Why does liquidity matter?

--  |   16/12/2020 Text size  Decrease  Increase   |  
email_fwd
<p><strong>Holly Black:</strong> Welcome to Morningstar. I'm Holly Black, with me is Tom Whitelaw. He's Director of Equity Strategies at Morningstar. Hello.</p> <p><strong>Tom Whitelaw:</strong> Hi. Thanks for having me, Holly.</p> <p><strong>Black:</strong> So, Tom, you've been doing some research into liquidity. I'm going to start with a really obvious question. What is liquidity in investing?</p> <p><strong>Whitelaw:</strong> Yeah. So, it's the ability to sell something in the desired quantity without impacting the price and that price impact is key as anything is liquid as long as you're not bothered about the price that you get. And it's why we talk about discount risk, that is, how likely is it I will have to take a discount on the market value of my investments if I want to sell them.</p> <p><strong>Black:</strong> So, how do you assess that discount risk?</p> <p><strong>Whitelaw:</strong> It's not easy because it's a fluid concept. So, one-minute liquidity is plentiful, and then the next, it's not. So, we look to build up a picture of the fund from all of its individual stocks, and we look at the liquidity of those stocks across a number of ways. So, we look at here and now how liquid is it today and then, also, how liquid has it been at the worst-case scenarios? We look at it on a couple of levels. We look at it on a pro rata style sell-down, which is, selling everything and keeping the portfolio structure exactly the same. So, if I've got 5% BP, 3% Vodafone, when I finish selling, I've got 5% BP, 3% Vodafone and also a waterfall sell-down, which is more like a fire sale sell-down. So, in that scenario, maybe BP and Vodafone are most liquid I end up with zero percent in there and we weight it towards the pro rata because that's what we think is more typical. And the final thing we look at is company ownership, so how big a chunk of individual companies am I owning because if you're owning 5%, 10%, 15%, 20% of individual companies, it's much, much harder to sell those weights.</p> <p><strong>Black:</strong> So, that's all good as an analyst for you. But if I am an individual investor, I buy and hold for the long term, do I still need to worry about liquidity?</p> <p><strong>Whitelaw:</strong> Well, I guess the very worst case scenario you can have of owning in a liquid fund is if it receives redemptions that overwhelm it and the strategy ends up having to gate or close down for a period of time, which means that during that period you can't get your cash back. Thankfully, those instances are rare, and often the impact of running too much money and having a liquid portfolio are more hidden.</p> <p>So, it could be that your fund has to pay more to trade, so the market impact costs are higher because you're a bigger fish in that pond. Or if that's not happening, it could also be because the strategy or the underlying strategy of the fund is changing and there's some style drift in there. So, the manager is actually not trading how they want to. They're kind of maybe holding onto the more illiquid names because they know they can't sell them and selling the more liquid names or vice versa if they get a huge inflow, they can't buy some of those less liquid names that maybe have driven some returns in the past. So, again, that will kind of eat into your future expected return.</p> <p><strong>Black:</strong> So, I was going to ask you for a recent example. I feel we can't discuss liquidity without mentioning Woodford Equity Income.</p> <p><strong>Whitelaw:</strong> Yeah. I mean, that's one of the instances that led to a lot of developments in our model because it was something that we were well aware of, because it kind of just flagged up all the stages that we have. So, on a pro rata level, like it was off the charts, like there was just such an illiquid tale of stocks and holdings within that fund that it was by far the least liquid. From a waterfall standpoint, even in a like a fire sale scenario, it had very little liquidity at the top that it could actually access.</p> <p>So, when it did get a big redemption, it couldn't even meet that redemption without having to dig into that really, really illiquid stuff at the bottom. And then, just from an ownership perspective, they owned kind of almost 20% of a ridiculous amount of companies, which meant that when they came to sell, the market knew they were trying to sell, the market knew they were in a jam. So, the prices that they were being offered to sell those stocks were way, way lower than what the market value would be or had been, and that's what led to some of the huge dislocations in performance you saw with that strategy.</p> <p><strong>Black:</strong> So, how do I avoid that sort of scenario as an investor, how do I assess liquidity?</p> <p><strong>Whitelaw:</strong> Yeah. I mean, read our research. I know that sounds glib, but it's very difficult to find out the liquidity position of a fund at an individual level because each manager does their own analysis. And when we were building this model, we looked at all the regulatory guidance out there and it's very, very broad and it really allows funds to put their fund in as good a light as they want. So, going back to the Woodford scenario, we were talking to Woodford, talking to his risk and compliance teams. They were saying they were fine. They were running their own assessments, which were all in the boundaries of what the regulators say. And they were saying they were fine.</p> <p>We didn't think that they were, and that's why we developed this &ndash; we developed our own model so that we could run it across every strategy and be able to identify the funds that look problematic. And if a fund looks problematic, then our analysts will do a much deeper dive into what's actually going on there and what might be causing it. And then, that ultimately affects the final rating that we give the fund, and you'll also be able to see commentary on that in the reports that we write.</p> <p><strong>Black:</strong> Tom, thank you so much for your time. For Morningstar, I'm Holly Black.</p>

Video Archive...

Why are Coles, Woolworths and JB Hi-Fi tanking? Morningstar explains
19/05/2022  Local investors were spooked after US retail giants Target and Walmart plummeted overnight as rising prices hit margins and inventory.
Dan Kemp's best tip for successful long-term investing: Beware market narratives
19/05/2022  On his recent visit to Australia, Morningstar's global chief investment officer Dan Kemp talks investing narratives, confronting the growing list of reasons to be concerned about markets and sustainable investing.
What's driving the latest big drop in US stocks?
19/05/2022  Worries about inflation’s toll on earnings sparks Wednesday’s 4% plunge, but stocks are now far undervalued.
Value strikes back: How to manage style in your portfolio
18/05/2022  One of the big themes of the year has been the value comeback. What is behind this resurgence after a pretty dismal period, and should your portfolio be tilting in its direction?
Is it time to recession-proof your portfolio?
11/05/2022  Here's what investors who are worried about a recession should consider today.
Morningstar Best Ideas List: An undervalued play in telecom
11/05/2022  Morningstar analysts have identified TPG telecom as the most undervalued telecom stocks in the ASX 200 detailing multiple catalysts for earnings recovery and growth.
Bill Browder: A scared Putin will only escalate the conflict
29/04/2022  Exclusive: Hermitage Capital Management CEO Bill Browder talks Putin, Russia, and the next six months for Ukraine
5 risks facing the US market right now
28/04/2022  Inflation, rising interest rates, geopolitical risks, and other things to keep your eye on.
Buffett and Berkshire in 2022
27/04/2022  Morningstar's analyst talks about the Buffett's recent deals, what the stock is worth, and whether Berkshire will pay a dividend any time soon.
Fair value upgrades on the table: Morningstar resources update
31/03/2022  Supply disruptions following Russia's invasion of Ukraine are forcing analysts to consider the possibility elevated prices persist.
Bank outperformance speaks to positive trajectory: Morningstar
30/03/2022  Rising interest rates, strong economic growth and cheaper valuations are driving banking stocks ahead of the broader market.
Stock vs stock: Netflix and Disney
28/03/2022  Where are entertainment and streaming services headed?
Morningstar Best Ideas List: WiseTech looks cheap after tech selloff
24/03/2022  Problems in global supply chains are an opportunity for WiseTech as its logistics company customers move to replace old software.
First fires, then floods: How listed insurers are weathering extreme events
23/03/2022  Markets focused on floods and bushfires are missing how insurers are cutting costs, doing more digitally and are looking down the barrel of a lift in investment income.
Don't get 'whipsawed' by false promises of peace in Europe
17/03/2022  Morningstar Investment Management's global CIO Dan Kemp explains why well-intentioned investors desperate for peace in Europe are making dangerous market calls
Morningstar Best Ideas List: Kogan to hold own in faceoff with Amazon
15/03/2022  Knowledge of the local market, strong branding and a growing subscription service should see the undervalued retailer retain market share in the rapidly growing online sales category, says Roy Van Keulen.
"There's been a big rotation in markets": Value surges as growth stumbles
08/03/2022  Higher inflation, rising interest rates and booming commodity markets are driving a major rotation away from the post-pandemic winners, says Tim Murphy, Morningstar director of manager selection.
Afterpay's rivals set for battle with rates and regulators
03/03/2022  Regulators are likely to be less lenient now the buy-now-pay-later sector is part of the fabric of Australian payments.
Industry champions on the cheap: Emerging markets at the Morningstar Investment Conference
23/02/2022  Strong commodity prices, cheap valuations and a head start on interest rate hikes means emerging markets are set for strength, says Dr. Joseph Lai of Ox Capital.
The Russia crisis is heating up, but you need to stay cool
23/02/2022  A belligerent speech from a president signalled the start of the latest phase of Russian agression last night, causing markets to wobble and investors to wonder.
Peter Warnes on FAANGs, investing in Asia and bond market smoke signals
15/02/2022  In an extended interview, Morningstar's Peter Warnes discusses the bear market in US technology stocks, interest rates and growth and his approach to investing outside the US and Australia.
Weighing up Magellan Financial Group after Douglass surprise exit
13/02/2022  Morningstar equity analyst Shaun Ler explains why he see valuation upside high for MFG even as shares lose steam.
Year of the Tiger: What's next for Chinese stocks
31/01/2022  The Chinese lunar year is almost over, and what a ride it's been. Morningstar speaks to JPMorgan Asset Management strategist Mike Bell about what's ahead. 
What to do (and not do) in a volatile market
23/01/2022  Christine Benz discusses how investors should handle the turmoil, whatever the life stage.
Bare shelves only a short-term hit to Coles and Woolies
18/01/2022  Empty shelves will negatively impact supermarkets in the second half of fiscal 2022 but the impact on long-term earnings is minimal, says Morningstar analyst Johannes Faul. 
Morningstar's outlook for 2022
17/01/2022  Bank earnings, house prices and China risk: Our experts and analysts discuss what they've got their eyes on in 2022.
Morningstar's Year in Review 2021
24/12/2021  Our experts and analysts weigh in on what mattered for investors last year.
"A bump in the road" as Magellan loses major client
21/12/2021  New products, lower fees and a portfolio of undervalued stocks set to help the fund manager right the ship. 
What role should Bitcoin play in your portfolio?
10/12/2021  And how does it match up against gold?
Years of demand remain for Australian coal producers
10/12/2021  Australian miners to be among the last standing as coal use fades.
Year-end portfolio rebalancing: What you need to know
08/12/2021  Rebalancing your portfolio is one of those beneficial habits that’s easy to let slide. But year-end is an ideal time to check how your portfolio is tracking against your target asset allocation. 
3 quality names from Stewart Investors
03/12/2021  The gold-rated fund manager shares three ideas with long-term potential.
Silver linings for investors amid the climate stalemate: COP26 debrief
01/12/2021  Long-term investor sees opportunities where businesses are moving towards a zero-carbon future faster than governments.
6 qualities of great index funds
30/11/2021  To understand your fund, get to know its underlying index.
Lazard's 3 top picks for the energy transition
29/11/2021  These companies are set to profit from the move to clean energy, says Lazard.
An uneven energy transition leaves room for coal and gas: COP26 debrief
24/11/2021  The results of the COP26 climate summit suggest coal demand is likely to persist for longer than expected.
What rising inflation means for Australian investors
17/11/2021  And how investors can protect their portfolios.
6 inflation-tough stocks for global investors
08/11/2021  Morningstar thinks these moaty companies will remain resilient in the face of inflation and ongoing supply chain challenges.
Risk/reward equation still looks good at Westpac
05/11/2021  Morningstar maintains fair value despite a fall in margins and slower progress on cost reductions.
These aren't the Bitcoin ETFs you're looking for
19/10/2021  These new US-listed exchange-traded funds will invest in bitcoin futures, not bitcoin itself.
ESG funds don't underperform - but nor do they outperform
15/10/2021  The ESG outperformance narrative is flawed, new research shows.
Building investment portfolios in a low interest rate environment
06/10/2021  Investors may need to hold more growth assets over the coming years, says Morningstar's Jody Fitzgerald.
Covid impacts still being felt in real estate and tech: Reporting season roundup
01/10/2021  And how G8 Education and Link Administration are positioned for long-term success.
Look to Credit Corp for a leading indicator of economic health: Reporting season roundup
30/09/2021  What Reporting Season August 2021 told investors about the health of the financials sector.
Cause for optimism at a2 Milk and Invocare: Reporting season roundup
28/09/2021  a2 milk is an opportunity to be greedy when others are fearful.
Post-covid normalisation is underway in healthcare: Reporting season roundup
23/09/2021  Covid's winners and losers are returning to their prior trajectories. 
One of the most underappreciated dangers of investing
21/09/2021  Sequence-of-returns risk matters for both retirees and savers. Here's why. 
REITs recover pandemic losses: Reporting season roundup
20/09/2021  Analysts expect the sector to recover to pre-Covid trading levels once borders reopen.
Australian banks face margin pressure amid low rates: Reporting season roundup
15/09/2021  Rising customer deposits and access to cheap funding helped Australia's banks stave off net interest margin pressure, but analysts see warning signs.
Greenwashing explained
14/09/2021  Morningstar's Hortense Bioy on how to spot greenwashing and how to avoid it.
Earnings down as private money circles infrastructure: Reporting season roundup
13/09/2021  Utilities and infrastructure names battle the impact of covid as private equity and pension funds circle. 
Frenzy of mergers in energy: Reporting season roundup
10/09/2021  Hydrocarbons poised for a comeback.
TPG tipped to recover as mobile competition eases: Reporting season roundup
09/09/2021  Providers have lifted prices after years of a debilitating chase for subscribers at all costs , says Morningstar's Brian Han.
Short-sellers bet against ARK Innovation ETF
08/09/2021  What shorting ETFs means for long-term investors.
Surging lumber prices were no match for Brambles: Reporting season roundup
07/09/2021  Morningstar senior analyst Grant Slade says Brambles secular growth trend is intact despite nearterm headwinds. He discusses results from the building and construction materials sector.
Miners soar thanks to iron ore: Reporting season roundup
03/09/2021  Miners bask in the glow of iron ore prices while bargains remain in coal.
BHP-Woodside merger is mutually beneficial
23/08/2021  Post-merger Woodside would be well positioned to deliver on the value we've seen for a long time, say Morningstar analysts.
Investors are getting serious about sustainability
16/08/2021  But the sector lacks uniformity, says Morningstar's Christopher Franz. 
Long term outlook for AGL is positive
11/08/2021  Higher wholesale electricity prices bode well for AGL, according to Morningstar senior equities analyst Adrian Atkins.
How you can hedge your portfolio against inflation
11/08/2021  Morningstar FundInvestor editor Russ Kinnel describes some direct and indirect hedges for inflation protection.
The iron ore party can't last: Morningstar
10/08/2021  Copper and iron ore have benefited materially from China’s stimulus and the developed world recovery. But Morningstar analyst Mat Hodge see these benefit as transitory.
What the Afterpay acquisition means for investors: Morningstar Minute
05/08/2021  We believe the transaction has a high chance of succeeding.
Cannabis' federal legal status is not a total buzzkill
03/08/2021  The industry still has significant growth potential.
Stock of the week: Toyota
03/08/2021  Is one of the biggest sponsors of the Olympics positioned for an all-electric future?
2 listed microcap names to consider
23/07/2021  Morningstar's Lex Hall talks micro-cap stock picks with Carlos Gil, chief investment officer at Microequities Asset Management.
Big returns, big risks: Making money with microcaps
22/07/2021  Mornngstar's Lex Hall catches up with Carlos Gil, chief investment officer at Microequities Asset Management.
3 small-caps with Dawn Kanelleas
21/07/2021  The head of Australian small and mid-cap stocks at First Sentier Investors has her eye on ARB, Breville and IDP Education.
Forecast 2021–2022: A correction could be around the corner
20/07/2021  The strong performances of global stock markets in 2020–21 are unlikely to be repeated in the coming year says Morningstar's Peter Warnes.
'Overvalued' warnings grow as ASX 200 hits new high
12/07/2021  Morningstar equity analysts warn that equities remain overvalued despite Australia's strong economic recovery.
What to know about private equity
08/07/2021  Private equity is an exciting area for investors, with lots of hotly-tipped stocks. But there are risks to be aware of, says Pitchbook analyst Dylan Cox.
Lazard's 3 top picks for the global covid recovery
08/07/2021  Warryn Robertson is looking at French infrastructure, retail pharmacy and tax services.
Aussie banks $34bn surplus points to more shareholder dividends, buybacks
06/07/2021  Australia's largest banks have excess capital because they cut dividends, were more conservative on lending, divested assets and raised equity last year. Morningstar's Nathan Zaia thinks most of it should be returned to shareholders.
Weighing up the PEXA IPO
02/07/2021  PEXA burst onto the ASX this week in the biggest float since 2019. Morningstar's Gareth James gives his take on the company's future growth prospects.
Can the iron ore price keep rising?
30/06/2021  Iron ore prices have  been on a tear, boosting the profits of Australia's top miners.  How did we get here and is the only way up? Lex Hall sits down with Morningstar's Mat Hodge.
2 new stocks to watch
28/06/2021  Morningstar has recently initiated coverage of a food delivery app and a consumer finance product. 
'Strongest earnings season I've ever seen'
24/06/2021  Meeting the deluge of demand is the biggest task for US companies, says Bell Asset Management's Ned Bell.
Biotech beyond covid
22/06/2021  Are there still opportunities in the biotech sector now the covid-19 vaccine roll out is underway? We ask International Biotechnology Trust manager Ailsa Craig
Alibaba is still deeply undervalued
21/06/2021  Morningstar's director of Asia equity research is confident the e-commerce giant will bounce back.
Weighing up the Endeavour IPO
18/06/2021  A wide moat and attractive dividend potential are among the key takeaways of Woolworth's decision to demerge from the liquor and hospitality group.
'Then we got hit with the equivalent of a war'
15/06/2021  Lazard Asset Management's Warryn Robertson explains how companies in the Global Equity Franchise fund have adjusted to covid, and assesses the threat of rising inflation.
Understanding Magellan's active ETF strategy
11/06/2021  Magellan's Craig Wright tells Emma Rapaport why it is leading the charge in the active ETF arena and how its global equity product works.
3 off-the-radar small caps
10/06/2021  Callum Burns of ICE Investors explains his conviction in pharmaceutical distributor Ebos, PSC Insurance Group, and elite sports analytics provider Catapult.
Small cap gems and how to find them
09/06/2021  Callum Burns explains how ICE Investors identifies companies with original products and sticky customer bases.
Stock of the Week: Salesforce.com
08/06/2021  They’re building an empire.
3 oil stocks we still like
07/06/2021  A year ago the oil price went negative. How have oil giants handled the past 12 months and what's the outlook from here? Morningstar analyst Allen Good explains.
Considering crypto? Here's what to think about
04/06/2021  As the investment world goes crazy for crypto, Morningstar Investment Management's Dan Kemp explains what to consider before putting it in your portfolio
Why we like Wizz Air
03/06/2021  The airline sector is set to recover as international travel resumes. Morningstar analysts think Wizz Air offer the best opportunity among low-cost carriers.
3 global infrastructure picks
28/05/2021  4D Infrastructure's Sarah Shaw outlines the investment case for Spanish multinationals Cellnex, and Iberdrola, and the potential of Mexican airports.
Are crypto ETFs coming?
28/05/2021  The SEC continues to sort out its regulatory concerns.
Stock of the Week: Apple
27/05/2021  We’re raising our fair value as sales hit new highs—but investors need to put it in perspective, says Andrew Willis.
Opportunities in global infrastructure
25/05/2021  Covid-19 has enhanced rather than impeded the future for global infrastructure, says Sarah Shaw of 4D Infrastructure.
Tribeca's eye for Domain
24/05/2021  Tribeca's Jun Bei Liu also explains why she sees opportunity in sleep apnea specialist ResMed as well as Treasury Wine Estates.
Stocks for emerging markets
19/05/2021  American Century Investment's Patricia Ribeiro sees growth in Chinese battery technology, biologics, and building materials in Latin America.
2 stocks for the rise of the robots
18/05/2021  Robotics is a fast-growing area of tech, creating opportunities in medical, logistics and life sciences sectors and much more.
Square: Stock of the week
18/05/2021  Square's Bitcoin purchase is more marketing than operations
Tesla: Stock of the week
10/05/2021  If Elon Musk ends up delivering, we might need to raise our fair value to US$1500 a share.
Why Tribeca's so upbeat on stocks
07/05/2021  Banks and resources are poised to deliver dividends, and Treasury Wine Estates and BNPL are worth a look, says Jun Bei Liu of Tribeca's Alpha Plus long/short fund.
Looking for value in emerging markets
05/05/2021  Digital banking, ecommerce and 5G are among the key trends set for rapid growth, says Patricia Ribeiro of American Century Investments.
Cash slashed, Aussie equities up: Why Morningstar updates Model ETF portfolios
04/05/2021  Analysts have made changes to the fixed interest, property, cash and equity allocations of Morningstar's Model ETF Portfolios to take advantage of the current market environment. They've also refreshed some of the funds in the portfolio.
Investing basics: Explaining the disconnect between the stock market and the economy
30/04/2021  The stock market and the economy are not the same. Here's why.