John Ferry
10/01/2005
When wealth advisors try to assess a client’s portfolio value, they not only consider the value of illiquid assets such as private equity and hedge fund holdings, but they also try to assess elements that are completely nonliquid, such as human capital and even holdings in companies that, for emotional reasons, are never likely to be sold. “In addition to technical illiquidity, I often also encounter what I call ‘tactical illiquidity’; holdings that cannot be liquidated for various reasons, such as emotional ties,” Mary Duke of HSBC Private Bank says.
For example, an individual may own shares in a publicly traded company that was started by a great-grandfather. Technically, such a holding is completely liquid, but in reality, the individual may never sell it because of the emotional link. “You might invest in a fund in order to get access to another great manager, or your assets might be held in totally liquid assets but are being used as collateral on a loan. You would be doing your clients a disservice to advise them on their wealth without taking these things into consideration,” Duke says.
Similarly, if part of an investor’s wealth is tied up in a private company, wealth advisors value it by looking to the public market for a suitable proxy. They can also derive a figure for the volatility of that illiquid asset by looking at the price of an option on the proxy company. These estimates of return and risk can then be factored into a portfolio optimization model.
Didier Duret, chief investment officer at ABN Amro Private Clients in Geneva, says human capital is another often-overlooked illiquid asset. “In certain cases, it is very important. For example, if you are an entrepreneur in the oil business, then you shouldn’t be investing your equity portfolio in the oil sector, because if you do, then you’re effectively compounding your risk.” Assets such as human capital can be valued (like other assets) by estimating the present value of future cash flows resulting from them. This can then be factored in as a completely illiquid asset to the overall portfolio value.
