Berkshire Hathaway As An Asset Class?

Admit it, if you’re using some sort of asset allocation strategy this question has crossed your mind. I’m not talking about indirectly owning Berkshire through a fund*, but a direct concentrated holding of the stock itself. Aside from having one of the greatest investors of all time run your money there are some additional fringe benefits. At the very least it gets you a ticket to the shareholder meeting held in Omaha every spring. Dilly bars anyone? Many have written about various pros and cons of Buffett’s businesses. The shareholder letters are publicly available to anyone who wants to read. But how has Berkshire performed as an asset in the context of an overall portfolio?

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The Factors Of Returns

The idea of exposing an investment portfolio to various “factors” (i.e. small company stocks, value stocks, etc.) as a means to improve returns has been around for decades. The value premium traces its roots back to the mid-twentieth century with the work of Benjamin Graham. Warren Buffett, a student of Graham, used value investing early on in his career to help build his fortune. Research on the size premium (small company stocks outperforming large company stocks) goes back to early 1980s and the work of Rolf Banz. [1]

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The Mythical Rebalancing Bonus-Part 2

In Part 1 I showed that as investment time increased there was, at least historically, a smaller probability of realizing a rebalancing bonus in 60/40 stock/bond portfolios. There was a lot that I left unaddressed at the time and I felt a need to develop a better understanding of the mechanics of the rebalancing bonus. Why does it work in some instances, but not in others? In other words, more was needed to demonstrate what actually drives the rebalancing bonus. A good place to start is with the work of Harry Markowitz, which showed that portfolio performance–both return and volatility–was mathematically related to three characteristics of the constituent assets

  1. Correlation with other assets
  2. Volatility
  3. Rate of return

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The Mythical Rebalancing Bonus-Part 1

Go to part 2

The rebalancing exercise that I performed with Shannon’s Demon implied that a premium may be obtained by rebalancing a portfolio of uncorrelated assets. These assets featured highly hypothetical performance with expected rates of return and volatility both well out-of-bounds of anything that’s likely to be seen in real world capital markets. The extreme nature of these make-believe stocks was used to illustrate what is possible.

Back to reality.

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Global Asset Allocation

If you’re interested in asset allocation strategies Meb Faber’s book Global Asset Allocation is worth a read. Generally speaking it’s short and easy to understand. The first few chapters deal with the basics of investment planning (inflation, historic rates of return of bonds, bills and stocks, etc.). Nothing new, but it lays the foundation for the content that proceeds. Whenever I read Faber’s work he always provides a few illuminating morsels of information that seem so simple you wonder why they haven’t been discussed more broadly. Here’s a few interesting points:

  • There are only two states that any given portfolio or asset can be at: all time highs or drawdowns
  • The traditional 60/40 stock/bond allocation has spent only 22% of it’s time at all time highs and the remaining 78% in a period of drawdown
  • The largest financial asset class in the world is foreign ex-US bonds
  • US stocks represent about half of all global equities

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