Many retail investors unfortunately often just chase past performance, crowding into investments unlikely to outperform going forward. Until a very recent uptick in inflows into actively managed equity mutual funds, money flowing into fixed income funds has been swamping money flows into their stock counterparts, particularly those funds not passively managed against stock indices. Actively managed stock mutual funds have actually been registering net outflows much of the time over the last few years.
Despite extraordinary low interest rates, many retail investors still seem to prefer fixed income to what they consider much riskier equity investments. While this could lead us to believe that comparatively little retail investor money has been flowing into the type of equities favored by actively managed funds, such an assessment is likely quite wrong.
Not only have passive equity mutual funds and ETFs been receiving healthy net inflows, but retail investor money has also been flowing into stocks more heavily owned by active funds in an indirect fashion. Since corporate stock buyback activity has been bolstered by many companies issuing debt at historically low interest rates, large amounts of money have been flowing into many stocks indirectly due to the large net inflows into corporate fixed income mutual funds of all stripes. In other words, the flow of money takes place as follows. Retail investor money flows into fixed income funds. Corporates easily issue new debt as heavy demand for those bonds is fueled by those retail flows. Those same corporates use plentiful cash to buy back stock and/or engage in mergers and acquisitions (M&A). Money is fungible.
Recently I wrote about the surprising apparent investor preference of late for illiquid investments. Even none other than my investment hero Warren Buffett seems to be taking some illiquid equity in exchange for more liquid stock holdings. Very soon after I wrote the note on liquidity, Mr. Buffett's Berkshire Hathaway announced it was exchanging P&G stock for a 'capitalized' Duracell.
Duracell, a subsidiary of P&G, is being sold to Berkshire Hathaway (bringing with it an additional sizable cash pile - boosted by the 'capitalization') in exchange for P&G stock (PG) Berkshire will give to P&G. Implicitly, Mr. Buffett is exchanging liquid PG stock for an illiquid investment in Duracell. Again, Mr. Buffett's investment horizon (not to mention his wealth) is very different from that of most mortals, so he can do certain things most of us can obviously not afford. He certainly does not need liquidity, and Berkshire Hathaway already manages and operates many of its 'crown jewels'.
We know that Mr. Buffett does not believe in trying to time the stock market. Still, Berkshire Hathaway continues to boost its impressive cash coffers, so it is interesting to note that in this latest major deal, Mr. Buffett chose to in fact 'cash in' his PG holding for a capitalized Duracell. He also could have held on to the large PG stake and used some of Berkshire's cash to pay for Duracell. There is some information in this. Still, there were also tax benefits to both Berkshire and PG from the specific structure of the transaction. In the case of PG in particular, instead of spinning off Duracell in a taxable sale or IPO, it is getting its own stock in payment from Berkshire. Adding icing to the cake, PG is in fact implementing a large stock buyback in a very efficient manner.
Plentiful liquidity currently in global financial markets can (and will) flow to where it is treated best. Retail investors have generally continued to funnel their investment dollars largely into fixed income funds. Money, however, is fungible, and it is likely to continue to support healthy M&A and stock buyback activity. Expect both of these large sources of demand for publicly listed equity to continue at torrid levels. Thus, the secular bull market remains very much in place.
