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So following on from my last post and video, with many market watchers calling for some sort of doom and overdue big pullback in the stock market, what can we learn from other great investors, like Warren Buffett’s, recent selling? As he’s widely considered the most famous and is therefore the most closely watched big investors and what has he been doing recently? He has been adjusting his asset allocation to a higher proportion of cash.
Although there are a few key things to bear in mind, especially with Buffett and his gargantuan investment firm, Berkshire Hathaway.
First, while his cash hoard is the largest he has had in history, he still has about 70% invested with around 30% of his portfolio in cash or cash equivalents. So that is the majority invested.
Second, he can earn about 4-5% on his cash today, whereas just a couple of years ago he could earn near zero on cash and therefore cash relative to inflation was a guaranteed losing trade. So it’s not so bad to hold cash for a few quarters when deciding where to invest next.
Third, Berkshire is so big that even if he puts $1Bn to work and it doubles on the best investment he can find this year, that extra $1Bn, while a great return, is about a 1% return for his total portfolio and therefore his investors. And there are only so many hours in the day, so can’t have 100 to 200 of these $1bn investments. He instead needs to find ever larger investments to make returns and there aren’t that many massive companies that he can invest $10, 20 or more billion into without breaching the 10% ownership threshold creating all sorts of takeover and mandatory disclosure issues for him.
Fourth, if he can get a guaranteed 4-5% on T-bills (US government debt) then he needs to find other investments that he thinks will generate him a greater return over the coming 90 days. And while Apple was a superstar investment for him, it became such a large proportion of his portfolio it only made sense to reduce that position after such a great 8 odd years owning it.
Fifth, he’s a patient investor and he aims to buy great companies at a reasonable, or ideally a discounted, price. So clearly he does not presently see many of those that fit his very specific needs – massive scale and liquidity and on sale, as many massive companies are fairly valued or even priced for growth. So not on sale currently.
Sixth, and finally, raising a meaningful amount of cash or the opposite, investing a meaningful amount of cash, for Buffett takes a significant amount of time. For Buffett to close out a position to raise 10-20% of his portfolio in cash means selling $100-200bn in holdings. If you sell that much too quickly you can cause a panic and typically the liquidity is just not there in stocks at that scale. Meaning he literary could not find a buyer for that much stock and needs to drip it into the market over weeks and months. Even at that slow speed, it will put downward pressure on whatever he is selling and it will take months at best. So if he wants to raise some cash so he is ready to buy something meaningful in size, relative to Berkshire’s size, then he needs to plan ahead by 6-12 months, which means you see him selling across multiple quarters. And then as he is the most watched investor, all the theories come to light as to what his reasons for selling might be, when maybe he is just getting ready based on all the reasons I have listed and many others I have not. And the reverse is also true, when he wants to buy, he can’t do it quickly as there isn’t $10bn let alone $100bn of liquidity just sitting there on sale. Again it takes days at best, if not weeks and months.
So for us normal investors, what are some key lessons we can learn from Buffett’s asset allocation changes? We can of course copy him and simply consider raising 10 or 20 or even 30% cash at the moment as volatility is rising and many valuations are not looking so cheap (but nor are many stocks, or the entire market, excessively overvalued either, based on forecast growth)…but as I said in my most recent in-depth post and video, link here for that. If you are developing a bearish view and are one of those prudent long-term investors who does their best to invest regularly, then perhaps instead of selling some of your stocks because you want to raise some cash as a proportion of your portfolio, like Buffett is doing, you could limit realising your gains and then having tax to pay by maintaining 90 or 100% of your long-term capital invested. Then to express your bearish view you instead delay some of your regular monthly investments for a few months as a way of raising extra capital. This way if your forecast downturn arrives you will have more capital than usual to put in when you feel it is the right time to invest again at a lower level but…if you are not right and no meaningful pullback arrives, or you time it poorly and miss any pullback, which often happens, then you will still have your portfolio predominantly invested and can simply return to investing regularly and you can kind of have a hedge to have the best of both worlds. Of course you miss out on getting your regular investments in sooner but you also won’t have tax to pay by selling your existing investments and realising any existing gains and have to time a pullback perfectly to make it worth selling and buying again. Or alternatively you can buy some put options as a hedge, but that’s a conversation for another day!
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