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An investment strategy with a difference: If you want to beat the market, buy illiquid stocks

by , 24 July 2014

There are certain styles of investing that beat the market over the long-term. The three main ones are: Buy cheap shares, buy penny stocks and buy shares that are in a rising trend.

But there's another investing style that beats the market. That is buy illiquid stocks. This goes against investment ‘rules,' but illiquid stocks appear to be market beaters.

Let's take a closer look…

What is liquidity?

Liquidity simply describes how easy it is to buy and sell an asset. For example, shares in Anglo American are far more liquid than a property, John Stepek in Money Morning UK explains. You’d expect to sell your shares far quicker than sell a house.

When assets are illiquid there are usually higher selling costs attached. Think about all the fees and costs you have to pay when you sell a property. Selling a liquid share is cheaper, and the spread between the buy and sell price is small.

On the Johannesburg Stock Exchange, the largest stocks tend to be the most liquid ones. Smaller, lesser known entities can see very little buying and selling activity, and that makes them illiquid.

The case for buying illiquid stocks

The Financial Times’ John Authers looked at a piece of work by Roger Ibbotson of Yale University. He’s a renowned finance researcher.

Ibbotson’s research shows that illiquid stocks outperform liquid stocks over the long-term. He looked at the performance of 3,500 shares on the US stock market. And ranked them according to their daily traded value or liquidity).

On average, the least liquid shares gave an annual return of more than 16% between 1972 and 2011. That’s against the most liquid shares, which returned 11%.

Yes the costs are higher trading illiquid stocks as the spread is wider. And then there’s the issue of selling the shares once you own them.

But if you fancy a trading strategy that appears to yield good results, look to illiquid stocks. Just bear in mind the higher risk involved with investing in them. But the risk might just pay off.

So there you have it, if you want to beat the market buy illiquid stocks.

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An investment strategy with a difference: If you want to beat the market, buy illiquid stocks
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