The great 20th-century playwright Tennessee Williams once remarked, “If I got rid of my demons, I’d lose my angels.” For those not keen on literary bromides, the translation in 21st-century vernacular might be: The good news is also the bad news. Either sums up the double-edged sword of stock liquidity. The good news is that investors can obtain an instantaneous stock quote and sell their shares with the click of a mouse. That is also the bad news.
Ben Graham was the first to write about the antithetical characteristics of liquidity in his classic “The Intelligent Investor.” He compared the benefits of owning non-liquid investments to those of liquid securities during the worst of the 1931-33 depression. Graham observed that there was a kind of “psychological advantage in owning business interests which had no quoted market.” He argued that those with illiquid investments could convince themselves that their investments had kept their full value — since there were no daily market quotations to prove otherwise. On the other hand, owners of stocks and bonds subject to daily quotations obtained a sense that they were “growing distinctly poorer” each day. For those of us who still feel the sting of the 2008 decline, Graham’s words resonate.
Warren Buffett, a student of Graham’s and his eventual collaborator on the fourth edition of “The Intelligent Investor,” is the modern-day personification of the intelligent investor. In his 2013 annual letter to shareholders, Buffett provides an example of two very successful illiquid investments he made in real estate. “Those people who can sit quietly for decades when they own a farm or apartment house … often become frenetic” when exposed to daily stock quotes and commentary. He concludes, “For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.” Click here for more:
Active money managers are having a tough time beating their benchmarks again this year. In fact, fewer than 15 percent of money managers were exceeding the market by the end of November.
You might say active management has hit a rough patch. According to Ben Levisohn of Barron’s, who cites the University of Chicago’s Center for Research in Security Prices, “From June 1983 to June 2014, the median fund underperformed the market by more than 80 percentage points.” That’s 30 long years of underperformance. Ouch.
If you invest in mutual funds, this information should be important to you. In addition to the high fees most funds charge, the majority have underperformed yet again in 2014.