ActiveAllocator Lets You Specify Desired Illiquidity

Liquidity is defined as the ability of an asset to be converted into cash quickly and without any price discount. It is a risk factor because illiquidity requires a return premium. Even investors without immediate liquidity needs prefer to hold liquid assets rather than illiquid assets, assuming equal return and risk. As a corollary, in order to entice investors into illiquid assets, it will be necessary to offer return enhancement relative to liquid assets. Since different measures are used to capture different aspects of liquidity, there is no consensus on the best proxy

Regardless of the proxy used, researchers have mostly demonstrated a negative relationship between stock returns and liquidity. For example, stocks with higher stock turnover have had lower expected returns. Expected stock returns have been positively correlated with both across stocks and over time. Thus, it is generally accepted that stocks with lower liquidity command a risk premium. There is significant interaction between size and liquidity factors. In fact, market cap is used as a proxy for liquidity as well. Large-cap stocks have much higher trading volumes than small-cap stocks. As a result, large-cap names naturally have lower illiquidity ratios. Nevertheless, liquidity risk adds value beyond the size effect. After controlling for size, stocks with higher turnover still tend to have lower expected returns. There is also interaction between liquidity and the price-to-book ratio. Growth stocks with high price-to-book ratios tend to have higher turnover than value stocks with low price-to-book ratios. However, when the stock universe is restricted to large cap stocks, liquidity premiums disappear. Compared with small cap stocks, large cap stocks are relatively liquid, which is why trading volume differences may have limited impact on the liquidity premium. Instead, large trading volume and high turnover may reflect momentum trading and information trading.

ActiveAllocator.com allows you to specify the amount of illiquidity you prefer across your entire portfolio. It allows you to extract a time varying illiquidity premium which is especially valuable in privately held asset classes and actively managed structures.

Author: Sameer_Jain

Partner. Sameer Jain is founder of FinTech ActiveAllocator.com, the world’s first portal that seamlessly integrates traditional, illiquid and alternative investments within portfolios. Prior to this he was Chief Economist & Managing Director at AR Capital. Before that he headed Investment Content & Strategy at UBS Alternative Investments. At UBS, he served as a non-voting member of the Wealth Management Research investment committee, and as a capital allocator was responsible for all illiquid investing including fund manager selection and due diligence across the platform. Prior to UBS he headed product development & investment research at Citigroup Alternative Investments that managed over $75 billion of alternative investments across hedge funds, managed futures, private equity, credit structures, infrastructure and real estate. Here he led a team that developed proprietary models for portfolio strategy and asset allocation with alternative investments, provided investment support and research to pension plans, sovereign wealth funds, endowments as well as internal clients including Citi Private Bank. Before this he was with Cambridge Alternative Investments and SunGard (System Access) where he travelled to over 80 countries for work across Europe, Asia, Middle-East and Africa. He has written over 30 academic and practitioner articles on alternative investments with thousands of downloads at SSRN, presented at over a hundred industry conferences and has coauthored a book, Active Equity Management. Mr. Jain has multiple degrees in engineering, management, public administration and policy and is a graduate of Massachusetts Institute of Technology and Harvard University. He is a recipient of the Alfred Sloan Fellowship and subsequently was a Fellow of Public Policy and Management at the Harvard Kennedy School of Government for a year. He holds Series 7 and 66 securities licenses. View all posts by Sameer_Jain