Photo Credit: Tim Green || Once my friend Jose Pedro Marcos de Fuentes said to me “A centavo for your thoughts.” I said, “Peter, I don’t deal in fractions of cents.” He said, “You certainly deal in fractions of sense.”
Since I mentioned my old friend Peter Fuentes, who I haven’t heard from in 35 years, let me tell you a funny story that he once told me. He had immigrated to the US, and came from a trilingual family in Mexico where they spoke Spanish, French, and English fluently. One day he was walking in the streets of LA, and he realized that an INS agent was following him. He had forgotten to bring his immigration documents with him and he wondered what he should do. The INS agent came up to him and said to him in perfect Spanish, “May I see your papers?” Peter replied in French, “I do not understand what you are saying.” The INS agent blinked and left.
Peter was a dear friend of mine during my graduate student days at the University of California at Davis. We had many discussions on intellectual topics as we shared a suite together with two other students from Brazil and South Korea. Most other suites were strictly US residents, but somehow I had the fun of interacting with a very interesting group of people who were not born in the US.
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Recently a client of mine asked me how he could buy fractional shares of stock for his grandchildren. He wanted to give them exposure to the S&P 500. I did some digging. The best Idea I ran across was perfectly free… buy an open end mutual fund from FIdelity that has no setup fees, no transaction fees, and no management fees. These are the Fidelity ZERO funds. The UGMA/UTMA accounts are free as well.
There was a surprise to me — one grandchild was older than 18, so I suggested an account in the client’s name, with transfer on death to the grandchild.
The original request from the client was an account that buys fractional shares. In this case, the shares could be of SPY or VOO. Those would cost nine and three basis points of management fees, respectively. I recommended the zero cost option above.
As I researched fractional shares, I found more than a dozen firms that did them. Given that most firms have Buffett envy, and don’t want to split their shares, fractional shares become a way to allow small investors to buy into a company.
Some of the firms that dd this were payments companies. Others were robo-advisors. Some were brokers. Regardless of what they were, the markets sell shares as units. They don’t sell fractions of shares. So when one of these entities allows the purchase of fractional shares, the entity has to purchase a whole share, and then parcel out the fractions to the various clients, and they hold onto the remainder. Now personally, I wonder what would happen if a broker became insolvent. How would custody work there? Could fractional ownership be less secure than owning fractional shares of an open end mutual fund? Who owns the share that has been split up?
Are fractional shareholders a sign of a market top? Perhaps. But they aren’t big enough to move prices. They may be “dumb money,” but they are a sideshow as far as the market as a whole goes.
What is likely more significant now is first the Fed is blowing asset bubbles through the creation of excess bank reserves. This benefits the wealthy versus the poor, at least on the face of it. Here’s the rub: the current value of assets may rise, but the ability to turn the assets into an annuity does not. The absolute level of what an annuity will deliver is mostly invariant to moves in bond yields.
Then there is the second reason: Leveraged speculation among unseasoned investors. One reason the volatility index has remained high amid a rising market is the high amount of call buying from retail investors. Now, I haven’t documented this myself, but I give you this link from Knowledge Leaders Capital, where they have shown this extensively. This is highly speculative behavior, akin to what you see near the top of bull markets.
Just as losses from call options eat capital, so does the inability of highly valued companies to grow enough destroy/eat capital. Throw into that the zombie companies that aren’t earning their cost of capital among those deep in junk bond territory. The Fed can throw out all the liquidity that it can, but it can’t fix companies that are fundamentally broken — it can only give them a lingering, painful death.
Well, this drifted beyond fractional shares. Just realize that in the present environment that there are many risks. The Fed does not control everything, nor does the US Government. Use your own good judgment and reduce risk in your portfolios as you see fit. Or, raise risks if you think I am wrong. But think for yourself. The financial media has is own bullish bias, and I am not talking about CNBC, I am talking about Bloomberg. I listen to Bloomberg a lot and not CNBC.