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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Good morning. Two years ago I wondered in Unhedged about what could possibly have been going through Bill Hwang’s head as he blew up his Archegos hedge fund with hyper-concentrated, super-leveraged, impossibly risky bets on stocks. “Hwang is not just (allegedly) dishonest. He is also (apparently) out of his dang mind,” I wrote. Today, the incomprehensibility of Hwang’s scheme has become a tricky issue in his trial. The judge has wondered aloud, “To what end?” Readers, I still have no idea. Send your thoughts: robert.armstrong@ft.com.
After Buffett
Does Berkshire Hathaway need to change, and if so, how?
Yesterday in this space I wrote about Berkshire’s last two decades of share performance, which have mirrored the S&P 500. The fact that at Berkshire’s current size, it will be very difficult to meaningfully outperform the index is widely acknowledged, including by Warren Buffett. The more interesting and difficult point is about the claim, made by Buffett and his fans, that the conglomerate is nonetheless a superior investment because it is less risky than the big-cap index.
The definition of risk is important. Buffett and other long-term investors rightly reject the notion that risk can be analysed as volatility. But using the main alternative definition — risk as risk of permanent loss — it is not clear in what sense Berkshire is less risky than the diversified and dynamic S&P index. The lower-risk claim is often explained in terms of Berkshire keeping pace with the market in good times but outperforming in bad. But Berkshire did not permanently increase its performance edge on the S&P in the years surrounding the great financial crisis. Its outperformance in the crisis years was counterbalanced by underperformance in the years immediately before and after.
Several readers emailed yesterday to make the Berkshire-is-better-because-of-lower-risk claim in terms of Berkshire’s large cash holdings. They pointed out, approvingly, that the group managed to track the index while holding a large cash reserve. But holding cash for cash’s sake does not earn companies a gold star. The company has to show that, at the right moment, it can deploy the excess cash to its advantage.
Which brings us, neatly, to the question of what if anything Berkshire — whether under Buffett or its next generation of leaders — can do to present a distinctive value proposition to investors in the future, other than index-like returns and an amorphous claim of greater safety. Of course the company has a loyal following among investors now. But at some point the Buffett public relations magic will fade, and Berkshire will be assessed as a diversified conglomerate that is substitutable by an index fund.
Berkshire’s cash pile is rising quickly relative to its total assets, in part because, in the last quarter, it was a net seller of stocks, including those of its biggest holding, Apple:
How might Berkshire Deploy this cash or, more to the point, change its structure? The company has never been frozen in time. Its addition of the businesses that make up Berkshire Hathaway Energy over the past 25 years, and of Burlington Northern in 2009, represented a major shift towards investment-hungry businesses that could absorb the rivers or capital the rest of the Berkshire throw off, while earning an acceptable return. Similarly the huge bet on Apple (its holdings peaked at almost $180bn last year) represented a huge shift in Berkshire’s view of technology.
It may be lack of imagination on my part, but I can only think of a few obvious options that might, if not help Berkshire outperform the index, at least become a more distinct alternative to it:
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More very large, Apple- or Burlington Northern- like single stock bets or acquisitions. I am surprised, looking through Berkshire’s 13-F filings, how many not-huge stock positions it has on big-but-not massive companies. I mean, I like Ally Financial too, but $1bn of its shares is 1/1000th of Berkshire’s assets; I’m not sure why they bother. Admittedly the field of choice is small on the stocks side. There are only about 40 companies in the world with a market cap of $250bn or more, which is about what a company would have to be for Berkshire to bet big on it without becoming a de facto owner. But there are options. A huge play on, say, JPMorgan Chase? Costco? Nestlé? It’s conceivable.
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Get rid of something big. The obvious candidate is the energy business, which is facing some serious structural headwinds, as Myles McCormick and Eric Platt recently explained in the FT. The problem is Berkshire’s model (which could be summed up in three words as “compound, compound, compound”) requires a stable of super investment-hungry businesses such as utilities to work. Get rid of the utilities and Berkshire gets rid of some terrible legal headaches and environmental risks, but gets a massive reinvestment risk in return (though you know what industry requires gobs of capital? Semiconductors).
Berkshire will be very patient, as it has always been and as it should be. But I would think, as the years pass, the pressure to change from investors might become acute, especially after Buffett is gone.
One good read
A big hospital chain goes bankrupt, a few years after its private equity owners sold their stake for a big profit to a group led by the chain’s chief executive, who subsequently took a huge dividend and bought himself a $40mn yacht. Capitalism is amazing.
