Good morning all and happy Sunday. Belated Mother’s Day thoughts and thanks to all those incredible Moms (or Mums) out there!
Two weeks ago, some big news came out of Omaha, Nebraska. Warren Buffet, maybe considered the best investor of all time, announced to the shareholders of Berkshire Hathaway that it was time for him to retire from the CEO seat but remain Chairman. The video clip can be found below:
I was lucky enough to attend the Berkshire Hathaway annual general meeting in May 2014, which felt more like a pilgrimage than anything else. People from across the United States and the world descend upon Omaha once a year in what feels like Comic-Con for value investors.
I have long admired Warren Buffet’s approach to investing and the track record speaks for itself. Since he took over Berkshire Hathaway, shareholders have received an annualized return of 19.8% compared to 10.2% for the S&P 500, turning him into the 6th richest person in the world. Alongside his business partner, Charlie Munger, Buffet created lasting legacies for many families. There are many fantastic books written about his investing approach and a short piece will not do that justice, but there are several quotes from Buffet and Munger that resonate with me when thinking about investing. Below are some examples and how we may apply those today.
“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful”
This is my favourite Warren Buffet quote as it really encapsulates his ability to be patient and remain true to his value style of investing. Berkshire Hathaway has shown this ability many times through different stages in the cycle. In effect a value investor cannot invest with the crowd. If you are trying to sell things that have become expensive and buy things that are cheap, by definition, you are investing against momentum.
Two great examples of Warren Buffet with this approach are:
- Writing Insurance: Maybe the simplest execution of this idea is around the insurance industry and how premiums are elevated right after periods of distress. Examples would be when a storm has just passed through a region, spiking insurance premiums. Berkshire has been a long-time user of this approach, which is even more attractive as the balance sheet swells with cash from the written policies (called float in the insurance industry).
- It could be simpler with the sale of equity derivatives when the price of fear in the markets is elevated. Something Berkshire Hathaway executed on in 2008 with spiked levels of fear (implied volatility).
“Cash Is Like Oxygen, If It Disappears for a Few Minutes, It’s All Over”
I remember Charlie Munger paraphrasing this at the AGM I attended in 2014. The quote relates to liquidity and the ability to generate cash when needed. Investing across private markets and levered strategies can certainly create cash vacuums at times. When needed most, the opportunity set can be the strongest, for those with liquidity.
The best example of Berkshire Hathaway putting this into practice was providing liquidity to banks during the 2008 financial crisis. In September 2008, many banks were struggling with losses related to the U.S. mortgage market. Many began to lose faith in the banking system and large withdrawals were made from banks deemed to be riskier (investment banks in particular). Goldman Sachs, supposedly under a liquidity squeeze themselves, borrowed $5 billion from Berkshire Hathaway through the issuance of 10% preferred shares. They were willing to pay 10% per year for the funding. The implicit guarantee from Berkshire Hathaway was enough to calm market fears around Goldman Sachs. The bank bought back the preferred shares from Berkshire (at an agreed upon premium) in March 2011. Alongside warrants the bank issued to Berkshire Hathaway, Buffet’s bet generated around $3.8 billion in profits.
The Oracle’s Positioning
With these quotes in mind, it’s interesting to look at the current balance sheet of Berkshire Hathaway and any potential next moves. First the question of cash. Berkshire Hathaway has around $380 billion worth of short-term U.S. Treasury bonds on the balance sheet. This is more than their entire holdings in public equities. Warren likes cash right now! That usually means that everyone else is greedy.
In Buffet’s shopping cart there was alcohol (Constellation Brands), pizza (Domino’s) and oil (Occidental Petroleum). He’s been selling banks (Bank of America and Citigroup) and beauty (Ulta Beauty). Berkshire has been growing the holdings of Japanese equities over the last 6 years and now holds around $25 billion across 5 core holdings. Buffet sees value in these names, unrecognized by their stock prices.
Is Berkshire building cash for a recession? Will the change in CEO coincide with a growth slowdown for the economy?
We don’t know, but as Warren Buffet famously said: “Only When the Tide Goes Out Do You Discover Who Has Been Swimming Naked”
My very best,
Stephen Harvey
Chief Investment Officer
Sagard Wealth
