Several years ago, I was approached with a ‘niche’ investment opportunity promising great returns. The sales pitch was assembled and presented well, but something didn’t sit right with me – I wasn’t sure how I’d be able to get my money back if I needed it. At the time, a friend of mine was examining the same opportunity; he pursued it and I didn’t. Several years later, the investment wasn’t performing as well as he’d expected and he wanted to get his money back, but when he approached the broker he was told that his shares were an illiquid investment and couldn’t be sold. He was frustrated, angry and came to me to ask whether I thought he’d been scammed.
My friend wasn’t alone in suffering that scenario; every year, countless retail investors go through the same experience, often with devastating consequences. They’re told that private investments are less volatile than public shares, more predictable and have great potential for yielding above-market returns. But if they’re such great opportunities, why can’t they get their capital back when they need it?
Why a niche investment is often an illiquid investment
My friend had invested in a shipping related investment opportunity; containers, if I remember correctly. A fund had raised capital by selling shares to investors like him, then used the money to buy hundreds of shipping containers – the big metal boxes that transport goods and materials around the world. When demand for global shipping was high, companies had a need for the containers, but if demand slowed down, there would be a glut of those containers on the market.
When that slowdown came, the company that had bought the containers could no longer rent them out – the demand had dried up and the returns paid to the investors with it. Considering that he was no longer getting an income from the investment, my friend tried to sell his shares, but the company couldn’t oblige. With all of its cash invested in the physical containers, there wasn’t enough left to accommodate the significant redemption requests triggered by the sudden lack of return. Although the money wasn’t lost, it was tied up in an asset the company couldn’t easily liquidate – after all, companies didn’t have a need for the containers they had, so why would they buy more?
Because the investment wasn’t traded on a public market, there was no way for my friend to sell his shares – he couldn’t log into some online brokerage and click the ‘sell’ button. In addition to this, my friend wasn’t able to sell the shares to a friend as they weren’t a licensed securities trader – their only option was to resell through the company.
What happened to the illiquid investment?
Ultimately, I referred my friend back to the terms they’d agreed to when they funded the investment. This document outlined the different options they had for getting their capital back.
Although the company said redemptions were available at any time, these were subject to the ability of the company to fund the redemption through the sale of the containers, at a price which ensured no loss would be incurred. If market conditions didn’t allow for this, the company would be unable to honour the redemption request, and the market would be reappraised after 90 days.
In this case, that meant that my friend was left with an investment which generated no income and which couldn’t be liquidated. Whilst this gave him little solace, I pointed out that he’d signed the terms originally and that he’d received a good return for many years – he shouldn’t feel too bad about a year or two of lacklustre returns. The market would eventually pick up and he’d be able to get his capital back. He just had to be patient.
This anecdote certainly isn’t unique to my friend. A know of at least three retail investors who have made investments without even reading offering materials, so presumably are unaware of restriction on their ability to retrieve their capital. Tempted by the promise of ‘above market’ returns, they assume that the good times will never end, and fail to manage the risk presented by an illiquid investment.
Although there is a broad movement towards making offering material more understandable, it is still the case the sophisticated investors, lawyers and accountants will have an advantage in understanding the hundreds of pages of complex terminology, advanced business structures and lengthy paragraphs present in much of this material.
Ultimately, if you don’t have complete clarity over what you’re investing in and you aren’t totally happy with the investment, don’t proceed! Offering documents often hand few rights to investors, end up padded with extra fees and conflicts of interest which would make your eyes water if you had them highlighted through obvious language.
Niche investments and off-market investments can provide fantastic opportunities for investors seeking income-generating assets, but don’t bank on being able to withdraw your money easily.