Part III · Chapter 6 · Ownership · lesson 4
The price on paper and the price you can get today
11 min
Builds on Assets, liabilities, and things that only look like assets
Part III · Chapter 6 · Ownership · lesson 4
11 min
Builds on Assets, liabilities, and things that only look like assets
A valuer says the flat is worth 300,000. A buyer standing in front of you today offers 246,000, cash, completing in three weeks.
Both numbers describe the same flat. The first is what it fetches given six months and a patient seller. The second is what it fetches this afternoon. The distance between them is not an error in either number — it is the price of time, and it belongs to the asset as surely as the roof does.
Liquidity is not a property an asset has or lacks. It is a curve: the price you can get, plotted against how long you are willing to wait.
For some assets the curve is nearly flat — a day or a month makes almost no difference to the price. For others it drops steeply in the first week and only levels out after months. The steepness of that first stretch is what people mean by illiquidity, and it is a real cost even in the years you never sell.
The spread. The gap between what a buyer will pay and what a seller will take, right now, for the ordinary size. Cross it and you have paid for immediacy. On heavily traded things the spread is trivial. On a used specialised machine, the spread can be a third of the value and there may be no quote at all until you go looking.
The depth. How much you can move before the price starts moving against you. One unit at the quoted price says nothing about a thousand. Depth is the thing people discover only when they try to leave, which is unfortunate, because it is a property of the exit rather than of the entry.
The time to complete. Even a willing buyer at a fair price takes weeks on some assets: searches, surveys, finance, signatures. A sale you cannot complete inside your deadline is not a sale.
Here is the part that makes illiquidity more than an inconvenience.
The occasions when you need to sell quickly are not randomly distributed. They cluster: a job lost, a business short of cash, a household emergency, a margin call. And those events cluster with each other, and with everyone else's version of the same events, because the conditions that cost you your job are usually costing other people theirs.
So the discount you take for speed is largest exactly when you are most likely to need speed. That is not bad luck. It is a structural feature, and it means an illiquid asset carries a cost that never appears in any year's accounts and then arrives all at once.
Predict
Two numbers get used interchangeably and should not be.
A mark is a considered estimate of what an asset is worth: a valuer's opinion, a model output, the last recorded transaction. A price is what somebody actually paid. Marks are available on demand and prices are not, which is exactly why marks get used for everything from net worth statements to performance figures.
The trouble is that a mark cannot pay a bill. Net worth calculated from marks is a defensible estimate of your position; it is not the amount of money available to you, and the difference between those two is the whole content of this lesson.
Not the same thing
An estimate of what the asset would fetch under normal conditions and reasonable time.
What somebody would actually hand over this week for the whole position.
Which is which? Put each one on a side.
The figure your bank shows for a fund holding at close of business
What the trade actually executed at, including the spread you crossed
The valuation used to calculate your net worth statement
The amount you could raise by the end of next week if you had to
None of this makes illiquid assets bad. Locking money up is a service you provide to whoever is on the other side, and it should come with compensation: a lower price going in, a higher yield while you hold, or access to something that liquid markets do not offer.
The question worth asking about any illiquid holding is whether that compensation is actually present. Sometimes it is substantial — private assets frequently offer a genuine premium for accepting a five-year lock. Sometimes the illiquidity is only a feature of a badly-designed product and nobody is paying you anything for it.
There is also a subtler version, which is being paid in the wrong currency. An illiquid holding that pays a premium in reported smoothness rather than in return has given you something that feels like a benefit and behaves like one right up to the moment you need money.
Check
There is an honest argument on the other side, and it is worth stating at full strength.
Assets that are hard to sell do not get sold in a panic. An owner who cannot check the price every morning does not react to every morning's price, and the behaviour track will spend nine lessons on how much damage that reaction does. Some of the return attributed to illiquid holdings is really the return from having been unable to interfere.
That is a real benefit. It is also one you could obtain other ways, at lower cost, and buying it by locking up money you might need is an expensive route to a behaviour you could get from a rule.