Conventional wisdom suggests that if you're going to invest $10 million into an illiquid real estate investment that will not bear delicious fruit for 7 to 10 years, you may want to be compensated for the illiquid nature of your commitment. In other words, there's an "illiquidity premium." Flexibility is worth something. If you can get the same return and have the flexibility to get your money back when you want it, isn't that better? I don't know; maybe that's not always the case. Here's an excerpt from a clever article written by Cliff Asness, founder of AQR Capital Management, where he argues the reverse:
If people get that PE [private equity] is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns?
Perhaps another way to think about illiquid private investments is that they kind of force you to think more like Warren Buffett. He has so many great lines to this effect: "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes." And: "The stock market is a device for transferring money from the impatient to the patient." He has also written over the years about how a tolerance for short-term volatility can improve long-term prospects. So, behaving in this way, it would seem, is generally good for making money.
The problem — and this is really Cliff's more precise argument — is that the majority of people simply aren't good at being like Warren Buffett. We're impatient and emotional. That's why he's so remarkable. His approach certainly sounds simple, but it's clearly not so easy. Illiquidity can help with this. It removes the fraught thinking part and might actually protect you from your own thoughts and emotions.
Cover photo by Maxim Hopman on Unsplash
At the beginning of this year I wrote a post about a mobile tracking app called Moves that I had heard about through my friend Sachin Monga. He had just published a beautiful set maps showing where he physically spent his time in both Toronto and San Francisco.
His post spurred me to download the app and at the end of my post I promised to share my own set of maps once I had collected enough data points. It’s only been about 3 weeks, but already my maps are starting to fill out, so I thought I would do a release.
The orange lines represent transport of some sort (car, subway, streetcar, and so on) and the green lines represent walking. I don’t cycle very often in the winter (I know, I’m a fair-weather cyclist), so you won’t see any of those lines just yet. However if I posted a map from the summer, I know it would look completely different.
Here’s a first one showing a regional scale:
Here’s a second one showing the city of Toronto:
And here’s a third one showing mostly downtown:
What’s interesting about these maps is how much you can tell about me and the way I move around the city.
For one, there’s a good chance I ski or snowboard given that I’m driving up to Collingwood, Ontario in the winter. You can also see how heavily dependent I am on the Yonge subway line, which is the thickest orange line in the middle of downtown. It’s also interesting to see how localized I am within my neighborhood (St. Lawrence Market). I walk to get groceries. I walk to the gym. I walk to coffee. And the list goes on.
This is fairly typical for people living in urban neighborhoods, but it would be interesting to see where it applies in the city and where it begins to fall apart. I would also imagine that there’s a correlation to the area’s Walk Score, although this (Moves) might actually be a better measure since it’s usage data.
Either way, imagine what cities could do if they had this sort of data for every resident. They would be able to see precise resident flows and then determine exactly where transit and infrastructure investments should be made instead of politicking to determine where they should be made.
That time is coming.
Conventional wisdom suggests that if you're going to invest $10 million into an illiquid real estate investment that will not bear delicious fruit for 7 to 10 years, you may want to be compensated for the illiquid nature of your commitment. In other words, there's an "illiquidity premium." Flexibility is worth something. If you can get the same return and have the flexibility to get your money back when you want it, isn't that better? I don't know; maybe that's not always the case. Here's an excerpt from a clever article written by Cliff Asness, founder of AQR Capital Management, where he argues the reverse:
If people get that PE [private equity] is truly volatile but you just don’t see it, what’s all the excitement about? Well, big time multi-year illiquidity and its oft-accompanying pricing opacity may actually be a feature not a bug! Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they’ll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns?
Perhaps another way to think about illiquid private investments is that they kind of force you to think more like Warren Buffett. He has so many great lines to this effect: "If you aren't willing to own a stock for 10 years, don't even think about owning it for 10 minutes." And: "The stock market is a device for transferring money from the impatient to the patient." He has also written over the years about how a tolerance for short-term volatility can improve long-term prospects. So, behaving in this way, it would seem, is generally good for making money.
The problem — and this is really Cliff's more precise argument — is that the majority of people simply aren't good at being like Warren Buffett. We're impatient and emotional. That's why he's so remarkable. His approach certainly sounds simple, but it's clearly not so easy. Illiquidity can help with this. It removes the fraught thinking part and might actually protect you from your own thoughts and emotions.
Cover photo by Maxim Hopman on Unsplash
At the beginning of this year I wrote a post about a mobile tracking app called Moves that I had heard about through my friend Sachin Monga. He had just published a beautiful set maps showing where he physically spent his time in both Toronto and San Francisco.
His post spurred me to download the app and at the end of my post I promised to share my own set of maps once I had collected enough data points. It’s only been about 3 weeks, but already my maps are starting to fill out, so I thought I would do a release.
The orange lines represent transport of some sort (car, subway, streetcar, and so on) and the green lines represent walking. I don’t cycle very often in the winter (I know, I’m a fair-weather cyclist), so you won’t see any of those lines just yet. However if I posted a map from the summer, I know it would look completely different.
Here’s a first one showing a regional scale:
Here’s a second one showing the city of Toronto:
And here’s a third one showing mostly downtown:
What’s interesting about these maps is how much you can tell about me and the way I move around the city.
For one, there’s a good chance I ski or snowboard given that I’m driving up to Collingwood, Ontario in the winter. You can also see how heavily dependent I am on the Yonge subway line, which is the thickest orange line in the middle of downtown. It’s also interesting to see how localized I am within my neighborhood (St. Lawrence Market). I walk to get groceries. I walk to the gym. I walk to coffee. And the list goes on.
This is fairly typical for people living in urban neighborhoods, but it would be interesting to see where it applies in the city and where it begins to fall apart. I would also imagine that there’s a correlation to the area’s Walk Score, although this (Moves) might actually be a better measure since it’s usage data.
Either way, imagine what cities could do if they had this sort of data for every resident. They would be able to see precise resident flows and then determine exactly where transit and infrastructure investments should be made instead of politicking to determine where they should be made.
That time is coming.
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