Understand the Illiquid Shares: Process of Removing Illiquid Shares from Your Portfolio

Illiquid shares are stocks that trade infrequently or with low volumes. This limited market activity makes it difficult to sell them quickly without incurring a significant price discount. They are often associated with companies facing operational challenges or lacking sufficient investor interest. 

Knowing the features and risks associated with illiquid shares can help you manage your portfolio better and comply with regulations.

Illiquidity refers to the inability to convert assets into cash quickly without a significant loss of value. Illiquid shares often belong to companies that are either suspended, delisted, or operating in niche or underperforming sectors.

Key Characteristics:

• Extremely low or no daily trading volume

• Wide bid-ask spreads increasing transaction costs

• Requires long holding periods before a sale

• Challenges in locating counterparties for transactions

Illiquid Assets

Assets that are difficult to sell quickly or may require a price discount to convert into cash.

• Real estate or property
  

• Unlisted or penny stocks with low trading volumes
  

• Collectibles (art, antiques)
  

• Private equity investments
  

• Employee stock options (ESOPs not yet vested)
  

• Shares of companies under suspension or with trading restrictions

Liquid Assets

Assets that can be quickly converted into cash with minimal impact on their market value.

• Cash
  

• Bank savings and fixed deposits (with premature withdrawal)
  

• Listed stocks with high trading volumes
  

• Government bonds
  

• Exchange-Traded Funds (ETFs)
  

• Mutual fund units (open-ended)

In stock exchanges, liquidity is key for minimal risk of price distortion. A stock may become illiquid due to several factors, such as the following:

1. Delisting or Suspension

Shares may be removed or suspended from trading platforms due to non-compliance with listing norms, regulatory violations, or failure to submit financial disclosures. Such actions halt regular trading, making the shares inaccessible to most investors.

2. Negligible Market Interest

Companies with minimal growth prospects, poor financial performance, or outdated business models often witness a sharp decline in investor interest. This leads to decreased trading activity and liquidity.

3. SEBI or Exchange Classification

The Securities and Exchange Board of India (SEBI) and stock exchanges regularly identify and publish lists of illiquid securities. This list is based on parameters such as turnover, price volatility, and trading frequency. Inclusion in these lists leads to a decline in trading.

4. Lack of Institutional Participation

Institutional investors typically avoid illiquid stocks due to the risk of price impact when entering or exiting positions. Their absence further reduces trading volume and liquidity.

5. Over-the-Counter (OTC) Trading

Stocks traded outside of formal exchanges, such as on OTC platforms, generally have fewer market participants. This structural limitation reduces visibility and liquidity.

6. Corporate Restructuring or Financial Distress

Events like mergers, acquisitions, or bankruptcy proceedings can result in reduced trading activity or delisting. These changes often leave the shares inaccessible or unattractive to the broader market. 

Holding illiquid shares can introduce several challenges:

• Limited Exit Opportunities

Illiquid shares may not attract buyers even after extended periods, making an exit difficult

• Portfolio Inefficiency

Assets that cannot be easily sold may skew portfolio rebalancing and reduce efficiency

• Demat Account Closure Delays

Depositories require all securities to be sold or transferred before account closure, which may be delayed due to illiquid shares

• Valuation Misrepresentation

Illiquid shares may retain a face value in records but do not reflect realisable wealth, potentially distorting net worth.

Knowing how to identify illiquid shares in your portfolio is crucial for avoiding potential losses and maintaining effective control over your investments.

1. Review Historical Trading Data

Look at 30- to 90-day trading volume records. Stocks with less than 10 trades per day or negligible volume are likely illiquid.

2. Check NSE/BSE Alerts

Regularly refer to the 'illiquid securities list' on the portals of the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). 

3. Look for Warnings from Brokers

Some brokers mark certain holdings with illiquidity risk alerts or trading restrictions.

4. Observe Price Spreads and Volatility

Shares with wide spreads or large price movements on minimal trades strongly indicate low liquidity.

5. Assess Market Depth

Illiquid shares often exhibit thin order books, characterised by few active buy or sell orders at varying price levels.

6. Calculate Turnover Ratio

A low turnover ratio (trading volume/shares outstanding) suggests limited trading activity relative to the stock’s size.

Since these shares are difficult to exit from, try these methods to remove them from your portfolio:

Step 1: Attempt Sale via Exchange

Place a limit sell order slightly below your acquisition price. This may take time, but it remains the most transparent route. Selling in small batches over time may improve the chances of finding buyers without drastically impacting the price.

Step 2: Off-Market Transfer to Another Demat Account

If you have a willing counterparty (e.g., a family member), initiate an off-market transfer using a Delivery Instruction Slip (DIS). Follow these steps to proceed:

• Confirm the recipient's demat account details

• Fill out the DIS form with the correct ISIN and quantity

• Submit the signed DIS to your Depository Participant (DP)

• Pay applicable charges

Ensure the shares are not blocked or frozen by the depository.

Step 3: Approach Your Broker

Some brokers offer illiquid desk services. This may incur a fee, but they can connect you with potential buyers or assist in disposing of such shares through block deals (if available). Brokers may also facilitate negotiated deals or access secondary markets.

Step 4: Gifting or Donation

Shares can be gifted to a family member or donated to a charitable organisation with a demat account via an off-market transfer. 

• Specify ‘Gift’ or ‘Donation’ as the reason in the DIS

• Maintain documents like the gift deed, donation receipt, and submit PAN details

• Gifts to specified relatives are tax-exempt for the recipient

• Confirm that the recipient’s Demat account is active and shares are not blocked by the depository 

Step 5: Monitor Special Regulatory Settlements

Regulatory exit windows usually apply to debt instruments, but there are rare exceptions for equity holders. In cases like compulsory delisting or SEBI’s one-time settlements, limited-time exit options may be offered. These are uncommon but worth tracking if relevant to your holdings.

SEBI, along with primary depositories in India, provides a regulatory framework to uphold market integrity and protect investors. Some of the major regulatory guidelines include:

• Stock exchanges, following SEBI guidelines, periodically identify and publish lists of illiquid stocks based on turnover and price criteria

• SEBI regulations restrict trading in certain flagged illiquid options contracts except through permitted channels

• Illiquid stocks meeting SEBI’s criteria must be traded through periodic call auctions to improve transparency and reduce manipulation

• SEBI (PFUTP) Regulations prohibit manipulative practices like reversal or synchronised trades in illiquid segments, with strict penalties for violations

• SEBI permits exchanges to run Liquidity Enhancement Schemes (LES) to incentivise trading in illiquid stocks under strict monitoring

• The National Securities Depository Limited and Central Depository Services Limited generally require all securities to be sold or transferred before an account can be closed

While knowing how to manage and potentially remove illiquid shares from your portfolio is crucial, an even better strategy is to avoid acquiring them in the first place. Here’s how you can go about it:

1. Do Volume Checks Before Buying

Avoid stocks with consistently low average trading volumes.

2. Beware of Penny Stock Promotions

Do not act on unsolicited advice related to thinly traded securities.

3. Diversify Exposure

A balanced portfolio reduces the impact of one or two illiquid positions.

4. Track Exchange Announcements

Regularly check NSE/BSE for any notifications related to your holdings.

5. Use Broker Warnings and Tools

Leverage brokerage filters and alerts to screen out high-risk, low-liquidity stocks. 

Illiquid shares are a common but manageable issue in retail portfolios. Early identification and adherence to regulatory processes ensure they do not disrupt your financial goals. Removal may take time, but with patience and the right approach, these shares can be responsibly managed or exited.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

https://nsdl.co.in/downloadables/TFK%20Mar-May%202021.pdf

https://economictimes.indiatimes.com/wealth/invest/this-type-of-illiquid-shares-cannot-be-transferred-out-of-demat-account-or-sold-anywhere/articleshow/104525616.cms

https://www.livemint.com/money/can-i-gift-shares-through-my-demat-account-11714451325623.html