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By Christine Benz | 03-04-2010 11:17 AM

Liquidity's Tremendous Effect on Returns

The less-liquid companies you've never heard of are actually the ones that are poised to have the higher returns, says the Ibbotson Associates founder.

Christine Benz: Hi, I'm Christine Benz for Morningstar. I'm here at the Ibbotson Conference with Roger Ibbotson. Roger, thanks for being here.

Roger Ibbotson: Great to be here.

Benz: Roger is chairman and a chief investment officer at Zebra Capital. He is also a professor at the Yale School of Management and was the founder of Ibbotson Associates.

So, Roger, this morning you presented some interesting data about liquidity, and how you see a connection in your research with liquidity and higher returns. Can you discuss what you see there, please?

Ibbotson: It starts out with, everybody's studied, for the last 60 years, that there's a risk/return relationship. What they've ignored, for the most part, something almost as important, is there's a liquidity/return relationship. Essentially, what that means is, the more liquid an asset is, the more you have to pay for it. If you buy a less-liquid asset, you get to buy it at a discount. And that means you get higher returns.

And this applies to all kinds of assets. That applies to, say, very illiquid things, like real estate or private equity. But it also applies to public markets. There's gradations of liquidity. And the most-liquid stocks you have to pay the full price for. The less-liquid stocks you get to buy at discounts.

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