Fixed interest investors are around the world have been given the gospel from St Warren of Omaha – what they are doing these days isn’t very smart.
Buffett said in his annual letter to shareholders that the current ultra-low interest rates around the world had diminished the appeal of the bond market.
“Bonds are not the place to be these days,” Buffett said.
“Fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future” he warned them.
Buffett noted that the benchmark 10-year Treasury yield had fallen drastically to 0.93% at the end of 2020 from 15.8% in September 1981.
Investors earn a negative return on trillions of dollars of sovereign debt in Germany and Japan, he added.
And there’s an irony here – governments around the world are issuing trillions of dollars of bonds to help pay for stimulus packages to help economies recover from 2020’s assault by the pandemic.
Central banks are major investors, buying hundreds of billions of dollars worth of bonds to help steady financial systems and fund in some part banks and other lenders and borrowers. In Buffett’s view it is a ‘bleak’ transaction for both sides.
The price of bonds has fallen in the past fortnight on misplaced nerves about the outlook for inflation. Suddenly it’s a fear where none exists and that has upset markets in the closing weeks of February as investors denied what was before their very eyes – that central banks are not worried about inflation (except the fatuous chief economist of the Bank of England).
That was the case up to Friday at least when yields in the huge US market reversed course at the end of a confusing week that saw the yield on the bellwether US 10% Treasury slump to 1.41% at Friday’s close from a brief high the day before of just over 1.60%.
And Buffett speaks with a very different investment idea for his insurance business – the world’s largest – motor vehicle, property and casualty, catastrophe, long tail, medical, annuities, life and especially reinsurance (taking on insurance risks to help other companies meet their claims and offer cover each year).
The Berkshire companies are all AAA-rated businesses
His insurance empire (such as Geico, National Indemnity) straddles the US and the globe and contrary to the practice in the sector, has a small exposure to bonds and fixed interest securities and invests its float in companies and in securities, such as equities, compared to the size of its risks (claims, potential and actual).
“Overall, the insurance fleet operates with far more capital than is deployed by any of its competitors worldwide,” Buffett pointed out.
“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.
“Some insurers, as well as other bond investors, may try to juice the pathetic returns now available by shifting their purchases to obligations backed by shaky borrowers.
“Risky loans, however, are not the answer to inadequate interest rates. Three decades ago, the once-mighty savings and loan industry destroyed itself, partly by ignoring that maxim.”
Buffett said that Berkshire now enjoys $US138 billion of insurance “float” – funds that do not belong to us, but are nevertheless ours to deploy, whether in bonds, stocks or cash equivalents such as U.S. Treasury bills.
“Float has some similarities to bank deposits: cash flows in and out daily to insurers, with the total they hold changing very little.
“The massive sum held by Berkshire is likely to remain near its present level for many years and, on a cumulative basis, has been costless to us. That happy result, of course, could change – but, over time, I like our odds,“ he added in his annual letter.
Berkshire has extensive business links in Australia offering reinsurance and other deals to local companies such as IAG and Suncorp. Berkshire has a 20% quota share deal with IAG which has proven to be a good earner for both – it allows IAG to use less capital than if it didn’t have the risk, in exchange for Berkshire’s company taking 20% of gross written premiums, Berkshire will meet 20% of claims. Berkshire also owns just under 5% of IAG.
