Asset allocation out of step with modern investment management

Portfolio management

Using the KISS principle

The title of this post refers to Warren Buffett’s approach to asset allocation. In fact, Buffett simply doesn’t have an asset allocation strategy. He will invest in asset classes other than stocks from time to time when some other type of investment is screaming at him. This is what I propose to look at in this post.

We start off by looking at Berkshire Hathaway. Next, we’ll compare what Buffett does with modern investment management practice as exemplified by Blackrock.

I should point out that I follow the Buffett approach to asset allocation with the exception that my percentage allocation to cash is very small whereas Berkshire Hathaway maintains a huge pile of near cash. My needs are different.

Berkshire Hathaway asset allocation

This is from the 2005 Berkshire Hathaway Annual Meeting:

“CHARLIE MUNGER: Well, if you look at Berkshire, you will find that it really doesn’t do much of conventional asset allocation to categories.

We are looking for opportunities and we don’t much care what category they’re in, and we certainly don’t want to have our search for opportunities governed by some predetermined artificial bunch of categories.

In this sense, we’re totally out of step with modern investment management, but we think they’re wrong.” (Emphasis added)

Warren Buffett has explained what drives his asset allocation. In the following quote he writes about “the investment”. What he’s referring to is any kind of investment, be it stocks, bonds, alternatives, real estate, or whatever you like:

“The investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase -irrespective of whether the business grows or doesn’t, displays volatility or smoothness in its earnings, or carries a high price or low in relation to its current earnings and book value. Moreover, though the value equation has usually shown equities to be cheaper than bonds, that result is not inevitable: When bonds are calculated to be the more attractive investment, they should be bought.” (Buffett W. E. The Essays of Warren Buffett: Lessons for Corporate America. 1998) p86 (Emphasis added)

I might add that I was 100% in 90-day treasury bills from 1985 to 1991 and 100% in two-year gov’t bonds from late 1998 to late 2002. At all other times I have been 100% equities.

An aside about growth

And don’t be confused when he writes “irrespective of whether the business grows or doesn’t”

In discussing the two customary approaches to investing, ‘value’ and ‘growth’, Buffett confesses to earlier fuzzy thinking and says:

“In our opinion, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive. In addition, we think the very term ‘value investing’ is redundant. What is ‘investing’ if it is not the act of seeking value at least sufficient to justify the amount paid?” (Buffett, 1998) p85 (emphasis added)

Modern Investment Management

As I understand it, conventional modern investment management practice calls for a dynamic asset allocation strategy based the outlook for the economy, interest rates, inflation, geopolitics, international diversification, big themes like globalization, demographics, climate change, ESG and so on.

BlackRock is one of the world’s leading providers of investment, advisory and risk management solutions. It probably exemplifies Modern Investment Management. Here’s what I gleaned from Blackrock’s website:

BlackRock describes the various ASSET CLASSES as follows:

• Alternatives

Growing demand and complexity in private markets calls for a new era of alternatives to overcome long-standing hurdles for investors. We are helping to evolve the industry to overcome those challenges and defining a new kind of partnership for our clients.

• Equities

As investors begin to rebalance, we see several opportunities to take advantage of changing equity markets and attractive valuations through active equity management. In an uncertain environment, we believe investors may find benefits in remaining disciplined, diversified, risk aware and flexible in their approach.

• Fixed income

After decades of historically low yields, investors have been underweight duration and many took on more risk to reach return objectives. With the move higher in rates, fixed income can again provide ballast for a portfolio and investors are revisiting underweights. It’s time to re-assess what’s inside your fixed income allocation.

• Multi-asset

Diversified return drivers

We access a full range of portfolio building blocks including index, factor, and alpha-seeking strategies.

Global Tactical Asset Allocation (GTAA)

GTAA strategies seek to generate performance through the exploitation of information asymmetries and behavioural biases among investors. GTAA is designed to deliver meaningful performance, diversification and capital efficiency benefits.

Diversified strategies

In addition to leveraging BlackRock’s global expertise in single asset class investing and risk management, the dedicated Diversified Strategies team has strong base of macro thematic research to identify key themes that will drive asset prices has become more important than asset class selection alone.

Multi-asset income

BlackRock’s multi-asset income strategies take a risk-first approach to generating income. We believe an unconstrained investment universe provides the opportunity to universe provides the opportunity to deliver attractive income opportunities across geographies, sectors, and asset classes.

Berkshire Hathaway vs BlackRock

The contrast between the Buffett approach to asset allocation and that of BlackRock could not be starker. BlackRock is selling its services. Fair enough. It is my general observation that, to make its services seem essential, the investment industry tends to make everything appear more complicated than it really is.

In all his writing, Buffett takes the complicated and explains it in a simple and understandable way. Ironically, one problem with true experts like Warren Buffett is that they make complex and difficult things seem easier than they really are. Successful investing is actually very difficult. But the simple fact is that the most complex human undertakings are best approached using the KISS principle. KISS means keep it simple stupid.

Conclusion

My own asset allocation strategy largely follows Warren Buffett’s approach. I take advantage of the fact that equities are generally a more rewarding investment than bonds. I also keep in mind that when bonds are calculated to be the more attractive investment, they should be bought. I find complex asset allocation strategies to be completely unattractive. I can get all the diversification and balance I need in a concentrated portfolio of the equities of superb companies.

+++++++++++++++

You can reach me by email at rodney@investingmotherlode.com

I’m also on Twitter @rodneylksmith

+++++++++++++++

Check out the Tags Index on the right side of the Home page that goes from ‘accounting goodwill’ to ‘wisdom of crowds’. This will give readers access to a host of useful topics.

+++++++++++++++

You can also use the word search feature on the right-hand side of this page to find references in both blog posts and also in the Motherlode.

+++++++++++++++

There is also a Table of Contents for the whole Motherlode when you click on the Motherlode tab.

Want to dig deeper into the principles behind successful investing?

Click here for the Motherlode – introduction.

If you like this blog, tell your friends about it

And don’t hesitate to provide comments or share on Twitter and Facebook