Warren Buffett (Trades, Portfolio) has long been a leading supporter of index investing, but seemingly does not practice what he preaches. At the 2019 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual shareholder meeting earlier this month, he was asked why he chooses to hold cash and government bonds, rather than investing in the S&P 500.
One attendee pointed out that if Berkshire had invested in the index over the past 15 years while looking for new opportunities to deploy capital (and maintaining a $20 billion cash reserve), rather than holding cash and low-yield Treasury bonds, that would have increased Berkshire’s current book value by over 12%.Â
Size matters
While acknowledging this could be a valid strategy, Buffett noted that deploying billions in capital is different from managing even a billion. Presumably, if Berkshire was heavily invested in index funds and needed to free up cash in a hurry, its sheer size would prevent it from doing so effectively:
“I would say that if we had instituted that policy in 2007 or 2008, we might have been in a different position in terms of our ability to move late in 2008 or in 2009. It has certain execution problems with hundred of billions of dollars than it does if you were having a similar policy with a billion or two billion. But that’s certainly a rational observation, and looking back on 10 years of a bull market it really jumps out at you.”
Moreover, the scenario in which Berkshire would want to deploy huge amounts of capital quickly would probably be one in which the market as a whole was selling off significantly. As a result, it would be closing its index positions in a way that would probably be value-reducing.
“There are conditions under which - and they’re not likely in any given week or month or year - but there are conditions under which we could spend $100 billion very, very quickly. And if we did, if those conditions existed, the capital would be very well deployed, much better than in an index fund...We’re operating on the basis that we will get chances to deploy capital, and they will come in clumps in all likelihood. And they will come when other people don’t want to allocate capital. You know in the next 20 to 30 years, there’ll be two or three times when it’ll be raining gold and all you have to do is go outside. But we don’t know when they will happen and we have a lot of money to commit.”
A strong fiduciary duty
It’s not just about being able to easily deploy cash, however. Buffett and Charlie Munger (Trades, Portfolio) see themselves as stewards of their shareholders’ capital, so they try to act in a way that first and foremost preserves that capital. This means they err on the side of caution when it comes to investing, preferring to pass up some opportunities to make money if it means they can guarantee a greater degree of safety.
“One thing you should very definitely understand about Berkshire is that we run the business in a way that we think is consistent with serving shareholders who have virtually all of their net worth in Berkshire. I happen to be in that position myself, but I would do it that way under any circumstances. We have a lot of people who trust us, who really have disproportionate amounts of Berkshire compared to their net worth, if you were to follow standard investment procedures. We want to make money for everybody, but we also want to make very, very sure that we don’t permanently lose money for anybody that buys our stock somewhere around intrinsic business value to begin with.”
Only time will tell whether Berkshire’s impressive record will keep going. However, we do know that when the next market downturn does happen, Buffett and Munger (or their successors) will be much better placed to buy the bottom than most other institutions.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Are Index Funds Bad for Corporate Governance?
- Buffett: Volatility Is Not Risk
- Why Is Financial Risk Like a Forest Fire?
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