Free newsletters - Wealth Advisor, Breaking News and More
Earn Free CE Credits
Free Seminars and Podcasts from Industry Experts
Access our Discussion Boards
BlogsTaking it to the Bank
The Liquidity Premium
By Pamela Black
February 18, 2011
¦
Advertisement
Most people don’t think about it, but there is a liquidity premium on publicly traded securities just as there is a risk premium, yet most only think about it in the case of extremely illiquid assets such as private equity.
However the liquidity premium is separate and distinct and there is a way to manage it to your advantage. This is what Roger Ibbottson, the former chairman of Ibbotson and Associates, is into these days as Chief Investment Officer of Zebra Capital Management. Zebra manages portfolios and hedge funds with an eye to capturing this liquidity premium.
“Less liquid securities are more difficult to trade, but they’re lower in price for the same set of cash flows and that’s what gives you the higher returns,” he says. “The key is don’t pay for liquidity you don’t need.”
Liquidity is easier to see in bonds, where you can have two identical bonds, with one trading at a slightly lower price because it’s less liquid. This is less apparent with stocks, but according to Ibbotson, 30 years of academic research supports the fact that you can make higher returns with the same risk by purchasing publicly owned stocks that trade slightly less than say glamour stocks also are cheaper. Hence, Ibbotson explains, you are paying less for the same cash flows as a stock that might have higher visibility and more trading volume.
To demonstrate this, he shows the returns research spanning the period from 1972 to 2010 using up to 3500 U.S. stocks comparing degrees of liquidity versus stock size (micro cap to large cap), growth/value and momentum. In all cases the lower turnover stocks show significantly higher returns. For example, the lowest liquidity stocks in the microcap category returned 18.17% over the time period compared with only 6.16% for microcaps with the highest turnover. Likewise in the large cap category, the least liquid publicly traded stocks had 12.49% returns versus 9.87 for the most liquid.
“Less liquid stocks trade at a discount to more liquid stocks,” Ibbotson says. “Less liquid stocks have higher historical returns, beyond any size, value, or momentum effects.” This strategy, he claims works in almost any public market, including international equity, publicly traded real estate, high-yield debt and global bonds.
An interesting concept but how do you put it into practice? Well you can try buying stocks that are more kind of staid and boring but still publicly traded, or you could buy the mutual funds his company released last June: American Beacon Zebra Large Cap Equity Fund and American Beacon Zebra Small Cap Equity Fund. The press release announcing these funds describes their strategy this way: Zebra Capital “uses these observable, relative liquidity measures to construct a portfolio that invests more heavily in stocks with strong fundamentals that are traded less often than stocks with comparable fundamentals. The Funds’ strategy is designed to generate higher returns over time, driven by three factors: less liquid stocks generally trade at a discount; individual stocks move in and out of favor, reverting toward mean liquidity; and a potential benefit from general worldwide increases in the liquidity of markets.”
So far the strategy seems to be working. Returns for the Large Cap fund according to Zebra’s monthly reports are 23.8% compared with 19.98% for the Russell 1000 since June. For the month of January the fund returned the company’s monthly. The small-cap fund fared less well in a market that favored large caps but still beat its benchmark, returning 20.20% versus the 19.04% for the Russell 2000 since inception. January returns were 0.08 for the fund versus -0.26 for the Russell 2000.
0 Comments
Be the first to comment on this post using the section below.
Add Your Comments...
Already Registered?
If you have already registered to IAG Blogs, please use the form below to login. When completed you will immeditely be directed to post a comment.
While half of U.S. banks are aware of the opportunity with mass affluent investors and are busy enhancing their online capabilities, the other half believe they distinguish themselves from the Charles Schwabs of the world with in-person advice.
How can advisors take advantage of opportunities created by limitations on fees and transactions? Program managers at BISA’s bank broker-dealer breakout session presented some interesting answers.
“Banks are struggling with where to get more revenues because of fee reductions,” said Rob Comfort, head of Huntington Investments. “This gives us an opportunity to play a prominent role.” …
Women want a quality relationship with their advisors that involves interpersonal, relationship-driven factors. What does that translate into in your practice? It starts by listening.
If interest rates can only go up from here, shouldn’t you minimize your exposure to bonds? Not according to Zane Brown, a fixed-income strategist from Lord Abbott who addressed a crowd of advisors at the IMCA New York Consultants Conference.
Advisors need to consider a Net Unrealized Appreciation calculation, according to C. James Johnson, a presenter of retirement planning and tax strategies for Allianz Life Financial Services.
There are two proposed pieces of legislation sitting in Congress that would seem to be no-brainers for helping people save for retirement and helping advisors help their clients.
A paradigm shift is occurring in how bank investment program executives see retirement planning, according to Scott Stathis, managing director of Kehrer LIMRA. Stathis discussed with me some of the key findings of his retirement roundtable back in October.
There are a variety of working styles and strategies represented by the top 50 bank reps, but some themes stand out that have helped keep them above the cut.
We’re thankfully off for the next two days so I wanted to send you to your turkey dinners early with some words of thanks to you and for you. Here are a few silver linings and just plain gold realities that we can be thankful for this holiday season.
Jobs: The glass is more than half full when it comes to the job market. While a stubborn 10% of people still don’t have jobs, you have…
When you think about it, what is a dollar bill but a piece of paper with a picture on it. But when it comes to our clients there are so many various emotions around money.
It sounds like the name of an honored Transatlantic ship, but this time the QE2 stands for the Federal Reserve Board’s second attempt at an economic stimulus with the name Quantitative Easing. Will this new round help keep the economy afloat and chugging toward an expansion?
It isn’t every day that you get your opinion validated by the likes of Jeremy Siegel, the “Wharton wizard,” market commentator and senior investment strategy advisor for Wisdomtree ETFs. Siegel delivered a very bullish talk at Sourcemedia’s ETF 360 conference in New York.
The idea of a bond bubble keeps bubbling to the surface. The argument is sound. Interest rates are at all time lows. In the bizarro world of bonds this means that prices are at all-time highs. Meanwhile investors spooked by the stock markets are pouring into bonds the way they poured into, well, real estate before 2008 and technology before 2000.
A new study published in Psychological Science finds that people who are primed to think about time spend more time socializing, while people who are primed to think about money spend more time working.
President Obama wants to let them expire. The Republican leadership wants to extend them. This is not a clear case of Republicans versus Democrats however.
Pamela J. Black is editor in chief of Bank Investment Consultant. A former editor at Financial Planning, Business Week, Worth, Individual Investor and Folio; and a senior financial writer at J.P. Morgan, she has been writing and editing financial stories for 25 years. Her has work also appeared in Barron¹s, The New York Times Magazine, Smart Money, The New England Financial Journal, Bottom Line and Ladies Home Journal. She is a graduate of Columbia Graduate School of Journalism.
FEED
Pamela J. Black is editor in chief of Bank Investment Consultant. A former editor at Financial Planning, Business Week, Worth, Individual Investor and Folio; and a senior financial writer at J.P. Morgan, she has been writing and editing financial stories for 25 years. Her has work also appeared in Barron¹s, The New York Times Magazine, Smart Money, The New England Financial Journal, Bottom Line and Ladies Home Journal. She is a graduate of Columbia Graduate School of Journalism.
0 Comments
Be the first to comment on this post using the section below.
Add Your Comments...