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The Bond Market vs. Warren Buffett: A Different Perspective

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Andrew R. Michaud

• November 07, 2023

It seems like everyone is saying the bond market looks attractive now, but one notable investor isn’t on board.

Warren Buffett's Stance

Warren Buffett, the 93-year-old CEO of Berkshire Hathaway (ticker: BRK.A, BRK.B), has long favored stocks over bonds. This view aligns with the historical outperformance of stocks, and despite the surge in rates since March 2022, Buffett's perspective remains unchanged.

Berkshire Hathaway's Investment Portfolio

To understand Buffett's stance, let's take a closer look at the enormous investment portfolio managed by Berkshire Hathaway.

According to Berkshire's quarterly 10-Q filing with the Securities and Exchange Commission, as of September, their portfolio comprised approximately:

• $340 billion invested in stocks
• $157 billion in cash, primarily held in U.S. Treasury bills maturing in less than a year
• Only $22 billion in bonds

It's worth noting that the bond portfolio held by Berkshire is largely cash-like, with approximately 75% ($17 billion) maturing within the next 12 months. In contrast, just 1% of the overall portfolio is allocated to bonds with a maturity longer than one year. Moreover, the bond portfolio has declined by approximately $3 billion since the beginning of 2023.

An Increasing Emphasis on Equities

Over time, Berkshire's investment portfolio has become even more equity-heavy. Back in 2020, when 10-year Treasury debt yielded less than 1%, Buffett expressed astonishment at the willingness of bond investors to accept such a paltry rate. Despite the current 4.6% yield on 10-year Treasury debt, Buffett remains cautious and continues to hold back.

The Role of Bonds in P&C Insurance Operations

A significant portion of Berkshire's investment portfolio supports its massive property and casualty insurance operations. Insurance companies typically invest the premium income received from customers and utilize the proceeds to pay claims, often years later. To ensure their ability to honor claims, regulators require P&C insurers to primarily invest in bonds due to the lower risk compared to stocks.

Comparing Berkshire Hathaway to Chubb

For a comparison, let's consider Chubb (CB), one of the largest property and casualty insurers. As of the end of the third quarter, Chubb's investment portfolio consisted of approximately:

• $100 billion in bonds
• $17 billion in equities (mostly private)
• $5 billion in cash

Chubb's portfolio serves as a typical example of investment allocations among major public property and casualty insurance companies.

Despite the bond market's current attractiveness, Warren Buffett remains steadfast in his preference for stocks. With his extensive investment experience and historical performance of stocks, it's clear why he has chosen this path.

Berkshire's Unique Investment Approach

Berkshire Hathaway, led by renowned investor Warren Buffett, has established a distinctive investment strategy that sets it apart from other insurers in the industry. It employs a "barbell approach" by holding a substantial amount of both risky assets, primarily stocks with Apple (AAPL) accounting for nearly half, and low-risk assets such as cash. This significant cash position serves as a substitute for traditional bonds.

One key advantage that Berkshire enjoys is its substantial capital compared to other major insurers. This allows the company to pursue more aggressive investment opportunities. Insurance regulators acknowledge this advantage and grant Berkshire considerable flexibility in its investment decisions. With approximately $300 billion in capital, Berkshire's net worth constitutes approximately 25% of the entire U.S. property and casualty insurance industry.

During the annual meeting in May, Berkshire Vice Chairman Charlie Munger emphasized this capital advantage. He highlighted that Berkshire possesses around four times more capital than the premiums it collects each year, surpassing industry norms.

Buffett echoed Munger's sentiments regarding investment choices during the meeting. When discussing an insurance contract with American International Group (AIG), which involved a $10 billion premium to insure against $20 billion of long-term liabilities, Buffett stated, "We don't agree to put it in 5-year bonds and 10-year bonds. We don't even think that way." This highlights Berkshire's aversion to traditional fixed-income investments and its preference for more dynamic options.

In recent times, Berkshire maintained a substantial cash position during periods of zero short-term interest rates in 2020 and 2021. Buffett accepted the financial cost of holding cash because he deemed bond yields unappealing. Unlike banks like Bank of America (BAC), which heavily invested in bonds during historically low yield periods, Buffett refused to follow suit.

Buffett's decision has proven prescient as bond prices have declined with rising yields, causing some banks to experience significant paper losses. In contrast, Berkshire has benefited as short-term interest rates surged to over 5%, delivering favorable returns on its cash reserves.

While the market eagerly awaits Buffett's potential allocation of cash into bonds, it may require substantially higher yields to entice him. Wall Street continues to watch Berkshire Hathaway closely for further developments on this front.