Non marketable securities

What Are Non Marketable Securities?

Non marketable securities are financial instruments that cannot be easily bought or sold on a secondary market or exchanged publicly. Unlike stocks or publicly traded bonds, these securities lack a formal trading platform, meaning their ownership transfer is restricted and often requires direct negotiation between buyer and seller. They fall under the broader category of investment products within capital markets, characterized primarily by their limited liquidity. The illiquid nature of non marketable securities typically means they are held until maturity or redeemed directly with the issuer.

History and Origin

The concept of non marketable securities has roots in government financing and private capital formation. One of the most prominent examples is the U.S. savings bond program. Introduced in 1935 as "baby bonds" and later expanded, particularly during World War II with Series E bonds, these instruments were designed to allow individual citizens to lend money directly to the government. Their design intentionally restricted transferability, ensuring a stable and direct source of funding for national initiatives without the volatility of market trading. "Since 1935, when President Franklin D. Roosevelt signed legislation creating the first 'baby bond,' United States Savings Bonds have encouraged saving and a broad participation by Americans in government financing."⁶ This direct relationship between the issuer (the U.S. Treasury) and the investor is a hallmark of non marketable securities. Similarly, the rise of private placements as a means for companies to raise capital without a public offering also contributed to the prevalence of non marketable instruments, often governed by regulations like the Securities and Exchange Commission's (SEC) Regulation D, which exempts certain private offerings from registration requirements.⁵

Key Takeaways

• Non marketable securities cannot be easily traded on public exchanges, contrasting sharply with their marketable counterparts.
• They often exhibit low liquidity, requiring investors to hold them until maturity or negotiate private sales.
• Examples include U.S. savings bonds, certain private placement securities, and annuities.
• These instruments often appeal to investors seeking stability, predictable returns, or specific tax advantages.
• Their limited tradability means their value is not subject to daily market fluctuations.

Interpreting Non Marketable Securities

Interpreting non marketable securities primarily involves understanding the terms of their issuance and redemption directly with the issuer. Unlike exchange-traded assets where price discovery happens continuously, the "value" of a non marketable security is determined by its contractual terms, such as its fixed or variable interest rates, redemption schedule, and maturity date. For instance, a U.S. savings bond's value is calculated based on its original purchase price and the interest accrued over time, verifiable through TreasuryDirect.gov. Investors evaluating non marketable securities must focus on the creditworthiness of the issuer, the contractual yield offered, and their own need for access to capital, given the limited opportunities for early exit without penalty. This makes them distinct from traditional fixed income securities that trade actively.

Hypothetical Example

Consider an individual, Sarah, who purchased a Series EE U.S. savings bond for $500. This is a classic non marketable security. Instead of buying a stock on the New York Stock Exchange, Sarah bought this bond directly from the U.S. Treasury via TreasuryDirect. The bond guarantees to double in value after 20 years, equating to a guaranteed annual effective return over that period, though interest is paid out at redemption. If Sarah decides she needs the money before the 20-year mark, she can redeem it with the Treasury after one year, but she might forfeit some interest if she redeems it before five years. She cannot, however, sell this specific bond to another investor on a stock exchange or through a broker; the transaction must be with the U.S. Treasury directly. This illustrates the non marketable nature, where the bond's value is derived solely from its terms with the issuer, rather than market supply and demand. This characteristic plays a role in portfolio construction for specific goals.

Practical Applications

Non marketable securities serve various practical applications for both issuers and investors:

• Government Financing: U.S. savings bonds are a direct way for the government to raise capital from individual citizens, bypassing the complexities of the broader bond market.
• Private Capital Raising: Companies, particularly startups or those seeking to avoid the costs and regulatory scrutiny of public markets, use private placements to raise capital from specific investors, often accredited investors. These privately placed securities are non marketable.
• Individual Savings and Retirement: Products like certain annuities, certificates of deposit (CDs) held directly with banks, and savings bonds offer a predictable, low-risk savings vehicle, often with specific tax advantages.
• Institutional Investments: Institutional investors are increasingly allocating funds to private assets, including privately placed debt and equity, which are largely non marketable. "Institutional investors continue to deepen their commitment to private markets, with 66% planning to increase allocations to private assets over the next five years."⁴ This trend highlights how large entities seek to capitalize on the unique risk-return profiles offered by these less liquid investments.

Limitations and Criticisms

While non marketable securities offer unique benefits, they also come with significant limitations and criticisms, primarily centered on their illiquidity. The inability to easily sell these assets on a secondary market means that investors cannot access their capital quickly without potentially incurring penalties or a significant discount if a private buyer is found. This lack of liquidity can be a major drawback, especially in emergencies or unforeseen financial needs.

Furthermore, the opaque nature of some private placements, a type of non marketable security, can lead to concerns regarding investor protection. Unlike public offerings, these private deals often have less stringent disclosure requirements, leaving investors to conduct their own due diligence. Financial institutions may face additional scrutiny when recommending these products due to potential conflicts of interest or suitability issues. "Private placements, however, are not subject to some of the laws and rules designed to protect investors, such as the comprehensive disclosure requirements that apply to registered offerings."³ Another criticism relates to the "illiquidity premium" or "complexity premium" associated with some non marketable private debt, which compensates investors for the difficulty in quickly selling the asset without incurring a discount.² This highlights that while they may offer higher yields, it is often in exchange for greater risk management challenges and reduced flexibility.

Non Marketable Securities vs. Marketable Securities

The fundamental difference between non marketable securities and marketable securities lies in their tradability and liquidity. Marketable securities, such as stocks, publicly traded bonds, and mutual funds, can be easily bought and sold on organized exchanges like the New York Stock Exchange or NASDAQ. Their prices are continuously updated by supply and demand, providing transparent valuation and immediate liquidity for investors.

In contrast, non marketable securities, like U.S. savings bonds or shares in a privately held company, do not trade on public exchanges. Their value is determined by their original terms with the issuer, and any transfer of ownership requires direct negotiation, often with restrictions or penalties for early redemption. This distinction means marketable securities offer flexibility and price transparency, while non marketable securities prioritize stability, direct issuer relationships, and often specific tax or investment policy goals.

FAQs

Are U.S. savings bonds non marketable securities?

Yes, U.S. savings bonds (such as Series EE and Series I bonds) are prime examples of non marketable securities. They can only be purchased from and redeemed with the U.S. Treasury, not traded on a stock exchange or sold to other individuals in a secondary market.¹

Why would an investor choose a non marketable security over a marketable one?

Investors might choose non marketable securities for their stability, predictable returns, and often lower volatility since their value isn't subject to daily market fluctuations. They can also offer specific tax advantages or contribute to diversification by providing exposure to asset classes not available on public markets.

Can non marketable securities be sold before maturity?

It depends on the specific security. Some non marketable securities, like U.S. savings bonds, can be redeemed early with the issuer, though there may be interest penalties if redeemed before a certain holding period. Others, such as certain private placement investments, may have very limited or no options for early liquidation, requiring the investor to hold them until the agreed-upon maturity date.

What risks are associated with non marketable securities?

The primary risk is illiquidity, meaning you may not be able to sell the asset quickly or at a desired price if you need access to your funds. Other risks include credit risk (the risk that the issuer defaults) and, for some private investments, a lack of transparency due to reduced disclosure requirements compared to public offerings.