Valuation of illiquid assets » ICMA (2024)

AMIC Valuation of assets working group

The ICMA Asset Management and Investors Council has been debating the topic of valuation of assets for some time on the basis of different presentations by leading academics and practitioner. The working group was set up in June 2010 and is supported by KMPG.

In July 2010, the IOSCO Technical Committee’s Standing Committee on the regulation of market intermediaries published a consultation report on intermediary internal controls associated with price verification of structured finance products and regulatory approaches to liquidity risk management.

The report sets out the results of surveys conducted around 2006 with firms and regulators on the internal controls and policies. The surveys were conducted prior to the crisis and the report makes recommendations to regulators in two areas in light of the crisis.

The AMIC’s response focuses on valuation governance arrangements for funds, particularly in the case of valuation of complex products such as ABS and structured products. The response recommends that a fund has a formalised Valuation Governance Arrangements. This would include a formal Valuation Policy detailing Valuation practices, procedures and controls. Valuations could be out-sourced to a third party service or there may be a Valuation/Independent Price Verification (IPV) unit internal to the fund or a combination of the two. If Valuations are outsourced to a third party, the Board of the asset management institution is responsible for making sure the policy is followed. In all cases, the Board is ultimately responsible for ensuring the accuracy of Valuations.

Valuation of illiquid assets » ICMA (2024)

FAQs

How to value illiquid stocks? ›

Illiquidity discount on value: You should reduce the value of an asset by the expected cost of trading that asset over its lifetime. Risk-Return model: Some illiquidity risk is systematic. In other words, the illiquidity increases when the market is down.

How are illiquid bonds valued? ›

Matrix pricing is used to value illiquid bonds by using prices and yields on comparable securities having the same or similar credit risk, coupon rate, and maturity. The periodicity of an annual interest rate is the number of periods in the year.

What is the rule of thumb for illiquidity discount? ›

The size of the illiquidity discount is largely up for debate, but for most private companies, the discount tends to range between 20-30% of the estimated value as a general rule of thumb.

How to estimate illiquidity discount? ›

Common methods to measure illiquidity include market-based methods, which utilize observable market data such as bid-ask spreads and trading volume, model-based methods like option pricing models and stochastic discount factor models, and survey-based methods that use surveys or interviews with market participants.

What is the ratio of illiquid assets to total assets? ›

The ratio of Illiquid Assets to Total Assets should be at least 25%. In terms of Shariah, illiquid assets are all those assets that are not cash or cash equivalents.

What are two examples of illiquid 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.

What happens when a stock is illiquid? ›

Illiquid stocks are high-risk stocks that cannot be easily and readily sold or exchanged for cash without a substantial loss in value, even using a stock trading app. They are difficult to sell as a result of the cost, lack of ready buyers, low trading activity, and other such factors.

Should you invest in an illiquid stock? ›

Although it might be possible to earn liquidity premiums, one should also take into account the risk characteristics of the investments involved. Investing in illiquid assets can be risky as illiquidity is usually most prevalent when liquidity is most needed.

How much should the illiquidity premium be? ›

Over the period 2004 to 2022, private equity and private credit outperformed their respective public market benchmarks by roughly 500 basis points per year. Over different periods, these indices sometimes yield higher or lower excess returns, but 3% to 5% is the typical range. That's the historical illiquidity premium.

What is the 15% liquidity rule? ›

Liquidity Management Rules: Current and Proposed

[1] Critically, the rule limits the portion of a fund's assets than it can hold in its illiquid bucket to 15%.

What is the 25% stock rule? ›

Here's a specific rule to help boost your prospects for long-term stock investing success: Once your stock has broken out, take most of your profits when they reach 20% to 25%. If market conditions are choppy and decent gains are hard to come by, then you could exit the entire position.

Why illiquidity is a major drawback for real estate investment? ›

Illiquid real estate investments pose risks such as difficulty in selling quickly, limited diversification opportunities, difficulties in obtaining financing, and lower liquidity premium.

How to quantify illiquidity premium? ›

For example, you can use the difference between the yields of corporate bonds and treasury bonds, or the difference between the returns of private equity funds and public equity indices, as proxies for the illiquidity risk premium.

What is the difference between liquidity discount and illiquidity discount? ›

Let's agree on the general terminology. Illiquidity discount: it is the discount that an owner of an asset needs to take below valuation to liquefy his asset. A liquidity premium is a premium an owner of an asset can get on top of the valuation.

How is illiquidity premium calculated? ›

The simplest way to calculate a liquidity premium is to compare similar investments, one of which is liquid and one of which is not. For example, you could compare two bonds from companies with similar credit ratings.

What can you do with illiquid stocks? ›

Make sure to analyze the market thoroughly while keeping these pointers in mind. Illiquid stocks have negligible trading volumes and cannot be sold immediately or easily. These assets give a higher yield but at the same time, are harder to sell as compared to liquid assets.

How do you value an undervalued stock? ›

Price-to-book ratio (P/B)

P/B ratio is used to assess the current market price against the company's book value (assets minus liabilities, divided by number of shares issued). To calculate it, divide the market price per share by the book value per share. A stock could be undervalued if the P/B ratio is lower than 1.

What is the simplest way to value a stock? ›

The most common way to value a stock is to compute the company's price-to-earnings (P/E) ratio. The P/E ratio equals the company's stock price divided by its most recently reported earnings per share (EPS). A low P/E ratio implies that an investor buying the stock is receiving an attractive amount of value.

What is the 15% illiquid investment limit? ›

Liquidity Management Rules: Current and Proposed

[1] Critically, the rule limits the portion of a fund's assets than it can hold in its illiquid bucket to 15%.

References

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