The Newest Memo From Howard Marks – Liquidity

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Mar 26, 2015
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My wife Nancy’s accusations of repetitiveness notwithstanding, once in a while I think of something about which I haven’t written much. Liquidity is one of those things. I’m not sure it’s a profound topic, and perhaps my observations won’t be either. But I think it’s worth a memo.

Liquidity defined

Sometimes people think of liquidity as the quality of something being readily saleable or marketable. For this, the key question is whether it’s registered, publicly listed and legal for sale to the public. “Marketable securities” are liquid in this sense; you can buy or sell them in the public markets. “Nonmarketable” securities include things like private placements and interests in private partnerships, whose liquidity is restricted and can require the qualification of buyers, documentation and perhaps a time delay.

But the more important definition of liquidity is this one from Investopedia: “The degree to which an asset or security can be bought or sold in the market without affecting the asset's price.”(Emphasis added) Thus the key criterion isn’t “can you sell it?” It’s “can you sell it at a price equal or close to the last price?”Most liquid assets are registered and/or listed; that can be a necessary but not sufficient condition. For them to be truly liquid in this latter sense, one has to be able to move them promptly and without the imposition of a material discount.

Liquidity characterized

I often say many of the important things in investing are counterintuitive. Liquidity is one of them. In particular, it’s probably more wrong than right to say without qualification that something is or isn’t “liquid.” If when people ask whether a given asset is liquid they mean “marketable” (in the sense of “listed” or “registered”), then that’s an entirely appropriate question and answering it is straightforward. Either something can be sold freely to the public or it can’t.

But if what they want to know is how hard it will be to get rid of it if they change their mind or want to take a profit or avoid a possible loss – how long it will take to sell it, or how much of a markdown they’ll have to take from the last price – that’s probably not an entirely legitimate question.

It’s often a mistake to say a particular asset is either liquid or illiquid. Usually an asset isn’t
“liquid” or “illiquid” by its nature. Liquidity is ephemeral: it can come and go. An asset’sliquidity
can increase or decrease with what’s going on in the market. One day it can be easy to sell, and the next day hard. Or one day it can be easy to sell but hard to buy, and the next day easy to buy but hard to sell.

In other words, theliquidity of an asset often depends on which way you want to go . . . and which way everyone else wants to go. If you want to sell when everyone else wants to buy, you’re likely to...

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