This is about liquidity risk. It may not be a practical concern for you and me as individual investors, unless we either dabble in ultra-small cap stocks or in mutual funds/ETFs that do so and where we and the fund end up holding significant chunks of a given stock’s float (the shares available for public trading). But it is a risk for institutions.
Early in my career, I managed a portfolio of Asia ex Japan stocks, a time when Australia was the largest component . In fact, the Kuwaiti Investment Office and I were the two biggest foreigners in the Australian market back then. After I ‘d been doing this for a bit over a year, I got an offer to manage a global equity portfolio for an obscure mutual fund complex whose global fund had a woeful record under a just-fired manager. My boss had begun to tinker with my Australian holdings after liquid lunches with Australian brokers, adding clunkers like “the Apple of Sweden,” which I would end up taking the blame for. So I left.
When I arrived at my new home, I looked more carefully at the portfolio I’d inherited–and found a gigantic area of risk that I just haden’t understood. The portfolio, which was having heavy redemptions, was chock full of illiquid stocks. The worst was Ampol America Israel, a subsidiary of Bank Hapoalim. As a company, Ampol AI was a gigantic mess. Worse for me, though, was the size of my position vs. trading volume. Assuming I could be 10% of the daily trade without anyone realizing that the largest US holder (i.e., my fund) was beginning to sell, it would be 27 years before I’d gotten rid of the last shares. Yes, there are normally things you can do as an institutional investor to disguise your intentions, but not a minnow like I was. I could have kept the secret for maybe a week before someone would begin to short the stock.
Not a pretty picture. Luckily for my shareholders, and for me, a corporate raider launched a takeover campaign, during which Bank Hapoalim bought my stock.
The first year was awful. The following five were just the opposite, though.
My point: the illiquid stocks were all close to zero volatility even though they were extremely risky.