Alternative Access June 2019

Alternative Access June 2019

DEFINING LIQUIDITY An Expensive Convenience That Punished Emotion-Based Decision-Making

Liquidity, in any market, can be defined as the extent to which such a market, be it stock, real estate, oil, real estate investment trusts (REITs), mutual funds, exchange-traded funds (ETFs), or gas markets, allows assets to be bought and sold quickly at stable prices. Technically, one thing liquidity does for the society is that it keeps the industry spinning. Despite the myriad myths surrounding its source, impacts, and efficiency, liquidity is real. It is an engineered financial product that serves as a streamlining tool for the process of buying and selling assets in a specific market. convenience for traders, in the sense that they can buy and sell an asset at any time in any proportion or size. If you need some money, as a trader, liquidity may work for you; it may help you lock in some profits in a very dynamic market where money changes hands at the speed of light! Unfortunately, this convenience comes at a price. Here are five reasons why liquidity is more expensive than you think. 1. Swift Transfer of Risks When a trader buys or sells an asset, there is an instant transfer of risk between the buyer and seller. What are the underlying factors behind such a buy? Is it because the companywith the stock is performing optimally? Are its products or services par excellence? And does the stock have a value that’s worth the money spent on buying it? Generally, people buy assets because the liquidity provides a chance for them to do so. But when the value of the asset suddenly drops, 5 ReasonsWhy Liquidity Is Expensive Liquidity provides some measure of

since it was inflated to begin with, the broker and the seller/buyer are protected against the person initiating the trade based on T-plus-3 liquidity. The seller/buyer has up to three days to fulfill the conditions of the transaction. If you are selling, you must make sure the buyer gets the asset and the broker’s fees are paid within three days. 2. Brokers’ Paradise Investors are drawn into the market by liquidity, but their demand to be able to get their money out is misplaced, at least for some (large) percentage of their portfolio. Surprisingly, the liquidity favors brokers. The larger the number of participants in the market, the higher the amount of fees they can collect from traders’ activities. Whose paradise does liquidity create? Brokers’ paradise, of course. 3. Volatility A highly liquid market is prone to uncontrollable volatility. And the commission structure facilitates volatility, meaning your broker gets paid when you sell. In other words, liquidity is not built for traders to actualize their financial liberty, but it is made to worship and sacrifice their sweat on the liquidity altar. 4. Anti-Inflationary Inflation hurts liquid assets. When there is inflation, they become a little more expensive than they used to be. Since most countries, including the U.S., have inflationary issues, it is right to say that liquid assets are unstable, unpredictable, and a disaster waiting to happen. abnormal. The amount of greed, carelessness and thoughtlessness, exposure to dangerous risk, and speculation displayed by traders often drives the market crazy — sometimes to a breaking point. Liquid markets crash every now and then, and theywill continue to follow the same pattern because of unmanageable volatility and unsustainable risk level in the liquid market. Liquidity’s Dilemma Here is a perennial dilemma: Liquidity only works when capital demands are idiosyncratic, meaning when market participants have different needs, it creates a complex and robust financial ecosystem. 5. Liquid Markets Are Crashing Liquid markets are usually volatile and

If we all have the same needs in the same time horizon, correlations go to one. This means returns for the individual are the same as the whole market. In reality, all assets require both a buyer and a seller to become liquid. If we all buy or sell at the same time, there wouldn’t be any liquidity. And if we, so to say, are desirous of the same thing at the same time, a competition will be created. This may increase the cost of executing trades or even cause a sudden crash in the market. What traders give up when they embrace liquidity is transparency and the possibility of trading in a less-chaotic and normal market, if there’s anything like a normal market. Emotion-Based Decisions: HowLiquidity Punishes Traders Markets are dynamic, and traders are compelled to live with volatility, no matter how scary and sometimes counterproductive it may be. The unpredictability in the market often makes traders vacillate between fear and complacency. When trading, everyone has a stop, a point when the value of the asset (e.g., stock) gets so low that they have to sell. Not everyone has the stop in mind — in fact, most people don’t — but everyone has it in their body. However, people can derive confidence from feedback loops, watching other people, or receiving recognition from fellow traders. Liquidity creates an atmosphere where greed and self-interest underlies it all. Traders, more often than not, are caught making adrenaline- fueled decisions or trade moves. When they are on the other side of the trend, when the liquidity is pushing the trade against them, some traders end up being punished severely by liquidity. They may lose a chunk of their portfolios in addition to paying humongous brokers’ fees. When buying or selling an asset, a liquidity trader may overlook the necessary steps in safe trading, such as paying undivided to analyses (technical or fundamental) and maintaining a steadfast trading psychology. Liquidity is a cruel punisher of thoughtless traders who do not do their homework before jumping into the markets. They may lose part — or all — of their trading capital.

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investment. Open-ended funds raise money by selling shares of the fund to the public. The fund manager earns income by collecting fees from the purchase of shares or a percentage of the overall lump sum. You could also collect commission based on your performance with your investments. Open-ended funds are consistently and continuously managed. You source, purchase, and manage the real estate investments and are responsible for the financial outcome of the fund. Sometimes when an open-ended fund has grown too large, a fund manager will decide to close the fund to new investors. On occasion, they may even close new investments to existing investors. This only happens if the fund performs extremely well and there is a rush for shares and profit. The type of fund you choose depends on your eventual purpose. A fix-and-flip fund, for example, invests money into single-family homes, fixes them up, and then sells them again for profit. These are a great fit for open-ended funds. If your fund expects to have a large number of investors with many buying and selling opportunities in short time periods, then it neatly matches this type. Open-ended funds are the opposite of closed-ended funds, which we will examine next month.

HARD QUESTIONS YOU MUST ASK BEFORE INVESTING IN COMMERCIAL PARTNERSHIP DEALS PART 2 Over the last few months, we’ve covered the most important questions you need to ask before investing in commercial partnership deals. Real estate is a wealth creator, but it’s also full of scams that will lead you to failure. Before investing in any deal, make sure you have all the information by asking these questions. IS THE OPERATOR OVERPAYING FOR THE ASSET? If your operator isn’t using any of their own money, what do they care if they overpay for the asset? If your operator has no stake in the deal he has sold you and others, he doesn’t really care if he overpays. And that is one of the biggest dangers in the industry. HOWMUCH LEVERAGE ARE THEY USING? Leverage has always been referred to as “the juice” on the street. Leverage is good sometimes, but if your operators are using too much of it, they’re probably trying to use that juice to make a marginal deal look like a home run. This leads to higher prices than the property is worth. It will be problematic to sell such as an asset in the future, and you may not be able to ever recover your initial investment. WHAT OTHER ASSETS DOES YOUR OPERATOR CURRENTLY HAVE? The primary reason for asking your potential fund managers about the other assets they currently have under management is to determine their level of expertise. Ask to know the intention of your operator’s crowdfunding exercise: Are they raising money from you to pay off legacy assets that are not that good, not as desirable, and not performing that well? Are they paying off their previous bad investments with the new money they have raised from you and others? These questions are critical. DO THEY HAVE PARTNERS? Don’t hesitate to probe your potential operators until you get a satisfactory answer concerning these questions: Do you have partners? If yes, do you have a partnership agreement or a document that clearly defines your working relationship? The best- case scenario is a couple of experienced operators working together after a long time off. The last thing you want is a bunch of folks who haven’t worked together before. Husband and wife teams are red flags too. No one wants to miss out on a great deal. Real estate is a competitive industry. If you’re caught sleeping, you’re going to miss out. But this doesn’t mean you should act without thinking. Grant yourself some time to ask these questions and feel out a deal before you commit to something big.

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A CLOSER LOOK AT OPEN-ENDED FUNDS

Traditionally, an open-ended fund is a type of fund with no restrictions on the number of shares the fund can issue. If someone wants to invest in an open-ended fund, they will be able to, regardless of the number of investors who currently invest. Another way of looking at it is that open-ended funds refer to the method of capital raising used. As the fund manager of an open-ended fund, you raise capital continuously, and this capital is deployed throughout all other fund processes. When you come across a new investor, the fund assets simply increase. That means the capital amount and the number of shares both increase to make room for the new investor. When an investor decides to call it quits and cashes out — whether it is with all of their money or part of it — the shares will be sold back to the fund and canceled.

While this reduces the number of shares and the overall fund assets, it does not affect anyone else’s

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