One of the unusual quirks of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)'s balance sheet is that the conglomerate has such a substantial investment in Treasury bills.
With interest rates where they are today, Treasury bills are a particularly poor investment; especially when compared to the returns the S&P 500 index has generated over the past 10 years.
Having so many tens of billions of dollars invested in these low-yielding instruments has undoubtedly had an impact on Berkshire's returns since the financial crisis. In fact, one shareholder calculated that this conservative investment policy has cost Buffett and his investors around 12% of Berkshire's current book value.
"A good alternative would be for you to invest most of Berkshire's excess cash in a well-diversified index fund until you find an attractive acquisition or buy back stocks.
"Had you done that over the past 15 years, all the time keeping the $20 billion cash cushion you want, l estimate that at the end of 2018, the company's $112 billion balance in cash, cash equivalents, in short-term investments and Tbills, would've instead been worth about $155 billion.
The difference between the two figures is an opportunity cost equal to more than 12 percent of Berkshire's current book value." -- a question posed by Carol Loomis to Buffett at the 2019 Berkshire annual meeting as proposed by Mike Elzahr of Boca Raton, Florida
Index funds are not always the answer
This is an interesting perspective, and one and that deserves more attention.
Buffett could have produced much higher returns for himself and his shareholders if he had invested the cash in a low-cost index fund over the past decade. But this approach wouldn't have been entirely sensible because, while index funds are a great way to invest in the market over the long term, one of their major drawbacks is that they match the market.
To be able to take advantage of the opportunities presented by Mr. Market in a bear market, value investors have to have plenty of cash available to them. If you were to invest all of your money in an index fund, your money would drop in value in line with the market, therefore limiting your financial firepower to take advantage of the market environment and buy deeply discounted securities.
Buffett tried to get this point across when he answered the question. "I would say that if we'd instituted that policy in 2007 or '08, we might have been in a different position in terms of our ability to move late in 2008 or 2009," the Oracle of Omaha opined.
"You know, we committed $10 billion a week ago. And there are conditions under which... and they're not remote, they're not likely in any given week or month or year ... but there are conditions under which we could spend a hundred billion dollars very, very quickly. And if we did ... if those conditions existed ... it would be capital very well deployed, and much better than in an index fund," he went on to say before concluding:
"So, we've been -- we're operating on the basis that we will get chances to deploy capital. They will come in clumps in all likelihood. And they will come when other people don't want to allocate capital."
Cash is king
Index funds are an excellent instrument for regular investors, but they're not a solution to all investors' problems.
Buffett has been able to achieve the returns he has done over the years by waiting for the perfect opportunity and then acting quickly, often at times when the rest of the market is too scared to. You will never get this opportunity with index funds.
Yes, in hindsight, Buffett might have produced higher returns, but if the market fell 50% tomorrow, those returns would be wiped out, and he wouldn't have the capital available to take advantage of the once-in-a-decade opportunities available to him. This is something regular investors can learn from as well. Index funds do produce excellent returns over the long term, but in a rough market, there's only one asset class that always wins, and that is cash.
Disclosure: The author owns shares in Berkshire Hathaway.
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