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Rupert Hargreaves
Rupert Hargreaves
Articles (778)  | Author's Website |

Charlie Munger: Liquidity Is Not Needed for Good Investments

Some thoughts about the role liquidity plays in financial markets

April 08, 2019 | About:

At the 2004 annual meeting of Berkshire Hathaway shareholders, one shareholder asked Warren Buffett (Trades, Portfolio) and his right-hand man Charlie Munger (Trades, Portfolio), why the company didn't want to split its A-Shares to make them more affordable for the average investor.

The duo has commented on this many times before. Warren Buffett (Trades, Portfolio) has said that he doesn't want to split his shares because he doesn't think that will encourage long-term investing. Even though some investors might believe that it will improve liquidity and access, it will drive a short-term mentality because the lower cost will attract less sophisticated investors who may not have the same long-term holding period as the current stable of shareholders.

It is this latter issue, the issue of liquidity, that Munger seems to be the most concerned about. His comments at the 2004 annual shareholder meeting on this topic are quite interesting.

Replying to the shareholder who asked:

"Now if liquidity helps price discovery, then does it make sense to split the stock of a company which has a low liquidity problem? As a corollary, why do you consider stock splits and bonus issues to be bad for shareholders in the long run?"

Munger responded:

"I think the notion, which is taught in so much of modern academia, that liquidity is this — of tradable common stock — is a great contributor to capitalism — I think that is mostly twaddle.

The GNP of the United States grew at very good rates long before we had highly - liquid markets for common stock. I don’t know where people got that silly notion.

I think the liquidity gives us these crazy booms, which have many problems as well as virtues."

There is one example in recent history of a company restricting the trading of stocks after a devastating bubble, and that is the South Sea bubble in England.

No liquidity, no problem

In 1720, to finance a war against France, Britain's House of Lords passed the South Sea Bill, which allowed the South Sea Company a monopoly in trade with South America. This sparked an investor mania as wealthy individuals rushed to buy the shares, and hundreds of other smaller companies emerged, many of which were wildly optimistic and fraudulent.

The bubble popped a few years after, wiping out tens of millions of pounds of wealth. In response, the British government outlawed the issuing of stock certificates, a law which remained in place until 1825.

The South Sea bubble is a great example, according to Munger, of how a civilization can flourish even without a liquid market for trading shares or indeed an asset of any kind:

"After the South Sea Bubble, England banned tradable common stocks for decades. It was absolutely illegal to have a company so widely held you got a liquid market in the shares, and England did fine during that period when you didn’t have a stock market.

So, if you think that liquidity is a great contributor to civilization, why then you probably believe that all the real estate in America, which is relatively illiquid, hasn’t been developed properly."

There isn't much evidence to suggest that England or indeed any other market did better or worse because they essentially closed the stock market, but there is some data which show that illiquid shares tend to outperform over the long term, particularly if they have one large investor or block of shares owned by a family.

This is something worth considering when analyzing the vast universe of investable companies out there. Buying an illiquid stock might not seem appealing a first, but there is some evidence which suggests it might be a better investment decision.

Disclosure: The author owns shares in Berkshire Hathaway.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. He is the editor and co-owner of Hidden Value Stocks, a quarterly investment newsletter aimed at institutional investors.

Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


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