The Appeal of Low-Liquidity Assets

July 11, 2022
by Noriyuki Morimoto

In investment, liquidity is the ability to sell an asset immediately at a reasonable price. Liquidity is an advantage because salability is an important precondition for risk management in investments. Since a price must be paid to obtain an advantage, liquid assets are priced at a premium to reflect its liquidity.

In theory, if highly liquid assets come with a premium, less liquid assets should come with a discount. As an investor, if you do not need liquidity, or if you can create a mechanism that does not require liquidity, you can invest in discounted assets. In other words, you can turn the constraints of other investors who prefer liquidity into your own advantage.

So, what are the conditions under which liquidity is not required? First of all, with regard to the sale of assets for the purpose of avoiding damage to the portfolio value, a thorough analysis and careful issue selection at the initial investment stage is the decisive factor and basic practice in investment. Investing for the long term in illiquid and undervalued assets after careful selection should be a classic approach in investment.

The principle is that assets are to be held. Assets are a mechanism for generating cash flow. The question is not the asset’s salability, but rather the asset’s ability to generate cash flow. Finding, refining, and holding assets that do not need to be sold, or rather, assets that one does not want to sell, for a long time, is the essence of investment.

In the first place, if the asset is designed to pay out cash by selling assets, it is better not to invest. Normally, as the investment of pension assets is designed so that the total value of interest, dividends and other income and pension premiums matches the benefits, interest and dividends etc. represent liquidity, and liquidity as salability is not required.

In contrast, at banks and other financial institutions that are subject to strong capital controls, the occurrence of valuation losses due to price fluctuations is a capital deduction item, resulting in a reduction of assets held, and therefore, the importance of salability is emphasized. In other words, the investment constraints of banks and other financial institutions create undervalued assets for other investors.

 

[Category /Strategic Investment]