Legg Mason, the giant asset management company that was recently sold off by Citigroup, issued a report on January 10, 2020 by Michael Mauboussin, Chief Investment Strategist, entitled, “Clear Thinking About Share Repurchases”.

	Legg Mason Report

A fundamental technique of Capital Flow Analysis is to look for the motivation of market players when examining Federal Reserve national flow of funds accounts.

Legg Mason, with $8.2 billion in its own assets and $373 billion of other people’s money under management, certainly qualifies as a major player; its official views are relevant to understanding the behavior of fund managers.

The Legg Mason commentary was available in PDF format at no cost on their website in March 2006.

Rather than hedge its strong support for stock buybacks, this report boldly states that “the views expressed in this commentary reflect those of Legg Mason Capital Management as of the date of this commentary.”

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On January 28, 2020, an Associated Press dispatch proclaimed: “Corporate Earnings Good Despite Headlines”, stating that “corporate profits remain very healthy overall, and the majority of corporations are beating expectations.”

Michael Mauboussin, chief investment strategist of a large fund management group, in the report cited in “Legg Mason Argues For More Efficient Stock Buybacks“, also wrote in January 2006 that “corporate America is flush, and returns and cash flows remain strong.”

Are these assertions true and does this mean that the outlook is rosy for the average investor in U.S. equities?

As the Federal Reserve national flow of funds table F102 reveals, the answer is,

“Yes, U.S. corporations are flush with cash and profits are growing”, and

“No, this does not mean the outlook is rosy for the average investor in equities.”

The reason for this apparent contradiction is that the most practical and useful measure of value for corporate profits depends on who you are.

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Private equity firms now control about 7% of U.S. corporate equity, or $800 billion, according to estimates of Thomson Venture Economics and quoted in the BusinessWeek cover story, “Going Private”, of February 27, 2020.

Private equity firms gather capital from the Super-Rich in order to take firms private and to concentrate on long-term goals, escaping over- and misguided- regulation by the SEC and the provisions of the Sarbanes-Oxley Act.

Since the Super-Rich own 47% of U.S. household financial assets and hold about one-third of this in equities (1997 estimates), $800 billion invested in private-equity ventures would amount to about 14% of their stock holdings — a substantial portion!

(See: “Rich and Poor“)

Private-equity ventures seem smart, compared to investments in ‘hedge funds’, which are often little more than flimflam deals, in which investors hand over cash, no-questions-asked, agreeing to pay 25% of profits, with no penalty for loss, to operators of essentially blind trusts, which, in recent years, have produced, on average, very mediocre results.

In contrast, partners of private-equity ventures typically receive 1.5% as an administration fee and 20% of the profits only when a venture is taken public or is sold.

The most attractive aspect of such arrangements is that, at least during the phase in which companies are privately-held, management does not need to focus on quarterly results or the burdensome reporting to government regulators, while the negative aspects of the buyback-options schemes that now dominate public equity markets are avoided.

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