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Global Report
Warren Buffett’s 2022 Letter to Berkshire Hathaway’s shareholders.
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Local Report
Regulation 28: “Yes”, to infrastructure; “No”, to Crypto. Limited Offshore Exposure Remains a concern.
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Global and local indicators to keep you updated on all aspects of the market.
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Global Report: Warren Buffett’s 2022 Letter to Berkshire Hathaway’s shareholders.
By Gielie Fourie
INTRODUCTION: Since 1965 Warren Buffett (91) has been sending “Annual Letters” to Berkshire Hathaway’s (Berkshire’s) shareholders. Buffett has never written a book – but his Annual Letters are a treasure chest of investment wisdom. Buffett treats all shareholders equally and he likes to keep things simple. Each shareholder receives a copy of his Annual Letter. Despite being one of the biggest companies in the world, this year’s Annual Letter is only 12 pages long. No discussions are granted to analysts, not even to large institutions. Whenever possible, important communications are released on Saturday mornings, when financial markets are closed. The reason for this is to maximise the time for shareholders and the media to absorb the news before markets open on Monday mornings.
TOP HOLDINGS: Berkshire is a diversified holding company whose subsidiaries engage in insurance, freight rail transportation, energy generation and distribution, services, manufacturing, retailing, and other activities. At 31 Dec 2021 the top 15 holdings were valued at $331 billion (bn). The cost price was $78 bn, representing a “book” profit of $253 bn, or 324%. The 15 holdings, all of them are listed companies, include familiar names like American Express, Apple (the biggest holding), Bank of America, The Coca Cola Company, General Motors, Mitsubishi Corporation, Moody’s Corporation (the ratings agency) and Verizon Communications. Its biggest and most profitable investment is GEICO, a car insurance company. GEICO is a wholly owned subsidiary of Berkshire – it is not a listed company. Warren Buffett: “GEICO, (bought in 1967), has grown Berkshire’s total (cash) float from $19 million when we entered the insurance business, to $147 billion. So far, this float has cost us less than nothing.”
PERFORMANCE: These 15 holdings are the real drivers of Berkshire. This is what Charlie Munger (98), Buffett’s long-time business partner, has to say about the top 15 holdings: “If you took our top fifteen decisions out, we’d have a pretty average record. It wasn’t hyperactivity, but a hell of a lot of patience. You stuck to your principles and when opportunities came along, you pounced on them with vigour.” In addition to these 15 listed companies, Berkshire owns more than 100 unlisted companies. Berkshire’s share performance from 1965 to 2021, compared to the S&P 500, is remarkable. The S&P 500 has increased by 30,209%. Berkshire has grown by 3,641,613%. This is not a typing error – 3.6 million percent.
BERKSHIRE’S FOUR GIANTS: Buffett calls the four biggest holdings his four “Giants”. The first Giant is GEICO, an insurance company, of which Berkshire owns 100%. The second Giant is APPLE, a listed company of which Berkshire owns 5.6%, valued at $161 bn. Giants number three and four are interesting – they are unlisted companies, and they remind one of South Africa’s struggling Transnet and Eskom. The difference is that Berkshire’s Giants are very profitable. The third Giant is BNSF Railway. It is one of the largest freight railroads in North America. BNSF has 32,500 miles of track and nearly 8,000 locomotives. To put things into perspective – Transnet owns just over 1,000 locomotives. The fourth Giant is BHE. BHE has become a leading force in wind power and solar power generation and transmission throughout much of the United States. Unlike Eskom it is working and profitable.
CASH MANAGEMENT: Berkshire’s balance sheet includes $144 bn of cash. Buffett does not like this. Buffett: “I always kept at least 80% of my net worth in equities. My favoured status … is 100% – and still is. Berkshire’s current 80%-or-so position in businesses is a consequence of my failure to find entire companies or small portions thereof (that is, marketable stocks) which meet our criteria for long-term holding. Charlie and I have endured similar cash-heavy positions from time to time in the past. These periods are never pleasant; they are also never permanent. And, fortunately, we have had a mildly attractive alternative during 2020 and 2021 for deploying capital. Today, internal opportunities deliver far better returns than acquisitions.” What Buffett means by this is that repurchasing Berkshire shares is one of the best investments he can make.
FINANCIALS: Full-year earnings for 2021 came in at $90 bn, more than double 2020′s total of $43 bn. Federal income taxes paid to the Treasury last year amounted to $3.3 bn – Berkshire pays roughly $9 million every day to the Treasury. The balance sheet is strong. Berkshire not only owns more than $350 bn in financial assets. The infrastructure assets (property, plant, and equipment) that it owns and operates, are valued at $158 bn. This is more than the infrastructure owned and operated by any other American corporation.
CLOSING REMARKS: Buffett is a value investor. Over the past few years value investors have experienced torrid times. On the other hand, growth investors have done very well but the pendulum has swung. Year-to-date (YTD) the price of Berkshire shares is up by 17%, while several Hi-Tech growth shares are down, some by double digits: Microsoft -10%, Amazon -2%, Tencent -21% and Facebook (Meta Platforms) -35%. Berkshire’s share price is trading around $540,000.00 per share, the highest priced publicly trading stock in the US. Berkshire’s Annual General Meeting (AGM) is scheduled for 1 May 2022 in Omaha. Want to attend? Then get vaccinated. Proof of Covid vaccination will be required to attend the “Woodstock for Capitalists”. Expected attendance is around 40,000 people. The AGM will be live-streamed.
US consumer price inflation accelerated again in February, from 7.5% to 7.9% year-on-year, its highest since January 1982 when it registered 8.4%. Oil and energy prices were the main culprit. Gasoline prices gained 6.6% on the month but the data was collected before Russia’s invasion of Ukraine. Gasoline prices are expected to rise by a further 20% in March. Core CPI, excluding food and energy prices, also accelerated, indicating a much-feared broadening in inflationary pressure. Core CPI accelerated on the year from 6% to 6.4%, although the month-on-month increase in core CPI slowed to 0.4%, down from 1% in January and 1.2% in December. This may offer some comfort, but the inflation outlook is clouded by the Ukraine crisis.
The Russia/ Ukraine crisis has created a significant supply shock in commodity markets, including oil, gas, wheat and metals. Russia is the world’s second largest exporter of oil and wheat. Ukraine is the fifth largest exporter of wheat. The invasion sent the oil price to $139 per barrel, a 64% increase since the start of the year. On 7th March, the wheat price recorded a peak of $12.94 per bushel, marking a 70% year-to-date increase. Gains in European natural gas prices are even more extraordinary.
Fortunately, the inflationary pass-through from higher food and energy prices is less today than it was in the past due to rising living standards and better energy efficiency. According to research from TS Lombard, cars were getting about 13.5 miles/gallon at the time of the first OPEC oil embargo in 1973 compared to today’s 25.4 miles/gallon. The percentage of household budgets spent on food and energy has halved since the 1970s. This implies less inflationary pass-through from the current commodity price shock.
When the Federal Reserve concludes its upcoming monetary policy meeting on 15/16th March, it is likely to lift its inflation forecasts, while at the same time reducing its economic growth forecasts. The Ukraine crisis will undermine growth. Higher food and energy costs will reduce the disposable cash of both consumers and businesses. Sentiment will also be affected. Despite the added inflationary impulse, the Fed will likely be more cautious in reversing its policy stimulus. Instead of lifting the fed funds rate by 50 basis points on the 16th March, as had been expected, the Fed will opt for a 25 basis point hike and signal afterwards that it will be prepared to adjust its plans depending on the war’s impact on economic prospects. This may be good news for financial markets. Share prices have become so attuned to low interest rates and policy stimulus, that they are probably less susceptible to changes in the Ukraine conflict than they are to changes in monetary policy.
Stagflation is the new buzzword. Stagflation is defined as rising inflation at the same time as falling economic activity. This is an unenviable situation, and a toxic scenario for equity markets. Some economists are comparing the current scenario with the 1970s, as there are many similarities. Following a decade of policy stimulus, inflation started rising sharply in the early 70s. Policy makers said it was transitory but then inflation was exacerbated further by the 1973 Arab oil embargo on the US. However, most economists believe it is unlikely that we will get a repeat of the “Stagflation” of the 1970s.
According to Dario Perkins of TS Lombard: “While there are certain superficial similarities, there are much more important differences. Back in the 1970s, product markets were generally domestically focused and ‘closed’, while the workforce was young, militant and typically part of a trade union. Wages were often indexed to inflation……. Today we are in a totally different world……Our best guess – and it is only a guess at this point – is that US inflation will settle in the 2-3% range in 2023…… There will be ‘no repeat of the 1970s’ and there is no danger of wages and prices suddenly ‘spiralling out of control’”.
Local Report: Regulation 28: “Yes”, to infrastructure; “No”, to Crypto. Limited Offshore Exposure Remains a concern.
By Kirk Swart
What Is Regulation 28: Regulation 28 is that controversial piece of legislation in the Pensions Fund Act that sets investment parameters for pension fund investments. This includes investments in retirement annuities, provident funds, pension funds, pension preservation funds and provident preservation funds. The Pensions Fund Act has been amended many times since its adoption in 1956 to stay relevant in the everchanging retirement landscape.
Why Regulation 28: The aim of regulation 28 is not to limit the investment options available but rather to protect investors from reckless investing. Reckless investing has the potential to create a burden on the state when investors enter retirement. The current investment limits and the recent changes are:
• A maximum of 75% may be invested in shares. (No change).
• A maximum of 25% may be invested in property. (No change).
• A maximum of 30% of assets may be invested offshore. (Lifted to 35%).
• A maximum of 10% of assets may be invested in African markets outside SA. (No change).
It is the last two limits, that limits exposure to offshore assets, which have been most controversial. Given the underperformance of the Johannesburg Stock Exchange (JSE) compared to other global markets and the exodus of companies delisting from the JSE, calls have been growing for an increase in offshore limits.
JSE Underperformance and De-listings: The underperformance of the JSE versus global indices over the last 10 years is clear. While the S&P 500 returned an average of 21% per year since Feb 2012, the JSE returned 8% over the same period. For long periods during the 10 years the JSE delivered negative returns. It is due to the recent rally in resources that the JSE managed a positive return over the 10 years. However, resources are historically cyclical which can turn negative very quickly.
The argument for increased offshore exposure becomes even stronger as the number of investable companies on the JSE steadily declines. During 2021, 25 companies delisted from the JSE and there were only 7 new listings. For 2022, 20 de-listings have been announced which will be completed before the end of the year. As de-listings escalate, the concentration risk on the JSE increases leaving Naspers, Prosus and resources as the remaining heavy weights. One might argue that to enjoy the tax advantages of a retirement product in South Africa, investments should be South African based. However, these tax advantages mean little if investors remain subject to a market that is underperforming.
Recent draft legislation on infrastructure and crypto assets: In October 2021 draft amendments introduced two new asset classes namely “crypto assets” and “infrastructure”. The draft amendments aim to prohibit pension funds from investing in crypto assets while opening the door for infrastructure investments. Crypto, given its extreme volatility, is not deemed safe enough for pension fund investing. While infrastructure investments are currently permitted under regulation 28, the draft amendments aim to define “infrastructure” as a sub-category. It is proposed that investment in infrastructure across all categories does not exceed 45% and not exceed 25% per single issuer. The draft amendments do not prescribe the investment of funds into infrastructure, they merely set the limits not to be exceeded. Infrastructure is defined as “any asset class that entails physical assets constructed for the provision of social and economic utilities or benefit to the public”. Having defined infrastructure could open the door for prescribed infrastructure allocations in future.
Do the draft amendments help: The draft amendments do very little to address the problem of investment underperformance in South Africa. Investors should be allowed to allocate a bigger part of their pensions offshore. With the ever-growing offering of global products available in South Africa, investors can optimize the offshore allowance by working with a trusted offshore portfolio manager. Today it is possible to gain access to markets all over the world from the east to the west.
Overberg Asset Management has created portfolios that specifically fit the offshore allowance gap allowed by regulation 28. These portfolios have exposure to global markets that are diversified across currencies, regions and asset classes. Do not let the lack of offshore exposure in your retirement portfolio negatively affect your retirement. Speak to Overberg Asset Management today to enquire about our global portfolios that will allow you to maximise your offshore allowance.
The World Bank, in its bi-annual Global Economic Prospects report, forecasts a slowdown in world economic growth in 2022, from an estimated 5.5% in 2021 to 4.1% in 2022, due to new Covid variants, rising inflation, reduced stimulus measures, labour market shortages and supply chain disruptions. Growth is expected to slow again in 2023 to 3.2%. The two largest economies, the US and China, are expected to slow from 5.6% to 3.7% and from 8% to 5.1%, respectively. Some economies, however, are likely to exhibit stronger growth this year, in particular the Far East economies including Japan, Thailand and Indonesia, which were relative laggards in 2021. However, the report cautioned against growing inequality between developed and less developed economies, exacerbated by varying stimulus support, vulnerabilities to rising inflation and interest rates and the imbalance in vaccine access.
The World Bank, in its bi-annual Global Economic Prospects report, forecasts a slowdown in world economic growth in 2022, from an estimated 5.5% in 2021 to 4.1% in 2022, due to new Covid variants, rising inflation, reduced stimulus measures, labour market shortages and supply chain disruptions. Growth is expected to slow again in 2023 to 3.2%. The two largest economies, the US and China, are expected to slow from 5.6% to 3.7% and from 8% to 5.1%, respectively. Some economies, however, are likely to exhibit stronger growth this year, in particular the Far East economies including Japan, Thailand and Indonesia, which were relative laggards in 2021. However, the report cautioned against growing inequality between developed and less developed economies, exacerbated by varying stimulus support, vulnerabilities to rising inflation and interest rates and the imbalance in vaccine access.
The World Bank, in its bi-annual Global Economic Prospects report, forecasts a slowdown in world economic growth in 2022, from an estimated 5.5% in 2021 to 4.1% in 2022, due to new Covid variants, rising inflation, reduced stimulus measures, labour market shortages and supply chain disruptions. Growth is expected to slow again in 2023 to 3.2%. The two largest economies, the US and China, are expected to slow from 5.6% to 3.7% and from 8% to 5.1%, respectively. Some economies, however, are likely to exhibit stronger growth this year, in particular the Far East economies including Japan, Thailand and Indonesia, which were relative laggards in 2021. However, the report cautioned against growing inequality between developed and less developed economies, exacerbated by varying stimulus support, vulnerabilities to rising inflation and interest rates and the imbalance in vaccine access.
The World Bank, in its bi-annual Global Economic Prospects report, forecasts a slowdown in world economic growth in 2022, from an estimated 5.5% in 2021 to 4.1% in 2022, due to new Covid variants, rising inflation, reduced stimulus measures, labour market shortages and supply chain disruptions. Growth is expected to slow again in 2023 to 3.2%. The two largest economies, the US and China, are expected to slow from 5.6% to 3.7% and from 8% to 5.1%, respectively. Some economies, however, are likely to exhibit stronger growth this year, in particular the Far East economies including Japan, Thailand and Indonesia, which were relative laggards in 2021. However, the report cautioned against growing inequality between developed and less developed economies, exacerbated by varying stimulus support, vulnerabilities to rising inflation and interest rates and the imbalance in vaccine access.
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The Bottom Line: Innovation and the Magic of Compounding
By Carel La Cock
The oldest investment trust listed on the London Stock Exchange can trace its beginnings back to the surging demand for rubber at the advent of the car industry. Following the Panic of 1907 when the New York Stock Exchange fell nearly 50% from its peak, credit markets dried up and realising the opportunity to lend to rubber plantations in Asia, Colonel Augustus Baillie and Carlyle Gifford established The Straits Mortgage and Trust Company Limited that would ultimately become the behemoth: Scottish Mortgage Investment Trust (SMT), a constituent of the FTSE100.
Baillie Gifford & Co, the investment management company that stewards SMT, oversee total assets in the fund of £16.67bn as at the end of February 2022. Outgoing manager, James Anderson, defined his career with early investments in Amazon and Tesla, which propelled the fund to cumulative growth of 696.8% in the last 10-years, compared to 220.4% for its benchmark, the FTSE All-World Index. Anderson’s investment philosophy has always been based on the belief that technological improvements will drive innovation and that even picking a small number of these successful future companies and holding on to them long enough to let the magic of compounding work, will lead to exceptional returns for clients. Tom Slater, co-manager since 2015, will take over the reins at the end of April and believes that it matters less failing to sell the holdings you should sell, than selling the holdings you should not sell. When they go long on investments, they remain long offering support as patient investors often nurturing private holdings until they go public.
After a stellar performance in 2020 which saw net asset value (NAV) grow by 106.5%, 2021 was more subdued by its own standards, up only 13.2%. This year the share price has come under severe pressure from rising inflation and the rising interest rate used in discounting long duration income flows on many of the growth stocks in its portfolio. Moderna, the manufacturer of Covid-19 vaccines and the largest holding in the portfolio at 8% is down nearly a third year to date, while Tencent, the Chinese e-commerce giant, at 4% of the portfolio is down nearly a fifth this year. Others in the top five holdings: ASML (-13%), Illumina (-9.6%), Tesla (-13%) and NVIDIA (-10.4%) have all been downgraded due to expectations of a steepening yield curve.
Is now the time to panic and if not now, then when? Geopolitical risk is at an all-time high, the US federal reserve has just hiked interest rates for the first time since 2018 and global inflation is running rampant while oil and gas prices have spike on supply fears. However, listening to manager, Tom Slater and deputy manager, Lawrence Burns discuss the current environment and the outlook for the portfolio in a recent investor presentation, you don’t get the sense that now is the time to panic, or indeed ever. Their strategy is long-term, and they have positioned the fund to participate in structural changes and technological advances in society. They have incredible deal flow built on decades of strong relationships and a reputation for stability and patience. Entrepreneurs are keeping companies private for longer and having early access to investment in these opportunities often leads to extraordinary returns.
As for its current top holding, asked if Moderna is a “one-trick-pony” with reference to the major windfall from the Covid19 vaccine, but recently downgraded as investors see the end of the pandemic and the Covid-19 vaccine franchise, Lawrence answered “Moderna is a one trick pony, but that one trick is a broad and important one and that trick is mRNA.” The biotechnology behind the Covid-19 vaccine is a powerful one with programmes to cure zika, HIV, cancer and a range of other ailments making the recent windfall unlikely to be a once-off.
Regarding the tightening of regulation in the Chinese technology sector and its impact on Tencent, the team thinks that the Chinese government is ahead of the curve in terms of regulation and that democratic western nations will eventually implement similar regulatory changes. They believe that companies that “go with the grain of society” and who are aware of their broader impact on society will find it easier to prosper. In this regard, Chinese tech companies are further along the route of enlightenment.
Lastly, Tom Slater does not agree that higher inflation and rising interest rates should lead to lower valuations on growth stocks. He cautions investors to also consider the impact of pricing power on some of these high growth companies as they become market leaders in their field. Therefore, with higher expected future inflation, one should also adjust the future cash flows that will yield a better current valuation. Looking past the current volatility, the fund has invested in some ground-breaking technology and the managers are excited by the intersection of computing power and biology calling the opportunity set “large and varied” They have 49 investments in private companies, and it is not difficult to imagine the next Amazon and Tesla coming from that pool.
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