Investment News recently published a column in its "Other Voices" series attempting to address illiquidity as a characteristic of some alternative investments being marketed today, especially through the broker-dealer channel. The main idea of the piece is that illiquidity is not necessarily bad; after all a byproduct of this illiquidity is a lack of volatility.
Balderdash. Just because a n asset is illiquid does not mean that its value does not fluctuate between pricings. A former boss used to say that if homeowners new how much the value of their homes fluctuated on a daily basis, they would never buy another home. The value of any business fluctuates as a function of global,n ational, and local economic conditions and demographics, competitive position in the trading area, the presence of potential acquirers, and the cost of acquisition financing. The extreme example is restricted stock of a publicly traded company, which is priced continuously during market hours (and sometimes during after market trading) but can not be sold until some contingencies are fulfilled.
Illiquidity is risk factor, not a product benefit. All else being equal, illiquidity should be compensated with incremental return, an illiquidity risk premium. Volatility is a measurement of sensitivity to risk risk factors. So, an illiquid investment may actually have MORE volatility in its pricing: it has a greater sensitivity to the pricing of illiquidity risk, so will therefore exhibit MORE volatility than another asset with the same risk profile save for greater liquidity.
The piece is a great disappointment as I have known the author for a long time, and have tremendous respect for him and the organization that he represents. I would expect both to better understand and communicate the nature of liquidity, volatility, risk and return than this column suggests.
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