Illiquid Assets: Overview, Risk and Examples (2024)

What Is Illiquid?

Illiquid refers to the state of a stock, bond, or other assets that cannot easily and readily be sold or exchanged for cash without a substantial loss in value. Illiquid assets may be hard to sell quickly because there is low trading activity or interest in the issue, indicated by a lack of ready and willing investors or speculators to purchase or sell the asset. As a result, illiquid assets tend to have lower trading volume, wider bid-ask spreads, and greater price volatility.

Illiquidity is the opposite of liquidity.

  • Illiquidity occurs when a security or other asset that cannot easily and quickly be sold or exchanged for cash without a substantial loss in value.
  • Illiquid assets may be hard to sell quickly because of a lack of ready and willing investors or speculators to purchase the asset, whereas actively traded securities will tend to be more liquid.
  • Illiquid assets tend to have wider bid-ask spreads, greater volatility and, as a result, higher risk for investors.

Illiquidity Explained

Regarding illiquid assets, the lack of ready buyers also leads to larger discrepancies between the asking price, set by the seller, and the bid price, submitted by the buyer. This difference leads to much larger bid-ask spreads than would be found in an orderly market with daily trading activity. The lack of depth of the market (DOM), or ready buyers, can cause holders of illiquid assets to experience losses, especially when the investor is looking to sell quickly.

Illiquidity in the context of a business refers to a company thatdoes not have the cash flows necessary to make its required debt payments, although it does not mean the company is without assets. Capital assets, including real estate and production equipment, often have value but are not easily sold when cash is required. The sale of illiquid assets is not a company’s core business. They generally include any property owned by the company that is outside of the products produced for sale. In times of crisis, a company may need to liquidate these assets to avoid bankruptcy, and if this happens quickly, it can dispose of assets at prices far below an orderly fair market price, sometimes known as a fire sale.

Additionally, a company may become illiquid if it is unable to obtain the cash necessary to meet debt obligations.

Examples of Illiquid and Liquid Assets

Some examples of inherently illiquid assets include houses and other real estate, cars, antiques, private company interests and some types of debt instruments. Certain collectibles and art pieces are often illiquid assets as well.

Stocks that trade on over-the-counter (OTC) markets are also often less liquid than those listed on robust exchanges. Though these assets may have inherent value, the marketplace in which they are sold often has few buyers in comparison to those interested in the purchase of more liquid assets.

On the other end of the spectrum, most listed securities traded at major exchanges, such as stocks, ETFs, mutual funds, bonds, and listed commodities,are very liquidand can be sold almost instantaneously during regular market hours at fair market price. Additionally, precious metals, such as gold and silver, are often fairly liquid. Trading after normal business hours can also result in illiquidity because many market participants are not active in the market at those times.

An asset's liquidity may change over time, depending on outside market influences. This change in price is especially true for collectibles, as an item's popularity in the consumer market may fluctuate dramatically, leading to highly volatile pricing.

Illiquidity and Increased Risk

Illiquid securities carry higher risks than liquid ones, known as liquidity risk, which becomes especially true during times of market turmoil when the ratio of buyers to sellers is thrown out of balance. During these times, holders of illiquid securities may find themselves unable to unload them at all, or unable to do so without losing money.

Illiquid securities also may demand a liquidity premium added to their price to compensate for the fact that they may difficult to dispose of later on. During times of financial panic, markets and credit facilities may seize up, causing a liquidity crisis, when sellers of even marketable securities find it challengingto find eager buyers at fair prices.

Real World Example

Illiquidity can leave both companies and individuals unable to generate enough cash to pay their debts. For example, The Economic Times reported that Jet Airways had delayed repayment of overseas debt for the fourth time “in recent months” due to a corporate illiquidity crisis that left the company struggling to access liquid funds. As a result, Jet Airways not only had to ground more than 80 planes, but it also put together a resolution plan that called for the resignation of its chair, Naresh Goyal, and the board voting to allow lenders to take control of the airline.

Illiquid Assets: Overview, Risk and Examples (2024)

FAQs

Illiquid Assets: Overview, Risk and Examples? ›

These are assets that cannot be quickly sold, that are difficult to sell or that cannot be sold without incurring a significant loss in value. The most common example of an illiquid asset is real estate. While a piece of land has significant value, converting that value into cash through a sale takes time.

What are the risks of illiquid assets? ›

Illiquid assets may be hard to sell quickly because of a lack of ready and willing investors or speculators to purchase the asset, whereas actively traded securities will tend to be more liquid. Illiquid assets tend to have wider bid-ask spreads, greater volatility and, as a result, higher risk for investors.

What are examples of illiquid assets? ›

Examples of illiquid assets: Some assets are just inherently illiquid: real estate, works of art, private company interests and certain types of debt instruments.

What happens if a company is illiquid? ›

A company that becomes illiquid may not be able to pay its creditors or suppliers on a timely basis. Unless the illiquid condition of the business is remedied in fairly short order, its financial troubles may eventually lead to bankruptcy or the need for a costly financial reorganization.

What are the types of illiquid securities? ›

Some examples of illiquid assets include houses and other real estate, cars, collectibles, private company interests, and some forms of debt instruments.

What are examples of liquidity risks? ›

An example of liquidity risk would be when a company has assets in excess of its debts but cannot easily convert those assets to cash and cannot pay its debts because it does not have sufficient current assets. Another example would be when an asset is illiquid and must be sold at a price below the market price.

What is considered an illiquid asset? ›

An illiquid or non-liquid asset is one that you can't sell easily. Real estate, works of art and antiques can be difficult to sell for many reasons: often it's not easy to find a buyer, the asset is very expensive or the process of selling the asset can take a long time.

Why do people invest in illiquid assets? ›

Illiquid assets provide portfolio diversification benefits with a relatively low correlation to the stock market. Typically, these assets remain more stable over time, as their pricing is not adjusted on a regular basis like publicly traded stocks and securities.

What is an example of a liquid and illiquid asset? ›

We use the term “liquidity” to describe where an asset falls on a spectrum ranging from cash (the most liquid asset because you can use it to buy anything) to items like art, jewelry, and collectibles that are characteristically illiquid. The liquidity of an asset can change depending on trends or economic factors.

Is a 401k an illiquid asset? ›

For a working employee, a 401(k) does not qualify as a liquid asset, since its purpose is to accumulate retirement savings. If you are younger than 59 ½, you will owe a 10% penalty on the amount you withdraw. The penalty imposed on premature 401(k) withdrawals makes a 401(k) a non-liquid asset.

Can illiquidity lead to insolvency? ›

Illiquidity will not automatically lead to a business becoming insolvent; however, when not remedied immediately, illiquidity may result in insolvency. The main solution for illiquidity is to increase a business's net income and cash flow.

What is an example of an illiquid business? ›

The most widely known illiquid investments are probably hedge funds, real estate, private equity and infrastructure. However, examples can also be found in more liquid markets.

How do you know if a company is illiquid? ›

A wide bid-ask spread may indicate that there is a lack of liquidity in the market for a particular stock, as there may not be enough buyers and sellers to bring the bid and ask prices closer together. Lack of recent price movement or volatility can also be a sign of an illiquid stock.

Is a mortgage an illiquid asset? ›

However, a mortgage is a relatively illiquid asset for the bank. The repayment of principal and interest occurs over long periods of time, often 15 to 30 years for residential mortgages.

What is an example of an illiquid stock? ›

It is not easy to sell them for cash as they are expensive to maintain and tend to be volatile. Illiquid assets include real estate like houses, commercial spaces or industrial sites, cars, antiques, private company interests, and debt instruments.

What are illiquid alternative assets? ›

An illiquid alternative investment is an alternative investment like fine art or real estate that cannot be bought and sold frequently. But, illiquid alternative assets offer relatively higher returns than traditional assets.

What is the disadvantage of liquid financial assets? ›

The investment outlook for such funds is typically short-term — often 91 days or less. Since the investment duration is so short, liquid funds rarely deliver significant capital gains. This may be a disadvantage of liquid funds for investors who want to create long-term wealth.

What is the downside liquidity risk? ›

Downside liquidity risk is measured by higher moment of liquidity-liquidity skewness. Downside liquidity risk premium significantly exists in Chinese stock market. Downside liquidity risk premium is persistent within the future one year.

Why is it important to hold some liquid and some illiquid assets? ›

Liquid assets may offer investors the flexibility to reposition, while illiquid assets may offer diversification from the public markets and certain avoidance of volatility.

Is it better to have liquid or illiquid assets? ›

Illiquid assets usually offer bigger returns than liquid assets. Their growth is slow and steady, so while they're not guaranteed, they are more likely to have a net gain if you hold them long enough. They're also less reactive to economic changes.

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