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The risk that many people ignore

Any asset is only worth what you can sell it for.

When many investors hear the term ‘liquidity risk’ they think of it as something technical that they needn’t be too concerned about. However it is something that is likely to effect everybody at some point.

Liquidity refers to how quickly something can be sold. Shares in Naspers are highly liquid because hundreds of thousands of them are bought and sold in thousands of deals every day on the JSE.

A game farm in Vaalwater, on the other hand, is a lot less liquid as there aren’t thousands of people lining up on a daily basis to get their hands on one. It will therefore take a lot longer to find a buyer.

Why this is significant is that if something cannot be disposed of quickly, it is very difficult to prevent or minimise a loss. If shares in Naspers fall and you want to exit, you should have little trouble in selling your holding to someone else and therefore managing your realised loss. If however the bottom falls out of the game farm market in Vaalwater, disposing of that property could be almost impossible.

Small caps and large properties

This is why liquidity risk is often spoken about in terms of small-cap stocks on the JSE. A stock like Erin Energy Corporation, for instance, hasn’t traded in months.

Shares in the company last changed hands in mid-December 2017 at R30 per share. However, the only bid currently in the market for that same counter is R2.18.

On Wednesday, Erin announced that it was filing for bankruptcy protection in the United States. If anyone holding the stock on the JSE wanted to offload it on the back of this news, they would not have been able to do so.

The reality is that any asset is only worth what you can sell it for. And if you have to sell something in a hurry, if it is not liquid, you may find yourself getting a lot less for it than you expected.

Another obvious example of this is the housing market. A home may be valued at R1 million, but in a downturn it is unlikely to realise that much.

If market conditions are poor and there is little demand, buyers may only be offering R800 000 or less. An owner who is in need of cash or has some other financial demands at that point may have no option but to sell at that price.

No value at all

Liquidity risk can also be taken one step further. If an asset is only worth what you can sell it for, then it also follows that if you can’t sell it at all, it is worth nothing.

This is a risk that many people putting their money into ‘alternative’, unregulated investment schemes fail to appreciate.

A unit trust, locally-regulated hedge fund or exchange-traded fund offers guaranteed liquidity. If you ever want to buy into or sell out of one of these funds you will always be able to do so because they are constructed to ensure that this is always possible.

However, this isn’t the case with a number of other so-called investment opportunities.

A particularly infamous example is Mandela Coins bought from dealers who do not guarantee that they will buy them back when you want to sell them. If you can’t find a buyer for the coin that you paid thousands of rand for, then what is its actual value?

Read: A rare R5 Mandela coin: A sound investment?

A more extreme example was Electio Alternative Investments, which purported to be selling clients baskets of rare earth metals. They priced these baskets at regular intervals (although how they did so was highly questionable), but there was never actually any market into which to sell them.

Investors have therefore been left holding assets which are, effectively, worthless. No one will buy them, and so they have no value.

Read: When valuable rare earth metals may actually be worthless

This is something that investors should be extremely alert to when considering ‘investment opportunities’ that are out of the ordinary. If they involve buying an asset in the belief that its value will increase over time, always remember that there has to be another party on the other end of that equation.

How is that value actually to be realised? In other words, who is going to buy it from you.

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COMMENTS   18

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Well said, Patrick – so many people miss this basic truth.

The same can be said for Freedom – being free is only possible for those that have nothing more to lose!

And talking about value…… R147billion Tencent shares have been sold over the last few months by the chairman, President, Directors and their biggest shareholder, Naspers at just over R3000 a share – does this therefore represent its top value?

I got out the bulk of mine at R3600 recently and am happy to take the ‘value’

It may go up – it may not – either way I have minimized my risk to virtually nil – the shares I still hold can stay there forever.

But my reading is that Chinese Government may get involved and the tenuous structure currently in place for Naspers’ holdings of Tencent may be at risk.

Good article , illustrating an aspect of investing which is often not attended to enough . A farm in SA is an obvious sale risk , but even listed companies can become high risk investments .Global trading exposes SA companies to new and unknowm risks , eg.our shoe , clothing and textile industries severely damaged by chinese imports , our steel manufacturers to compete with cheap imports .Excellent companies can and do now lose their value to investors virtually overnight . Diversification of the assets we invest into , has become critical for anyone who depends on income from an investment portfolio. The risk perception of most our local fund managers seem to be that a 25% global exposure is sufficient for local investors and the majority of SA investors are now locked into such an asset allocation . The risks in SA are ever increasing , whether we like it or not , and i would urge investors to increase their global exposure .

True, it only takes poor quality control killing 150 people to drastically lower the share price of the company doing the killing.

Is there perhaps somebody on this forum that can give advice regarding the use of preference shares to generate income in retirement especially from a liquidity point of view….in this case I am specifically referring to Ecsponent preference shares?

Pref Shares are like diapers. It is a good investment if you are a baby, or very old.

Good for income but dont underestimate the risks. You know they invest into the unsecured lending space which carries its own specific risks of course

The article effectively equates price and value and this is not correct.
E.g.
An animal with 5 year lifespan is only needed for the milk it produces. It produces milk worth R200 annually, a fact well known. The lifespan is less know to the public. On the 4th year, at which time the animal could worth ~R150, the owner puts up the animal for sale at R600. An ignorant buyer buys it.
Does that make the animal worth R600 for which it was sold?

the headline is ‘Any asset is only worth what you can sell it for.’ – which seems about right…..irrespective of whether you paid R150 or R600, if you can sell it for R600 then it is worth R600.

Depends if you are buying for milk production or the intrinsic value of the cow – the meat.

Good Point raised by the cow analogy…. a share is worth what any buyer, ignorant or otherwise is prepared to pay based on advise or lack thereof!!! Those in the know, usually don’t disclose what they know until it’s too late to do anything about it. That’s called risk – something every investor has to decide on for themselves.

It isn’t a bad analogy about “risks” that can be researched using known data. A bigger risk is when the proverbial cow dies somewhat suddenly (a Stenhoff, Erin or Abil cow) although a knowledgeable person may have engaged a vet to check the cow and prevalence of disease etc; maybe. For me as a farm owner; my cow starting looking sick when CGT started to bite. When CR embraced EWC the cow took a turn for the worse. Davis’s wealth tax “ideas” make the cow look decidedly ill. And this was a healthy cow with an unlimited lifespan – no more land cows are being born; or so I thought.

So I have had a late and unpleasant epiphany and let me link it to the cow; even a land cow. If you buy a cow in a 3rd world environment anything can happen to it; almost randomly and even if it was healthy and wellbred. It can be stolen (legally nogal by EWC), impregnated by the neighbour’s scrub bull, maimed by stray dogs (or stray people), die from eating plastic litter and so on (and so on; even for its calves which can be heartbreaking).

But a 1st world cow has a better chance of living a longer and more productive life; a Berkshire Hathaway cow say (hopefully not a Steinhoff or Enron cow). It may cost more to keep (no free grazing on the freeway median), the price of its milk may be regulated and its living conditions may be legislated and hence costly. But it is likely to remain productive (albeit without the wild fluctuations that can boom or bust us in the 3rd world) for longer. Pay your money and make your choice.

Enjoyable article, thanks Patrick!

When you mentioned certain investments difficult or impossible to sell assets (under certain conditions), my mind wandered to Timeshare-contracts *lol* OK, to be fair…more like a “lifestyle expense”, but it’s marketed to sound like an investment.

Mentioning rare coins, if have Questions for our MW readers:
Anyone had bad (or good) experience trading Kruger Gold Coins through any of those exchanges? (e.g. SA Gold Coin Exchange, SCOIN shop, SA Mint, others..) Was is worth it, considering holding the physical coin does not earn interest, and may have insurance cost (or safe-deposit box cost)? And I wonder if those dealer commissions don’t kill any long-term asset growth?

Is investing in gold (or plat or palladium) commodities not more cost effective through ETF’s, instead of holding the physical coins?

Comments are welcomed.

When you cannot buy food for love or paper money gold and silver have always been acceptable. Its mad money for the last resort and should be well hidden or buried in a place easily accessible to you and those you trust but no one else:) NOT in someone elses vault.

Dont look at gold and silver as investments – rather as Catastrophe insurance but only as previously said – in your own control not someone else’s vault

You are touching the tip of the Iceberg here Patrick!
Most traders know that Quantitative Trader are trading on strategies based on quantitative analysis, which rely on mathematical computations and number crunching to identify trading opportunities. Problem is, all of them are using similar models – and end up buying and selling the same equities in a bull market…when the market changes to a bear market. All of them need to unwind the same positions, and the market collapses, Steinhoff style! A
The small investor without regulatory protection is at a huge disadvantage when it starts to collapse, as the market ‘’makers’’ has absolute no intention to make prices in such a volatile collapsing market.
I worked in the London Treasury market in 1987 when I experienced how liquidity evaporated – which caused the crash – which resulted in a US Congressional investigation. The 87 crash was not caused by a genuine economic meltdown but a temporary institutional collapse.
The NASDAQ was accused of deliberately maintaining inefficient markets so that the insiders could take advantage of the public.
I read a very entertaining book ‘’Dumb Money’’ – around 1988, after the markets crash and to this day remember the warning:
If you want to experience the glories of the new stock market – you should have its main rule inscribed , not just in your brain, but in your stone cold heart’’ – Here is the rule:
• You are not an owner
• You are not an investor
• You are not an employee, customer or stakeholder
• You are not a patriotic
• American (or South African) waving a flag, glad to go long in the name of freedom
‘’You are only in it for the money’’

The same can be said for shares as game farms with game farms there is nothing price cannot fix if the bottom falls out of the game farm or housing market. The same could be said for Steinhoff and other shares.

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