our article on fixed
income (page 62) points out, some more exotic bonds become very
hard to sell just as their perceived risk increases, and when less liquid
assets are pooled in typical (open-end) funds, such difficulties can
be amplified (see page 24).
This does not imply at all that we would advise against investing
in illiquid assets. In fact, assets that eventually generate high returns
are very often highly illiquid. Those who invested in Apple, Google
or Microsoft when they were small (unlisted!) ventures run out of
“garages” garnered huge returns. Apart from private equity, this GI
covers a broad range of other more or less illiquid assets – ranging
from forests to farmland to infrastructure, and from real estate, the
most common of illiquid assets, to the most exotic “passion” investments.
We also look at the pros and cons of investing in hedge funds,
which are not necessarily particularly illiquid, but where the sources
of return are often harder to identify than those of other more visible
illiquid assets.
Adrian Orr, CEO of the New Zealand Superannuation Fund, known
for its innovative investment philosophy, points out (page 26) that
even investors with long horizons should gauge the liquidity of their
overall portfolio carefully: investments in illiquid assets should be
balanced by some that can be easily sold. This rule is of even greater
importance for private investors whose investment horizon is
typically shorter and where the potential for a drastic change in
personal circumstance (and thus need for liquidity) is that much more
pronounced. The temptation of abandoning such caution seems particularly
high at a time when both nominal and real expected returns
on the most liquid of assets are so meager. Conversely, investors
should avoid overpaying for liquidity: Professor Ibbotson (page 10)
argues that investors tend to overrate (and thus overpay for) the
benefits of owning large cap stocks. The fact that these assets can
be traded in almost any circumstance may not only render them
more expensive but also prone to excessive price gyrations. In sum:
make sure that the analysis of risk and return is complemented with
a careful review and “stress test” of the liquidity of assets and
investment vehicles.
Giles Keating, Head of Research and Deputy Global CIO