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October 20, 2011
Liquidity – The Ultimate “Siren’s Song”?
A lot of discussion concerning liquidity is encountered when deliberating the benefits of private equity vs publicly-listed equities with investors.
One of the primary criticisms of private equity relates to the fact that an investor is essentially invested in an equity vehicle over a medium time period (e.g. 7-10 years) and that liquidity during this time period is both restricted and can be costly (i.e. via a secondary sale). In contrast, an investment in a publicly-listed equity security offers virtually continuous liquidity with a known associated cost. The question we at Kensington have often wondered is “how beneficial is that potential liquidity”?
A significant amount of economic and financial literature has been written to attempt to ensure that investors are positioning their equity investments “for the long term”. Countless studies have been written that denigrate the “market timing” approach to equity investing – a recent article suggested that financial advisors have a better chance of beating Roger Federer (…or maybe Novak Djokovic) in a tennis match than in successfully timing the market. As was succinctly noted by Jane Bryant Quinn, an American financial journalist and leading commentator on personal finance, “the market timers Hall of Fame is an empty room”. Given all of this evidence, it is somewhat puzzling to note certain investors seeming pre-occupation with liquidity for the equity portion of their portfolios.
Empirical results are equally startling. A recent financial article examined the results of investing in the U.S. stock market from 1982 through to the end of December 2005. During this period of time, the stock market averaged 10.6% annually. However, if you were not invested in the market during the 10 best trading days (i.e. 0.16% of the indicated time period), the average return would have dropped to 8.1%. Similarly, if you were not invested in the market during the 50 best trading days (i.e. 0.80% of the indicated time period), the average return would be just 1.8%!! Looking at it another way, if the investor decided to exert its liquidity rights and be out of the investment for less than 1% of the total time, it would cost the investor almost 85% in terms of foregone returns!!
At Kensington, we are not advocates of trying to “time” either public or private markets. We very much believe that the most assured way of generating wealth in an equity investment is through a consistent, long term approach. We believe investors should focus more on getting the allocation they have to equity (both public and private) right as an initial step. Investors should then determine how much value can they really attribute to the liquidity associated with a publicly-listed equity security. The empirical analysis gives one view of the potential costs of acting on that liquidity. As my parents often said to me, “…just because you can, doesn’t mean you should…”.
- John Matovich |
