#303: Managing liquidity risk

"Brought to you by Absa ETFs"

Simon Shares

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• Steinhoff (JSE code: SNH) now under 300c at 226c, well below late 1998 listing - all-time-low and the bad news just continues to drip out.
• ETFs and the cost of the spread.
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Liquidity risk

Homechoice (JSE code: HIL) keeps on putting out great results and cash generation but has almost zero liquidity (30 trades since 6 March and currently no offers to sell on market with last trade at 4700c and buyers at 1226c! This makes it uninvestable in my world as we'd essentially be buying into a quasi private equity arrangement as exiting would be almost (absolutely) impossible. But they did announce in the latest results they plan to improve liquidity and I'll keep an eye on this.

In the excitement of finding a great share we'll often over look the liquidity issue but I remember getting very badly caught in an illiquid stock way back in the day and while I could have held on I panicked and exited at a nasty loss.

Liquidity is not just the spread, which is a cost. But also the amount of volume being traded and we also have to remember that liquidity can disappear very quickly.

So two things to look for.

1. What size spread are you having to cross to buy. A 1100c / 1500c is 400c and over 30%. I want spreads as tight as possible and certainly not more than 5% at worse.
2. I want average daily value traded to be at least 30x the size I am buying so even if it dries up I can still get out without too much pain.

For traders liquidity even more important an I want spreads less than 1% and value traded 100x my trade size. This is because I want to have no impact when buying or selling (or as small as possible because there is never no impact) and I need the liquidity for very quick and efficient exits.

Last important point. Liquidity in terms of volume is not an issue for ETFs as the market maker ensures that they will have a bid and offer either side of fair value at all times. So while the ETF may not be trading it has the capacity to trade in larger volumes if required.

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