Buffett Warns Investors That Safe-Looking Bonds Can Be Risky - Bloomberg

Buffett Warns Investors That Safe-Looking Bonds Can Be Risky

February 24, 2018, 11:56 PM GMT+11 Updated on February 25, 2018, 2:47 AM GMT+11

Billionaire says company needs to make one or more huge deals

Berkshire CEO comments on market lessons in annual letter

Warren Buffett Photographer: Daniel Acker/Bloomberg

Sometimes the best lessons are worth repeating.

Billionaire investor Warren Buffett used his widely-read annual letter to Berkshire Hathaway Inc. shareholders on Saturday to again call out the wasteful fees that many money managers charge. He highlighted the risk of bonds and emphasized the importance of sticking with a simple investment strategy.

“Performance comes, performance goes,” Buffett wrote. “Fees never falter.”

The letter was notably shorter than in years past, at 17 pages versus 29 in the 2016 version, and didn’t include commentary on some of the company’s largest stock holdings.

Buffett, chairman and chief executive officer at Berkshire, meditated on what he thinks people should take away from his charitable bet against Protege Partners. He challenged the asset manager to pick a group of hedge funds that it thought would beat an S&P 500 Index fund over 10 years. When the wager concluded on Dec. 31, the index fund had won easily.

Buffett also drew a lesson from a tweak he and Protege made to the bet. Five years in, the two parties took the wagered amount out of Treasury bonds after yields fell and put it in shares of Berkshire. That led to Buffett’s charity getting more than double the promised $1 million, and bolstered his urging of investors to stick with stocks even though they can be riskier in the short-term.

‘Terrible Mistake’

“It is a terrible mistake for investors with long-term horizons -- among them, pension funds, college endowments and savings-minded individuals -- to measure their investment ‘risk’ by their portfolio’s ratio of bonds to stocks,” Buffett wrote. “Often, high-grade bonds in an investment portfolio increase its risk.”

Buffett’s advice to investors comes in a month when the U.S. equity market experienced its worst single-day plunge in almost seven years. He warned against using leverage to invest in stocks because it can accentuate panic during periods of volatility.

“There is simply no telling how far stocks can fall in a short period,” he wrote. “Even if your borrowings are small and your positions aren’t immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

He also spent much of the letter explaining Berkshire’s results for 2017, which were aided by a huge gain on the recent U.S. tax overhaul. The Omaha, Nebraska-based conglomerate’s insurance businesses, however, posted a rare underwriting loss.

He discussed some of the challenges to finding large deals. Cash and cash equivalents have been piling up at Berkshire -- reaching $116 billion by year end -- but Buffett said most of the businesses he looked to buy last year were too expensive.

“We will need to make one or more huge acquisitions,” Buffett wrote. “Our smiles will broaden when we have redeployed Berkshire’s excess funds into more productive assets.”

Buffett wrote that his “one sensible” standalone deal last year was to buy a stake in the owner of the Pilot Flying J truck stop chain. And he couldn’t resist making a plug for the business.

“When driving on the Interstate, drop in," he encouraged shareholders in the letter. “PFJ sells gasoline as well as diesel fuel, and the food is good. If it’s been a long day, remember, too, that our properties have 5,200 showers.”

Succession Planning

Buffett wrote the company’s goal is to increase earnings of its businesses outside of insurance through acquisitions. That side of the company is now run by Greg Abel, who was promoted in January to oversee those subsidiaries within the conglomerate. At the same time, Buffett put another longtime Berkshire executive, Ajit Jain, in charge of insurance operations. Both were also appointed to the board as part of a move toward succession planning.

“You and I are lucky to have Ajit and Greg working for us,” Buffett told shareholders in the letter. “Each has been with Berkshire for decades, and Berkshire’s blood flows through their veins. The character of each man matches his talents. And that says it all.”

The 87-year old reiterated that while he’s “never felt better,” the company has a plan in the works for when he’s no longer running it.

“Our directors know my recommendations,” he wrote. “All candidates currently work for or are available to Berkshire and are people in whom I have total confidence.”

— With assistance by Vincent Bielski, and Luke Kawa