It seems like everyone is saying the bond market looks attractive now, but one notable investor isn’t on board.
Warren Buffett, CEO of Berkshire Hathaway, has long favored stocks over bonds. This view is supported by the historical outperformance of stocks, and the recent surge in rates since March 2022 hasn't changed his perspective.
Berkshire Hathaway's Investment Portfolio
Just take a look at the enormous Berkshire investment portfolio overseen by Buffett.
At the end of September, Berkshire held the following assets:
- $340 billion of stocks
- $157 billion of cash, mostly in U.S. Treasury bills maturing in less than a year
- Just $22 billion of bonds
This information is according to Berkshire’s quarterly 10-Q filing with the Securities and Exchange Commission, released on Saturday in conjunction with its third-quarter earnings.
Berkshire's Bond Portfolio
Berkshire's bond portfolio is largely cash-like. Approximately 75%, or $17 billion, matures in the next 12 months. Only 1% of the entire Berkshire portfolio is invested in bonds with a maturity longer than one year. Since the start of 2023, Berkshire’s bond portfolio has decreased by about $3 billion.
Berkshire's Emphasis on Equities
With time, Berkshire's investment portfolio has become even more equity-heavy. When 10-year Treasury debt yielded less than 1% in 2020, Buffett expressed astonishment at the willingness of bond investors to accept such a paltry rate. Although 10-year Treasury debt now yields about 4.6%, Buffett continues to exercise caution.
The Role of Bonds in P&C Insurance Operations
A significant portion of Berkshire's investment portfolio supports its extensive property and casualty insurance operations. Insurers invest the premium income they receive from customers and use the proceeds to help pay claims, often years later. As a result, most P&C insurers invest the majority of their assets in bonds to ensure the ability to pay claims, as stocks are considered riskier.
Berkshire vs. Chubb: A Comparison
To illustrate this further, let's compare Berkshire to Chubb, one of the largest P&C insurers. As of the end of the third quarter, Chubb had the following assets:
- $100 billion in bonds
- $17 billion in equities (mostly private)
- $5 billion in cash
The Chubb portfolio is representative of big public P&C companies.
Warren Buffett's perspective on the bond market remains unchanged, as he continues to favor stocks over bonds. Despite the recent surge in rates, Berkshire Hathaway's investment portfolio remains focused on equities, with a small allocation to bonds.
Berkshire Hathaway's Unique Investment Approach
Berkshire Hathaway is known for its distinctive investment strategy, often referred to as a "barbell approach." This strategy involves maintaining a sizable portfolio of both high-risk assets, such as stocks, and low-risk assets, mainly cash. In fact, Berkshire holds nearly half of its risky assets in the form of Apple stock.
The significant amount of cash that Berkshire has on hand serves as a substitute for bonds. This is an important factor that allows the company to invest more aggressively than other major insurers in the property and casualty (P&C) industry. With approximately $300 billion in capital, Berkshire holds around 25% of the total net worth of the entire U.S. P&C insurance industry.
One of the advantages of having such a substantial capital base is the flexibility it affords Berkshire when it comes to investment decisions. Insurance regulators grant the company significant leeway due to its financial strength. Charlie Munger, Berkshire's Vice Chairman, highlighted this during the company's annual meeting by pointing out that Berkshire has roughly four times more capital in relation to its annual premium collection compared to its industry counterparts.
During the meeting, Warren Buffett, Chairman and CEO of Berkshire Hathaway, was asked about an insurance contract with American International Group (AIG). In this particular agreement, Berkshire collected a $10 billion premium to provide coverage against $20 billion of long-term liabilities. Buffett emphasized that Berkshire does not conform to traditional investment strategies like putting the received funds into bonds with fixed durations. The company thinks outside the box.
In recent years, Buffett held a significant amount of cash despite interest rates being at historic lows. He endured the financial pain because he believed that bond yields were unattractive. Unlike other banks like Bank of America, which heavily invested in bonds during this period, Buffett remained steadfast in his decision.
This decision has proven to be wise as bond prices have fallen due to rising yields. As a result, banks like Bank of America now face substantial paper losses. Meanwhile, Berkshire is being vindicated as short-term interest rates have surged to over 5%, providing ample returns on its cash holdings.
However, the market eagerly awaits the moment when Buffett decides to reinvest a portion of the cash into bonds. It remains to be seen what conditions would entice him to make such a move, but it is speculated that appreciably higher yields would be necessary.