Warren Buffett’s Preferred Equity Allocation Is 100%. Why the Berkshire CEO Hates Bonds.

The

Berkshire Hathaway

(ticker: BRK.A and BRK.B) CEO wrote in his annual shareholder letter that his penchant for stocks goes back a long way. He made his first investment in March 1942 at age 11, purchasing $114.75 of Cities Services preferred stock, which amounted to all his savings.

At the time, the Dow Jones Industrial Average closed at 99, “a fact that should scream at you. Never bet against America,” Buffett wrote. The Dow is now close to 34,000.

“After my initial plunge, I always kept at least 80% of my net worth in equities. My favored status throughout that period was 100%–and still is,” Buffett wrote. He has noted in Berkshire’s “owner’s manual” that he has over 98% of his net worth in Berkshire stock.

Buffett wrote in the manual that he’s comfortable with his “eggs-in-one-basket” investment in Berkshire “because Berkshire itself owns a wide variety of truly extraordinary businesses.”

“Indeed, we [he and vice chairman Charlie Munger] believe that Berkshire is close to being unique in the quality and diversity of the businesses in which it owns either a controlling interest or a minority interest of significance,” Buffett wrote.

His nearly 100% equity approach is something that many financial advisors would reject as too risky, particularly for retirees. He doesn’t have to worry about relying on Social Security if he takes a big financial hit given that his Berkshire holding is worth over $100 billion and he has more than $1 billion of other assets.

Berkshire’s investment strategy with its insurance businesses sets it apart from virtually every other major insurer given its heavy equity orientation.

In its 2021 10-K report, Berkshire disclosed that its vast insurance businesses held $335 billion of stocks, $95 billion of cash and equivalents, and just $16 billion of bonds at year-end. Berkshire’s insurance liabilities, or float, totaled $147 billion at year-end 2021.

Berkshire had a total cash position across all its businesses of $147 billion and equities of $351 billion, with the insurance operations representing the bulk of both.

Berkshire’s insurance asset allocation is roughly 75% stocks, 21% cash, and 4% bonds. This is an interesting alternative to the standard 60/40 mix of stocks and bonds and amounts to a “barbell” strategy of higher-risk stocks and low-risk cash.

It’s something for financial advisors to consider given the risk in bonds given deeply negative real interest rates and the prospect of higher cash returns assuming the Federal Reserve starts boosting interest rates in the coming months. Cash could be yielding 2% in a year from now, from nearly zero.

It’s notable that the bulk of Berkshire’s bondholdings are in foreign government debt–some $11 billion of the $16 billion. This indicates how little Buffett thinks of Treasuries as an investment.

Berkshire has little or no municipal bonds, unlike most insurers. Individuals have long favored munis. Berkshire however does like Treasury bills, with the ultrasafe government short-term obligations representing the bulk of its cash and equivalents. Buffett wants to have maximum liquidity if Berkshire ever needs it.

Buffett, however, is less enamored of stocks and has been so for more than a year. He wrote in his letter that there is “little that excites us” in equity markets. Berkshire was a net seller of stocks in 2020 and 2021

Buffett’s approach has paid huge dividends for Berkshire given the stock market rally of the past decade. He has viewed bonds as a bad bet given historically low yields. Berkshire’s equity orientation has gotten more extreme. Berkshire has cut its bond portfolio in half since 2010 while its equity portfolio is up sixfold and cash up more than fourfold.

At

Chubb

(CB), one of the largest property and casualty insurers, bonds made up about 90% of its investment portfolio at year-end 2021 and stocks and cash about 5% each. That asset allocation is common among insurers.

The typical property and casualty insurer has the vast portion of its invested assets in bonds because of the greater volatility of stocks and policies of rating agencies that encourage bondholdings.

Berkshire is able to carry such a heavy equity weighting because its insurance operations are overcapitalized and Berkshire has significant earnings outside its insurance businesses. Buffett has said that one important benefit of Berkshire’s conglomerate structure is the ability to have an equity-heavy asset mix at its insurance operations.

Here’s what Buffett wrote in his 2020 annual letter about Berkshire’s insurance investment approach:

“Overall, the insurance fleet operates with far more capital than is deployed by any of its competitors worldwide. That financial strength, coupled with the huge flow of cash Berkshire annually receives from its non-insurance businesses, allows our insurance companies to safely follow an equity-heavy investment strategy not feasible for the overwhelming majority of insurers.”

“Those competitors, for both regulatory and credit-rating reasons, must focus on bonds. And bonds are not the place to be these days. Can you believe that the income recently available from a 10-year U.S. Treasury bond–the yield was 0.93% at year-end–had fallen 94% from the 15.8% yield available in September 1981? In certain large and important countries, such as Germany and Japan, investors earn a negative return on trillions of dollars of sovereign debt. Fixed-income investors worldwide–whether pension funds, insurance companies or retirees–face a bleak future.”

Buffett was right because the 10-year Treasury note now yields nearly 2% and bond investors have had negative returns in the past year.

Write to Andrew Bary at andrew.bary@barrons.com