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Doing More With Less – Cliff Asness Illiquidity Discount Article

In this article, Cameron Hight references Cliff Asness’s piece, The Illiquidity Discount. This prompts the question: is it worth not knowing the price of an asset if knowing the price caused you to sell and buy at the exact wrong times?

We’re all familiar with controls that point you towards the right decisions because knowing what to do and doing it are not the same thing. This is why our car dings until we put our seatbelt on, why there are signs reminding your server to wash their hands, and why we hire personal trainers. But what about blinders that help you avoid making bad decisions?

There are studies that show how a store that offers more options can cause customers to buy less because the extra information confuses the buyer's decision and causes them to make no-decision. More germane to our field, I know of funds where the PM restricts themselves and their analyst teams from checking P&L because they’ve attributed it to poor decision making. In this case, less information is more. Would you pay for less information?

In Cliff Asness’s latest piece, The Illiquidity Discount, he discusses that concept in the context of asset pricing. What is it worth to not know the price of an asset if knowing the price caused you to sell and buy at the exact wrong times? Where the artificially smoothed volatility of infrequent pricing was a feature.

The preference for illiquid, infrequently-priced assets that don’t smash you in the face with their volatility (even though it’s really there) could be rational in the same sense. Perhaps a levered small-cap portfolio is a rational investment for long-term investors, but there’s little chance they’d stick with it full-cycle. However, they find PE easy to stick with? It’s not hard for me to imagine these are both true for some (or many).

Finally, to address our main topic, what’s the next implication of extreme illiquidity and pricing opacity being a feature, not a bug? Well, you pay up in price (and give up in expected return) for features you value (not bugs you can’t stand). Attractive smoothness of returns may not come for free. If illiquidity is more positive than negative to many investors, it could easily mean paying a higher price and accepting a somewhat lower return to obtain it. Sounds really counter-intuitive, I know. But it also sounds, to me, pretty plausible.

I appreciate those that question conventional wisdom. I especially appreciate it when it is done in the pursuit of better decision making. There is something beautiful about simple hacks that help us make better decisions (i.e. that’s what we do at Alpha Theory). I think we’ll be spending more time at Alpha Theory in the coming months (years) thinking about if there is the information we present (or maybe the timing of that information) that may lead to sub-optimal decision making and what changes we can make to improve how/when information is delivered.  

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