Recently, I had what I think was a very revealing conversation with a hedge-fund portfolio manager. We were discussing the values and virtues of traditional, publicly traded stock and bond investments verses the more private and more privately traded world of alternative investments. The hedge-fund PM really surprised me by stating "as an investor, things that are not publicly traded on a regulated exchange terrify him!" I wondered why this highly sophisticated investment professional (as well as millions of stock and bond investors) mistakenly put so much faith in public markets and the "liquidity" they supposedly provide.Much of my professional life was as an institutional capital markets salesperson - and I have seen liquidity in both the debit and equity markets evaporate. And interestingly, liquidity evaporates at precisely those times of market turbulence and dislocation - where it's needed most!On the equity side of the equation, owning stock in publicly traded companies provides investors with liquid assets (stock) of companies that have complied with a number of regulatory, administrative, accounting and corporate governance bylaws. These higher regulatory and reporting standards were devised to promote corporate transparency and protect investors from fraud. Ultimately however, the public markets and their more stringent reporting standards cannot protect investors from fraud in those instances where it is the clear intent of a company is to perpetrate and hide fraud. Two examples of corporate malfeasance on steroids that rocked both the markets and those investors who thought they were protected by those more rigorous accounting standards are WorldCom, a company plagued by an accounting scandal that created billions in illusory earnings and Enron, another example of systemic fraud and corporate corruption. In both instances the companies filed for bankruptcy. I don't remember market makers providing any liquidity for either name when the stuff hit the fan! In both cases, while senior management of both companies went to jail, investors got caught holding the financial bag.The debt markets remember when in 1998 a firm called Long-Term Capital Management (LTCM) came close to causing the collapse of the global financial system as a result of their highly leveraged risk arbitrage trading strategies. LTCM essentially bet the highly-leveraged ranch on the Russian financial crisis - and was on the wrong side of the trade. The Federal Reserve Bank of New York took the unprecedented step of facilitating a bailout of the private hedge fund, out of fear that a forced liquidation might ravage world markets. Needles to say, during this time of market crisis the markets had seized - there simply was no liquidity in the public markets.Ten years later in 2008 both Bear Sterns (eventually sold to JP Morgan Chase) and Lehman Brothers (filed for the largest bankruptcy in history) collapsed under the weight of sub-prime mortgage exposure and poor management. The demise of both of these firms contributed to greatly exacerbate the global financial crisis. In fact, during October 2008 both firms contributed to the erosion of close to $10 trillion in market capitalization. For those that remember - many of the public markets experienced protracted seizure, and once again there was no liquidity. Massive Federal Reserve intervention was necessary to stabilize a frail market and economy for a number of years.So - the bottom line is that investors need to be extremely prudent about factoring "liquidity" as a value-added into any "public" long term investment asset purchase or strategy. In fact, investors would be best served by treating every investment asset as something they will likely "own" for the long term. And, lastly, to be aware that - in the event of any significant market turmoil, the liquidity you thought your "publicly traded" investments had - won't be there!
