The market behaves in this way because of the depth of liquidity in modern markets. Individuals come to the market to buy or sell and you will not see even a ripple on your seismometer.
However, the world of illiquids is topsy turvy to this. With illiquids, anyone wanting to sell is likely to drive the price down, as they have to tempt someone who was not intending to buy to come in for their share. Similarly, at times when there is a surfeit of buyers, prices will be bid up as demand exceeds supply.
Those investing in illiquids should act like a visceral trader: listen carefully to the market and buy when you hear others selling.
Equally, be prepared to forget all those plans that this was ‘a long term investment’ and sell out early if someone offers you a really good price.
It might just be that they need to catch up on their Mansion House compact obligations and their desire to buy your illiquid asset trumps any sound approach to valuation.
Rule #3: Be quick to exit if things are going south
This is a bit like what to do when a building catches fire – those that move fastest to the exits will survive the blaze. Investing in illiquids is not like TheTowering Inferno, The Poseidon Adventure or Die Hard in that the last to get out when a fire sale is coming often take the greatest losses.
Some years ago, when I was running an annuity book, I talked to my bond investment manager and heard he had never had a bond he was holding default. I probed a bit and realised that this was not just his skill in selecting good risks, but his fleet of foot nature in getting out as trouble began to manifest itself.
Of course, a hasty exit will probably mean your client taking a loss, and at the time he or she may well be unhappy about that. However, they will thank you later when they see those that were initially reluctant to take that early loss travel all the way to the bottom.
To conclude, we note that illiquid investments are growing in popularity as a satellite investment alongside a core portfolio.
Large defined contribution schemes already hold between two and 15 per cent of their assets in illiquids, as they try to lay their hands on some of those additional returns for their members.
Your clients may benefit from this too, and these three golden rules could help them navigate any potential downside risks.
