Some investors say that small illiquid stocks are the place to be. They’ve got a point – but you can still lose a lot of money here. Today we go further and explore some things you might not have realized about illiquid securities.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
Illiquid Securities: Goldmine... or Graveyard?
Transcript
Hey there i am christian right there of Korean capital. And 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 going to 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 and 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 more than 1 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 everyday or trades every few weeks or even every few months. That's a liquid for everyone on earth. Then 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 that can be a problem for you. But that's what we mean by and illiquid security.
The reasons that you'll see on the Internet on finance Twitter or on other YouTube videos are where have you. The reasons for investing in illiquid securities are few. So first off they're going to be investors who have rules against investing in illiquid securities at all. And so these people are just by basis of the 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 going to 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 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 very smart but they can't invest in these things. So you as an intelligent investor can go in and get them not the rules falling 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 take advantage of your your size your nimbleness and take advantage of the silly rules or circumstances that other investors find themselves in. So that 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 and say yes I will take those shares of that stock or the security off of your hands. But it's going to be at a lower price. So then you come in get stock at a low price and you're able to take advantage of that liquidity. 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 to be 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 the 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 where we could sell completely if we wanted to. But there are other days where it would take awhile.
It's a five out of my eight maybe a little bit over 50 percent of the portfolio is in these illiquid securities and I've started to notice you know some of the downsides some of the risks that are inherent in illiquid securities that you might not have thought of or that don't really come up until you start getting a little bit bigger. So one of the things that you have that you hear about illiquid securities is that you are sort of in a longer term relationship with these things because the security doesn't trade very often.
