Investors searching for a guru that has been uber-bullish on the U.S. economy for decades need not look beyond Warren Buffett (Trades, Portfolio). In many televised interviews and his annual letters to shareholders of Berkshire Hathaway, Inc. (BRK.A, Financial) (BRK.B, Financial), the guru has emphasized why the largest economy in the world will continue to grow infinitely.
However, over the last couple of years, both Buffett and Charlie Munger (Trades, Portfolio) have been vocal about their inability to find lucrative investment opportunities as a result of markets being overvalued. In 2019, the Oracle of Omaha said that great businesses are trading at sky-high valuations, making it impossible to acquire a controlling stake at a fair price.
According to the fourth quarter 13F filing, Berkshire invested in two index funds, which marks the first time the conglomerate has executed such an investment. Investors can draw a few conclusions from this move by the legendary investor.
Buffett’s view on index funds
The guru has advised retail investors to start their journey by initially allocating a large portion of their portfolios to index funds, as these provide diversification benefits whilst enabling them to obtain the services of an expert fund management team. Buffett, in an interview with John C. Bogle for his book titled "The Little Book of Common Sense Investing," said:
“A low-cost index fund is the most sensible equity investment for the great majority of investors. By periodically investing in an index fund, the know-nothing investor can actually outperform most investment professionals.”
However, Buffett is not a know-nothing investor. In fact, he is one of the most successful investors the world has ever seen, which might be the reason why Berkshire never invested in index funds that track the performance of the broad market or a specific industry. The below chart is proof that actively managing the conglomerate’s portfolio has been rewarding to shareholders.
Source: Marketwatch
Considering the massive success of actively picking companies to invest in over the last three decades, the move by Berkshire to invest in index funds in the fourth quarter of 2019 comes as a surprising strategy.
A bet on the U.S. economy
Below are the two funds the company bought in the last quarter:
The first conclusion that can be drawn from this tactical decision is that Berkshire, led by Buffett, is still bullish on the American economy, despite the lack of large-stake value opportunities. Both of the funds represent the broad U.S. market, and if overall economic growth slows down, the value of these investments will drastically decline with a change in the investor sentiment. While it is entirely possible that the decision to invest in index funds was more influenced by either Todd Combs or Ted Weschler, I find it highly unlikely that this investment decision would have been made without Buffett's belief in its advantages.
Therefore, I feel certain that Berkshire has a positive view of the long-term outlook for the U.S. economy. Investors should also remain focused on the big picture without being distracted by temporary market movements driven by macroeconomic and geopolitical developments.
An easy and effective way to achieve diversification benefits
Investing in funds that track the S&P 500 Index is a tried and tested method of gaining exposure to a wide range of stocks representing multiple industries and business sectors.
Source: ETF.com
The overall risk of the portfolio of Berkshire is reduced with the addition of these two funds, and this emphasizes the importance of diversification at this late end of the business cycle.
A fix for the growing cash-pile problem
At the end of 2019, Berkshire Hathaway was holding on to approximately $128 billion in cash according to company filings, which is a record high. The decade-long bull run has pushed stock prices to historic highs, creating a dilemma for Buffett and his company as attractive investment opportunities have become scarce. However, liquid assets deliver near-zero returns in the long run, which makes holding cash not the most shareholder-friendly decision at any point in time.
Source: GuruFocus
To reduce the allocation to cash, Buffett and co. might be considering the use of index funds over making investments in a smaller number of overvalued companies, as the indexes are less-risky options.
Takeaway: never bet against America
If there’s one thing to learn from Buffett’s latest investments, it’s that investors should look at the long-term view of markets and remain bullish on the prospects for the U.S. economy, regardless of growing risks in the short term. The country has survived multiple recessions and still provided stellar returns to investors who did not panic. In an interview with CNBC in 2017, Buffet said:
“American businesses – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. The years ahead will occasionally deliver major market declines, even panics, that will affect virtually all stocks. Widespread fear is your friend as an investor because it serves up bargain purchases. For 240 years, it’s been a terrible mistake to bet against America and now is no time to start.”
The guru seems to be following his own advice by betting on American companies to deliver the goods for many years to come.
Disclosure: I do not own any stocks mentioned in this article.
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