You can’t always get what you want...
The investment world I encountered back in 1999 has changed significantly and, no doubt, will continue to change. Investment managers are much more aware of the potential risks in their portfolios including liquidity.
To read Blake's article from November, "All I want for Christmas is..." click here
I vividly remember back in 1999 when I was at school, my Business Studies teacher created an investing game for all of the students to participate in. He gave us a virtual amount of money to invest in the UK stock market, with the ultimate goal of delivering the highest returns using just the pedestrian school internet facilities, national broadsheets, the Economist, and stock prices quoted in the newspaper. Over the subsequent months, returns were booked, and by the end of the process the winning team had doubled their money!
Whilst the game captured my interest, and provided me with a brief introduction to the financial world, it had a number of shortcomings: firstly, there was no accounting for any costs associated with buying stocks such as stamp duty. Secondly, we looked just at simple share price returns, and didn’t adjust for risk. As a result, the winning team was very fortunate, investing in a highly speculative penny stock which happened to double in value (can you tell I didn’t win?). The other assumption we made was that we could access immediate, 100% liquidity at the price quoted in the newspaper. 20 years later liquidity has become a much more important focus for investors.
So what’s the problem?
Managing relatively small sums of money (like the hypothetical £100,000 we as a team were entrusted with back in 1999) makes it fairly easy to get in and out of stock positions, but it becomes increasingly difficult when funds are hundreds of millions, maybe even billions, of pounds in size.
An ‘illiquid’ stock is one that cannot easily be sold at the current value, and may be hard to sell quickly because of a lack of ready and willing investors to purchase the asset. The lack of buyers can lead to larger discrepancies between the asking price, set by the seller, and the bid price, submitted by the buyer. The lack of depth in the market (i.e. lack of ready buyers) can cause holders of illiquid assets to experience heavy losses when selling, especially when they are forced to move quickly.
We have a number of funds across the Behavioural Finance range which have the flexibility to invest down the market-cap spectrum, and as such liquidity is a key consideration in the decision-making process. As well as our portfolio management teams we also have an independent board of investment directors, and an independent risk team, both of whom are monitoring portfolios for factors such as: how quickly portfolios can be liquidated, the size of individual positions in the portfolio, and the percentage of free-float and total shares outstanding held across the group.
The investment world I encountered back in 1999 has changed significantly and, no doubt, will continue to change. Investment managers are much more aware of the potential risks in their portfolios including liquidity. Clearly when managing portfolios of significant size and delving into more illiquid assets, you can’t always get what you want, or at least not always at the price you would like. Liquidity has to be a key consideration in the decision-making process.
Blake Crawford is portfolio manager of the JPM UK Dynamic Fund. Find out more >