Stephen Gandel has an interesting piece in Fortune this week on Warren Buffett and interest rates. He writes:
Buffett said that he wouldn’t have predicted that interest rates could have stayed this low for this long without a problem. “So far, I have been wrong on interest rates,” said Buffett. “It is so hard for me to believe that you can drop money from a helicopter and not have inflation, but we haven’t.”
Two years ago, the Berkshire CEO said he was worried about the Federal Reserve’s efforts to stimulate the economy. In particular, Buffett warned that the end of the Fed’s so-called quantitative easing program, in which the U.S. central bank bought billions in bonds to drive down interest rates, would end badly.
It’s true. Buffett basically adhered to many of the myths I’ve emphasized over the years. For instance, in a 2010 interview Buffett said:
I think [QE] opens up certain dangers in terms of people worrying about the United States government printing money.
Of course, the “money printing” never led to high inflation. And despite many claims, there’s no reason to think that QE will lead to high inflation. And I would emphasize that anyone who hasn’t understood QE at an operational level has misunderstood its impact and probable outcomes That is, people who viewed QE as “money printing” were at a huge disadvantage because they were incorrectly describing the transmission mechanism through which QE works. Had Buffett viewed QE as an “asset swap” (a simple exchange of bonds for cash) then he likely wouldn’t have been worried about the dollar, inflation or rising interest rates. When combined with the understanding of a debt deleveraging it was clear that lowflation and deflation remained much higher risks than very high inflation.
Now, Buffett is no macro investor, but like many investors he relies on some understanding of macro. For instance, Buffett owns $87 billion in cash equivalents and fixed income securities. That’s over 15% of Berkshire’s entire asset base. Understanding the likely path of interest rates is crucial to properly managing that position. What’s more interesting is that Buffett completely reallocated his bond portfolio in late 2008 and early 2009 after QE was initiated. He shifted from a nearly $6 billion position in T-Bonds in early 2008 to just $2.5 billion in 2009. And he’s essentially maintained that position since. And T-bonds have rallied over 70% since he started to pare back his US government bond exposure. That means he’d be sitting on a $10 billion T-bonds position at present had he just maintained the original $6 billion allocation.
We can’t be certain that Buffett made these changes based on concerns about inflation and rising rates, but that would certainly make sense. And if that’s right then it means that Warren Buffett left billions of dollars on the table in large part because of macro misunderstandings. It just goes to show that you don’t need macro to be a successful investor, but misunderstanding macro can certainly end up costing you quite a bundle.
NB – Some people have noted that Buffett might have shifted from bonds to stocks, however, Berkshire Hathaway’s allocation of equity securities has fallen as a % of assets since 2008 while cash and fixed income assets have increased as a % of assets. Further, since 2008 T-Bonds have generated 8% annualized returns with a Sharpe ratio of 0.64 while stocks have generated returns of 6.6% with a Sharpe of 0.34. Buffett, like many investors, has been holding way too much cash in part because he’s been afraid of the prospects of holding safe interest bearing government bonds.