Institutional Investor: How Allocators Can Avoid “Secondhand Smoke” From Illiquid Investments
The increasing market wealth of the past few decades has seen a rise in investors interested in alternative assets. Different from stocks or bonds, these assets can offer higher returns, but also carry higher potential risks.
One such risk is that alternative investments can be illiquid. Buying a stake in an early-stage company before it goes public leaves few ways to exit. One would have to find a buyer, rather than rely on liquid markets like those that publicly-traded stocks enjoy.
And, such investors may also have to contend with systemic risks, where all asset classes are being sold off at the same time.
Investors with a mix of assets are likely to sell the most liquid ones first to meet their cash needs. If illiquid assets have to be sold, it may be at a far more considerable discount to the investment’s value relative to a stock.
That said, investors who have some proportion of their holdings in such alternative assets can earn higher returns over time. And there’s generally lower volatility in most markets. That’s because illiquid assets don’t change price too often, if at all.
To ensure the right mix, investors should balance the potential for market shocks and how they can impact a portfolio. And investors should consider the allocations of other market participants. And finally, it’s important to consider cash needs when markets are humming along, not crashing.