According to the Wall Street Journal, Warren Buffett (Trades, Portfolio) was reportedly bewildered by a massive surge in trading volume in Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) Class A stock over the past year. The trading volume has jumped from around 400 shares a day to nearly 2,000, implying there are some very large buyers and sellers in the market.
Buffett has always encouraged Berkshire's investors to hold the stock with a long-term mindset, especially the Class A shareholders. Many of these investors have owned the stock for decades. A spike in trading might have concerned the Oracle of Omaha as it could indicate that some investors are starting to lose faith in him and selling out early.
However, as it turns out, according to a study by professors Robert Bartlett of the University of California, Berkeley, Justin McCrary of Columbia University and Maureen O'Hara of Cornell University, the surge in trading volumes has been caused by retail traders buying and selling fractional shares, which brokers like Robinhood (HOOD, Financial) tout.
Berkshire's liquidity problem
Fractional trading allows individuals to buy part of a share, which can be helpful for smaller investors. As the most expensive stock in the world, trading at around $400,000 per share, fractional trading for Berkshire's Class A shares has hugely increased the stock's accessibility.
Still, this liquidity is not a good thing. Yes, it allows smaller investors to buy a stake in a business they might not have otherwise been able to, but liquidity is generally not a value-creating quality.
This is something Buffett and his right-hand man, Charlie Munger (Trades, Portfolio), discussed at the conglomerate's 2004 annual meeting.
Specifically, Munger said:
"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. And in England, if you'll remember, 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."
Liquidity does not create value
Liquidity does not create value in itself. In fact, research shows that illiquid stocks tend to outperform the market over the long term because investors do not jump ship at the first sign of trouble.
Liquidity can help investors buy and sell a security, but we should never let liquidity drive our investment decisions. It is nothing but a technical market factor. It does not have any impact on the underlying business or asset. It is more likely liquidity will distort the price of an asset and make it more speculative. While this could benefit those investors who can emotionally detach themselves from market gyrations, liquidity could become a wealth tax for emotional investors.
Investors are far more impacted by losses than gains. Market sentiment is quickly reflected in liquid assets, which means it is more likely sudden drawdowns will hit them. This means that investors are much more likely to be forced by their own emotions into making a bad investment decision with a liquid asset.
There is nothing we can do as individual investors about market liquidity. It is just something we have to put up with. Nevertheless, investors need to remember that liquidity is not always a good thing, and illiquid assets can be better investments in the long run.
