Market Commentary – March 2021
Berkshire Hathaway’s 2020 Shareholder Letter – Drawing Parallels to How We Invest Money at KOA
Over the past couple of weeks, we heard from Warren Buffett, courtesy the annual 2020 Berkshire Hathaway shareholder letter. While there have been different takes on it, including whether Berkshire’s/Buffett’s views are as timely as they were once were given that investment decisions at Berkshire are also made by his lieutenants (Todd Combs/Ted Weschler), we use takeaways from this letter and quotes from past shareholder letters to draw parallels to how we at Koa Wealth Management frame investing (Full disclosure: We own Berkshire Hathaway and Apple stock in our client portfolios).
1. Investing for the truly longer-term.
Periodically in our industry, we find that clients either ask us about our investing timeframes OR over what timeframes we should be judged regarding the performance of our investment portfolios. Regarding the former, save for tactical investing decisions based around market cycles or that are centered on specific shorter-term catalysts, we at Koa typically use 3-5 years as our investing timeframes. For the latter, we ask clients to judge our collective investment decision making not across shorter time frames (e.g. 6-months, 1 year) but across an entire market cycle which can last 6-10 years. Consequently, with some exceptions such as tactical investment decisions made around where we are in the market cycle, we generally have relatively longer investment hold periods.
Case in Point: Buffett’s mention of his investment in Apple. Berkshire began investing in Apple shares around 2016, and the firm continued to accumulate shares through mid-2018 with the exception of a small stake sold in 2020 ostensibly when the shares had a nice run in 2H2020 ahead of Apple’s new iPhone launch. Overall, Berkshire seems likely to continue to own Apple shares across product/market cycles and let dividends reinvest while not being overly concerned about whether sector rotations or the growth vs. value debate influence Apple’s price action.
2. Investing patiently within our circle of competence but expanding/broadening the definition of this circle with the passage of time.
At Koa, we manage multi-class investment portfolios for clients which include public and private investments, and both direct investments and indirect investments via external managers. In short, we adopt a ‘go anywhere’ investment strategy based on ever changing client needs and market scenarios. However, while we are comfortable owning individual equities in industries such as Technology, Consumer, Financials and Industrials using a high-quality, asset-light, easy-to-understand long-term compounder lens, we are less likely to own individual equities in cyclical areas such as Energy or Mining unless we find them to be egregiously undervalued. Similarly, in areas such as Emerging Markets which tend to outperform in early-cycle, weak dollar environments but where we might not have the resources or local market knowledge to invest directly, we favor pedigreed, long-tenured investment managers that have a long history of successfully navigating such markets.
Case in Point: Back in the Berkshire Hathaway 1996 shareholder letter, Warren Buffett first introduced this concept of a ‘Circle of Competence’ clearly stating that to construct a portfolio intelligently, one does not have to be an expert on many companies outside this circle but knowing those boundaries was more crucial. Over the course of time, Buffett has preferred to own entire businesses or public equities tied to businesses that exhibit the following characteristics: sound franchises that are easy to understand, have reliable cash flows, minimal debt and that are run by sound management teams. However, Buffett has also expanded his own circle of competence by being willing to venture into areas such technology as was evident in his Apple investment, or moving beyond traditional Benjamin Graham-style deep value investing to owning quality companies at fair prices, as suggested by the influential Philip Fisher in his well-known book ‘Common Stocks and Uncommon Profits’.
3. Investing with a focus on the downside and using scenario analysis, while retaining a measure of humility in learning from mistakes and course correcting.
We view investing through the lens of probabilities, which involves considering a range of potential market scenarios for each investment ranging from the most bullish to the most bearish to the most likely, and we try to manage our risk through a combination of purchasing undervalued investments (which is not just confined to value-stocks) and appropriate position sizing, which tends to be one of the most underrated investing skillsets. Also, while investing, we try to compound capital slowly and surely by seeking consistent singles/doubles and avoiding “big stupid mistakes” (as Charlie Munger puts it) rather than try to hit home runs; when decisions do not turn out as planned due to black swan or other unplanned events, we try to learn from them and move on quickly.
Case in Point: Buffett’s $11 billion recent write down of Precision Castparts Corporation (PCC), a market leader in the production of metal parts serving the aerospace and energy markets. In the shareholder letter, Buffett acknowledged that his decision to purchase Precision Castparts in 2016 for ~$32 billion was in retrospect a mistake that was attributable entirely due to his own overestimation of PCC’s future earnings potential, a mistake that may have been compounded by the hits that PCC’s aerospace industry customers took last year. However, and this was a key takeaway to us, that Buffett lay blame squarely on his decision making rather than blame extraneous factors or PCC’s management team for the write down.
4. Investing in curated income-producing alternative assets over low-yielding long-term bonds.
With the 10-year treasury hovering around 1.6%, long-term bonds face the risk of notable price declines should rates rise unexpectedly (for instance, every 100 bps rise in rates causes the 10-year treasury to fall by ~8%), while the broader S&P 500 index trades at a 1.5% dividend yield with the prospect of capital appreciation as the economy recovers with Covid-19 taking a backseat. As illustrated by J.P. Morgan, the chart below from January (the 10-year yield has doubled since then) highlights the predicament that most retirees and pension plans investing in bonds face when seeking income in an environment of low rates. To counter this, we will continue actively researching/picking income-producing alternatives such as private real estate or via private credit/direct lending funds through managers like Blackstone/Starwood where we sacrifice liquidity for returns less correlated with public markets.
Case in Point: Warren Buffett made this point in the shareholder letter where he lists that long-term bonds are not the place to invest in these days in the US given historically low rates, and more so in foreign countries such as Germany and Japan, where trillions of dollars in sovereign debt earn a negative return in real terms. Further, Buffett forecast a bleak future ahead for institutions such as pension funds and insurers which typically underwrite to a 7% annual return from a portfolio comprising both equities and bonds, which may turn out to be a huge challenge given what will likely be a mediocre few years ahead for the latter.
We hope this note illustrated a few key tenets of our investing framework, at Koa Wealth Management. Let us know if you have questions or if we can help with your wealth management needs in any way!
Koa Wealth Management
11260 El Camino Real, Unit 220, San Diego, CA 92130
This material should not be considered a recommendation to buy or sell securities or a guarantee of future results. Koa Wealth Management, LLC is a registered investment adviser. Registration does not imply a certain level of skill or training. More information about Koa Wealth Management, LLC can be found in our Form ADV Part 2, which is available upon request or by visiting our website at www.koawealth.com/disclosure. Past performance is not a guarantee of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions, or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio.
March 2021 MC PDF