6 remarkable benefits of an illiquid investment
09 May, 2022
Illiquidity can get a bad rap. Investors typically want the flexibility of pulling their funds out of an investment seamlessly when the need arises, and with an illiquid investment, that option just isn’t there. Yet an illiquid investment, like real estate or term deposits, carries some of the biggest benefits for investors that sometimes go overlooked:
- Low risk profile
- No liquidity premiums
- Higher rate of return potential
Let’s take a look at each of the pros of having an illiquid investment in your portfolio (and being prepared to keep it in there for a while).
By far the most popular benefit of an illiquid investment is its stability. One of the reasons illiquid investments don’t move rapidly in value is because they are traded so few times. The opposite can be seen in liquid investments.
Take a look at the share market, the investment type that’s closer to a rollercoaster than a smooth travelling investment vehicle. Shares are so easily traded that their value is constantly changing with every sale and purchase. The ease of divestment means that one negative headline can cause rapid drops in stock prices, forcing hard earned capital to shrink in value overnight. There are plenty of benefits to share investing. But it’s the stability that stocks (and other illiquid investments) lack which make illiquid investment options so appetising to many investors.
Owning property – whether commercial real estate or residential property – is perhaps one of the most stable investments an investor can partake in. For the property market to have the same volatility as the share market, nearly every property in every market would need to be valued, sold, and bought every day or week. The time required to transact on property is one of the reasons it’s so stable.
For investors with a long-term game plan, the diversification benefits involved in many illiquid investment assets carry significant weight.
When the stock market is riding an s-shaped cycle it’s hugely handy for investors to have a predictable investment in their arsenal. A stock market investor might do well to combat market fluctuations with other investments that have little correlation with the share market (this correlation is called beta, the measurement of how an individual asset moves when the stock market changes). Low beta investments are beneficial in down share markets because they might minimise portfolio losses.
The length of time it takes to transact on an illiquid investment arguably creates more transparency for investors. This is because there is little opportunity in the long, drawn-out investment period for prices to be manipulated by unscrupulous parties.
Investors in illiquid investments typically have more foresight than their liquid investment counterparts, thanks to the stability of their investment. Interest rate and property market forecasts are plastered across our news headlines on a daily basis, meaning investors don’t need to go far to find solid information about the potential future of their investment. On the flipside, stock market investors generally wake up to news of major market fluctuations. They are rarely predicted.
4. Suited for investors with lower risk tolerance
Investors looking for passive income are possibly better suited to illiquid investments. These investors, who crave a low-risk investment with a secure and regular income stream, can expect far fewer surprises when their investment is highly illiquid. The value of their chosen asset is likely to only change incrementally.
5. No liquidity premiums
The cost to continuously buy and sell liquid assets will come with premiums, or costs for the privilege of transacting on them. The more transactions you perform, the more fees you’ll inherit. These are called liquidity premiums and they can eat away at your returns if care isn’t taken.
The other option is of course transacting fewer times. An illiquid investment won’t be the subject of frequent hand-changes meaning the volume of premiums are far lower.
6. Potential for higher rate of returns
This is perhaps more of an expectation rather than a benefit, but the rate of return for an illiquid investment has the prospect of being higher than one that is liquid.
This is because investors will likely have their capital held in an illiquid investment for far longer, forcing the compounded returns (and the mere longer holding period) to provide a higher rate of return than they’d otherwise achieve with a short, sharp liquid investment. (Learn more about how long to hold a property investment.)
Want to diversify your portfolio with a stable and high-yielding illiquid investment? Consider commercial real estate. It’s the choice of many passive investors, with yields typically exceeding residential real estate, term deposits, and other high-income illiquid assets.
For more information on what we offer our growing list of sophisticated investors, book a quick 30-minute meeting with our investor relations manager Guy Doggett today.