- Hey there, I am Christian
Ryther of Curreen Capital.
Today I wanted to talk about investing in
illiquid securities,
the opportunities as well as the risks.
And if you stick around at the end,
I'm gonna talk a little
bit about some of the risks
if you're looking at funds that invest in
illiquid securities,
but that's the bonus at the end.
So first, let's talk
about illiquid securities
and what I mean by that.
An illiquid security is a
position that you could not
get out of completely, on
a day of your choosing,
without moving the security
price by one percent.
So part of that is just
the security itself,
where a small security
might be illiquid for
everyone on earth just because
it doesn't trade every day,
or it trades every few weeks,
or even every few months.
That's illiquid for everyone on earth.
There there are securities that are liquid
based on your personal circumstances.
If you're Berkshire-Hathaway
and you need to
put 100 billion dollars into any idea,
most securities on earth
are, by definition,
our definition, illiquid.
So part of it is the security itself,
part of it is your position,
and part of it will change over time
as the company matures
or changes, goes dark,
what have you.
So the company itself will change,
your circumstances will change,
and the times that you're investing in,
they will also change.
During a crisis, a lot of
securities that used to be liquid
tend to stop being liquid
and that could be a problem for you.
But that's what we mean
by an illiquid security.
The reason that you'll
see on the internet,
on finance Twitter, or
other YouTube videos,
or where have you,
the reasons for investing
in illiquid securities
are a few.
So first off, they're are
gonna be investors who
have rules against investing
in illiquid securities at all,
and so these people, just
by basis of their rules,
will never even be looking
at these securities.
So you've got less demand for them,
you can go in and scoop them up.
Nobody else is even gonna buy them,
not because they didn't look at them,
but because they're not
even allowed to touch them.
So that's one good reason.
Then you've got other investors,
who might be very smart,
like Berkshire-Hathaway,
but they just can't invest
in illiquid securities
because those securities
are too small to move the needle,
or too difficult--
just, they're smart but they
can't invest in these things.
So you, as an intelligent
investor, can go in and get them.
The rules-following
investors won't get them
and the bigger, smart
investors won't get them,
so you can get them.
And so you might be able to
get these gems of businesses
that other people just can't
invest in for no good reason,
aside from their size
or their silly rules.
So that, I think, is a
compelling, emotional idea
of being able to take
advantage of your size,
your nimbleness, and take
advantage of the silly rules
or circumstances the other
investors find themselves in.
So that tends to be something
attractive for people.
Another reason to invest
in illiquid securities
is to be able to take advantage
of their very illiquidity.
So because they don't trade very much,
because they're hard to get out of,
you might have days or situations
where an investor needs
to get out of the stock,
almost regardless of price,
and you can come in and
relieve them of that burden.
Say, "Yes, I will take
those shares of that stock
"or this security off of your hands."
But, it's gonna be at a lower price.
So then you come in, get
the stock at a low price,
and you're able to take
advantage of that illiquidity.
So those are some of the reasons to invest
in illiquid securities and
some of the reasons why
I, historically, have
been partial to the
arguments for investing
in illiquid securities.
I'm attracted to this,
I like being nimble,
I like to be able to take advantage of
other people's foolish rules.
All of this has worked for me.
But, as my fund has gotten bigger,
and I've put more of, what I'd say,
illiquid securities into the fund,
I've started to notice
some of the downsides.
So right now, out of eight
positions that we have,
five of them fit my definition
of illiquid securities.
Three of them it would
take days or even weeks
to sell out of.
The other two there are definitely days we
could sell completely if we wanted to,
but there are other days
where it would take a while.
So five out of my eight,
maybe a little bit over
50% of the portfolio,
is in these illiquid securities.
And I've started to notice, you know,
some of the downsides.
So, the risks that are
inherent in illiquid securities
that you might not have thought of,
or that didn't really
come up until you started
getting a little bit bigger.
So one of the things that you have
that you hear about
with illiquid securities
is that you are, sort of,
longer term relationship
with these things.
Because the security
doesn't trade very often
you have to consider
it more of a marriage.
So the argument is it needs
to be a very good business
because you're married to it,
or it needs to be very attractive
security or opportunity
because you're in there for a long time.
And people a little bit
brush this off as saying,
"You gotta be good.
"You gotta know what you're doing.
"You gotta know what you're buying,
"so shame on you if you buy something bad.
"It was your mistake.
"It's not the fault of
the illiquid security."
Which I get.
Also, that as you buy
something that's good,
over time is becomes more known,
it becomes more liquid,
so as long as you buy it right
all the illiquidity issues go away.
Some other risks that I've thought of
that I've been aware
with illiquid securities
is the fact that it's illiquid means
that it could be you
who is having the need
to get out of these stocks.
It could be you who needs cash.
And all of the sudden
instead of being the person
who comes in to relieve
someone of their burden,
it could be your burden.
And it could be somebody
else who is coming in
to relieve you of that.
So you could have a
personal emergency that
requires you to get cash,
or you could have if you have a fund,
you could have redemptions
that require you to sell
whatever you can sell.
And so you're forced to sell
these illiquid securities
at prices that you would not want to,
just because everybody has bad days.
So that illiquidity premium
that you got on some other day,
but for the grace of God, there go I,
some day that might be you going there.
So you need to handle your affairs
so you can handle bad days so that
you won't be the one selling,
you won't be the one providing
that illiquidity premium
to somebody else.
What's become more apparent
to me lately is that
the risk with illiquid
securities is that you need cash.
And sometimes you need cash
because it's a bad day,
but sometimes you need
cash because it's a day
full of opportunity.
So the upside, if you will, of, hey,
you find a once-in-a-lifetime
or once-in-a-decade
opportunity and you want
to put cash into it now,
it could be another
illiquid security where
somebody wants to get out really bad
and you could buy it at
a super attractive price,
or it could just be a great
opportunity that comes up
and you want to buy that.
But you realize that
your portfolio is full of
these illiquid securities
and so either you have to
attempt to sell some of
these illiquid securities and take
whatever haircut you have to take,
and it might be impossible,
even, to get out of them,
or you're forced to sell
your more liquid things,
which might not be the
ones you want to sell,
even if they're very attractive
and your illiquid securities
are at a higher price
compared to their value,
but you just have to sell
the liquid names because
they're the ones that can give you money.
So it could a happy day, where you got
this great opportunity,
but you find that these
illiquid securities are
holding you back.
So, as Buffett says, if you're hunting
large, fast-moving elephants,
you need to carry a loaded gun,
illiquid securities are
bullets that you put away
and you can't use.
So that can be a risk you
might not have thought about
with these things.
Another issue is the
more illiquid securities
you put into your portfolio,
the bigger a portion of
the portfolio they become,
the more blocked in you are.
So the first illiquid security you buy,
no problem.
You can take advantage
of whatever opportunities
come along the way.
The second illiquid opportunity you buy,
there might be some rare
circumstances under which
you'd have trouble
buying something amazing
or taking advantage of
some amazing opportunity.
But once you start getting
three, four, five...
Five out of my eight,
maybe a little bit more
than 50% of the portfolio
is in these illiquid securities...
You realize that, hey, maybe
too much of my portfolio
is locked up in these things,
and now I'm no longer as
nimble as I want to be.
I'm no longer as able to take
advantage of opportunities,
or recover from bad days,
as you might want to be.
There are a couple ways, I think,
that we can deal with this
issue of illiquid securities.
So one way is you want
to raise your standards
for illiquid securities.
So if it's an illiquid security,
because you're basically
getting married to this thing,
you want to make sure that it's
truly an outstanding opportunity.
And this is something you wanna think of
with the first illiquid security
because you put one in and
it doesn't really matter,
you put the second in,
it starts to matter,
but that third one, all of the sudden,
you need to have super high standards.
And now that third one might be way better
than the first one you bought.
It's hard to get rid of that first one.
So you gotta start thinking
about this, sort of,
before it affects you.
So that's one way to think
about illiquid securities,
is to raise your standards for
what you're willing to accept.
The second way is to
start following rules,
like those crazy institutions,
and sort of limit how much
of the whole portfolio
you are willing to put into
these illiquid securities.
One, to handle adversity,
but also two, to be able to
take advantage of opportunities.
Because, again, on a good
day if you wanted to,
you couldn't even use margin debt to buy
that new, great opportunity
because your illiquid
securities probably won't be
acceptable for margin.
And even if they are, now
you're running a big risk
because you can move the stock prices,
or the security prices
of those relatively small
amounts of money.
And that could get you into margin call,
all sorts of problems ensue.
So you could try to avert this by limiting
the amount of illiquid securities you have
to X percent of your portfolio.
(static)
Hey, my camera turned off
before I could tell you
another way to avoid this
problem is to hold cash.
Then, no matter how many
illiquid securities you have
in a portfolio, you can handle
adversity or opportunity
with that cash that you
have sitting on hand.
So, back to the show.
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So, if you want to go after them,
you want to be thinking of
how you handle those days
when you need cash.
Both the bad days and the good days.
And I hope that some of the ideas I have
gave you some ideas on that.
Thanks for watching, everybody.
I hope you enjoyed this video.
I try to put things out there that aren't
the 101 level basics that
you find everywhere else.
What I want to provide
is a graduate level,
or even post-graduate level,
investing information and ideas.
Because there are some
of these topics out there
that I don't think are addressed properly,
or as deeply as you deserve.
So if you like these types of videos,
hit that like button,
hit that subscribe button,
and I'll see you later.
All right, thanks for
sticking around for the bonus.
I want to tell you about a risk that
you might not have thought about
if you are looking at
or already invested in
funds that invest in illiquid securities.
So one thing that I
noticed when I was buying
a particularly illiquid security was
how easy it was to move the stock price,
even unintentionally,
of those illiquid securities
just by buying it myself.
So with a few hundred dollars
I could move the stock price
if I wasn't careful.
And even when I was careful,
I ended up moving the stock price.
I had a situation where I was buying,
the stock price went up.
It made me mad that all
the other buyers were
bid jumping and all this stuff.
It made me mad that we were
all not acting properly
and just keeping the stock
price low and buying it.
And so I decided to stop
buying and see what happened.
And, lo and behold, the stock price fell.
So even though I had been
buying smart and carefully,
I had actually been
boosting the stock price
without my knowing it.
And this made me realize
that you can move the prices
of these illiquid
securities much more easily
than you might think.
So you might have a fund
manager who is inadvertently
moving the stock prices of
the positions that they own.
And this can create a
problem, or a situation,
for the fund that you
might not think about.
So if a fund buys an illiquid security
and makes it a decent-sized
portion of a fund,
now you've got hundreds of
thousands or even millions
of dollars in a position.
And that position can be moved
by very small amounts of cash
flowing into that stock.
So this fund manager might
have driven up the stock price
of that illiquid position
just by buying it themselves.
That might, in turn, create
good performance statistics
for that fund because
they've got this position
and this position has moved up
and so the fund has done well.
That might lead to inflows.
And where are those inflows going to go?
Well, some of them might go
into that illiquid security,
or into another illiquid security.
And you can get that same feedback loop of
cash flows in, the stock price goes up,
that drives performance,
and you get high performance statistics.
So more money comes into
the fund, and again,
you get this vicious, or
virtuous, cycle depending on
how you're looking at it.
One of the problems is that
this cycle is dependent
on new money flowing into the fund.
It might be related to
fundamentals and it might be
divorced from the fundamentals of
those securities themselves.
And it might be the case that
if money stops flowing in,
if the fund manager then
stops buying these positions,
the stocks might start to fall.
Which could create poor performance,
which could lead to redemptions or
the fear of redemptions.
And you might get sort
of a run on the bank
where performance is
weak, redemptions happen,
the fund manager has to sell stock,
which is of this illiquid stuff,
which drives worse performance and so on.
You get this vicious cycle
instead of the virtuous cycle,
depending on your perspective,
that you saw before.
Another problem would be
because it is so easy to
move those stock prices
with small amounts of money,
the fund manager might be tempted,
and might succumb to the temptation of,
supporting the stock
prices of these things.
Because with a few hundred or even
a few thousand dollars
you can support a position
which might be millions of dollars
just because these things don't trade.
So you put in a bid,
or you even buy stock supporting it,
and you could justify
it in all sorts of ways,
of value, or blah blah blah,
like crazy people are selling.
But you have a fund
manager might be tempted to
protect their stocks,
protect their performance,
so they don't get that bank run,
so they don't get that vicious cycle.
But again, that creates it's own problems.
So be careful, be aware if
you're invested in funds
that invest in illiquid securities.
Strange things can
happen with performance.
And all might not be quite as it seems
So a particular look
at the trading activity
on the last day of reporting periods for
the large portfolio
positions that are illiquid,
you want to make sure that
the fund manager, or somebody,
isn't doing something crazy on those days
that might impact performance temporarily
or support a stock that
doesn't need to be supported.
Anyway, buyer beware and
hopefully you're aware now
about something that you
might not have thought of
with illiquid securities and funds.
Thanks again, bye.
