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By Nadia Papagiannis, CFA | 08-11-2010 01:35 PM

Ibbotson: Capture Excess Returns on Illiquidity

When you buy any kind of an asset in a less liquid form, you're going to get it at a discount, which means higher returns, says Yale professor, Zebra Capital CIO and Ibbotson founder Roger Ibbotson.

Nadia Papagiannis: Hello. My name is Nadia Papagiannis. I'm an alternative investment strategist here at Morningstar. Today I have with me Roger Ibbotson, who is a professor of finance at the Yale School of Management, CIO of Zebra Capital, and of course, the founder of Ibbotson Associates, a Morningstar company.

Thanks for joining us today, Roger.

Roger Ibbotson: It's great to be here. Thank you for inviting me.

Papagiannis: Roger, recently you've done a lot of research on liquidity and the illiquidity premium, and in fact, you've incorporated that into an investment strategy. Can you define for us what liquidity is and what an illiquidity premium is?

Ibbotson: Well, we think of a liquidity premium is a fact that you can get higher returns by investing in any kind of asset that's somewhat less liquid. If you buy an asset in its most liquid form, you're just going to have to pay the full price for it, but if you buy any kind of an asset in a less liquid form, you're going to get it at a discount, and that means you're going to get higher returns. That's the liquidity premium.

Papagiannis: So, can we consider this as a style? Is this a style of investing, liquidity?

Ibbotson: You certainly can think of this as a style because it's separate enough from size or value that it could be a style. In fact, it's just as strong of an impact as any of the existing styles. So, it certainly could be thought of as a style, I guess. I don't know how it's going to fit into the nine-style boxes at Morningstar because it brings a another dimension into this, but it's just as strong of an impact as any of the existing styles.

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