Let’s talk about what Warren Buffett is doing right now. I guess the cheeky answer is that the headline could be that he’s not really doing anything, because everyone is really looking for him to bring on that elephant gun that he’s been talking about for years and put some of that $140 billion of cash to work. However, I don’t really think that’s the full story. Rather, I think that they are at least one actionable purchase that he did over the past quarter. 

There are a lot of interesting observations here for Warren Buffett. The most noticeable is that Buffett has picked a winner in the US banking sector. Now, we as investors know that it’s very hard to pick a winner in any industry. That’s even so that it’s sometimes easy to see that a sector in general will perform well. 

If Buffett is picking a winner, you just better pay attention. What I’ve noticed here is that he picked up an additional $2 billion from Bank of America, when it was priced around $24 and change. Right now, Bank of America is trading very close to that price. If you agree with Buffett and his thesis, and we’ll talk more about what the investment thesis could be, there could be some value here.

What is the thesis? Well, Warren Buffett is hard to ask so I guess you have to put up with Preston and me here today. We have seen a few interesting things there because when I say he picked a winner, just for qualification, like he picked up more Bank of America, but he also liquidated his positioning in Goldman Sachs. He actually reduced his exposure in most of his other bank stocks. It really seems like Buffett has a keen eye to the stock. Buffett or Berkshire Hathaway now owns 12% of the stock. 

What’s interesting is that back in April, the Federal Reserve Bank of Richmond approved Berkshires’ application to boost its stake as high is 24.9%. It’s quite crucial, because we’re usually talking about a 10% limit for investors. They can’t buy more than 10%, and if they do, you have to get approval. It might be an issue because for instance, you don’t want someone to have too much of one sector and perhaps that person would own several of the bigger players. That’s why it needs to be approved. 

Actually, Buffett can still buy more than 24.9%, but then he would have to do another filing and then have his company become a bank holding company, which is a bit more complicated process. 

The other more practical implication of owning more than 10% is that the way Berkshire Hathaway is now regulated is that they are now considered the insider. That means that they can’t just load up on more stock without telling anyone. They actually have to disclose it every time that they’re buying. That’s also why this purchase has been disclosed, even though it’s not in the filing system yet, because it’s a very recent purchase. 

You might be thinking, “Well, Stig, didn’t you start off by saying that he had like $140 billion in cash, and he only plowed in $2 billion?” 

Well, I still think it’s worth mentioning for a few different reasons. It’s a public stock that most people can take advantage of. It’s very easy to pick up. He also made another purchase, which we’ll talk about later, which might be a bit harder for people to imitate. It’s very easy for most investors to do. 

Bank of America is now the second biggest public holding. It’s only trailing Apple and the exposure to Bank of America now is more than $20 billion. So it’s bigger than both Coke and American Express. I just do want to say for the record that I do own shares in Bank of America.

Preston Pysh  4:57  

I just want to highlight most of what he’s doing is pruning and adjusting his marketable securities, the stocks that he owns within Berkshire Hathaway. When you look at his stock portfolio inside of Berkshire Hathaway, it’s $202 billion as of the last quarter. It’s not like he’s really added too much to the cash position, like you said. What was it, Stig? $140 billion? 

Stig Brodersen  5:20  

Yeah.

Preston Pysh  5:21  

This is an important highlight. When you’re thinking of how that $202 billion is allocated in his portfolio, $89 billion of that is Apple stock. It’s kind of interesting to see because a few years ago, when he first started taking a position, it wasn’t like this big overall position inside of his portfolio. However, because it’s gone up in value so much, it’s really kind of taken on. I think it’s helped maintain his stock price significantly, having all that Apple stock in there. 

What you’re seeing on the financial stuff, he’s really just kind of re-baselining his allocation, instead of owning BNY Mellon, PNC Financial, US Bank, Core Visa, [and] MasterCard. All those he’s cut back the positions that he’s had there. 

Then, he’s added to the Bank of America position. It’s kind of interesting to see what he’s doing in that regard, specifically how he’s basically rebaselining everything and making it more focused than having it spread out.

Stig Brodersen  6:17  

Yeah, and it’s interesting you say that Preston. I really wanted to talk about what looks like it’s just changed for someone like Buffett… what happened when he did disclose it? As probably most of you would expect, the price just shot up, which was probably why he just bought all he could. 

Then what happened after that is that the price has fallen back to the point. That’s a very classical thing you see with a lot of Buffett’s bigger buys. You see like a short term effect and there’s another new cycle or whatnot. Then people forget about it and then the price falls back down. 

However, Bank of America, in particular, has really been on my radar for a long time. We can even go back to 2011 when he did that famous purchase of Bank of America. He bought $5 billion of preferred stock with a 6% annual dividend. Then, $700 million shares, or warrants that could be converted as shares. 

For our audience that might be more familiar with Bank of America, from Bill Nygren that we had on here from Oakmark Funds. He manages more than $3.5 billion. Together with Charlie Munger, Warren Buffett, Guy Spier, and *inaudible* and quite a few investors you’re probably familiar with, he has made the most significant conviction bets on Bank of America. That was back on Episode 293. Of course, we’ll make sure to link to that if that’s something you’re interested in. 

Nygren, just to give you a spoiler alert, was looking at a fair valuation of around $40 plus for one share of Bank of America. Right now, it is trading around, I want to say just looking up here, $24.47 before the market opens on the 22nd of September. 

I just wanted to mention a few things that I found interesting also about the stock. Generally, I kind of feel that there’s an interesting thing at play here with, let’s just call it interest rate protection. 

You might be thinking, “What do you mean with interest rate protection because there’s no way that interest rate is going up? Jay Powell has talked about it and now given COVID-19 and everything that’s happening, why would you even say that?”

The reason why I am saying it is that you would probably have a normalized earning for a stock like this around $3. You’re looking at a stock that back in the 1980s, revenue from non-interest income was only 15%. 

I guess my point is that Bank of America has really done a good job adjusting to the times with low interest rates. Back in 1980, revenue from non-interest income was only 15%. Today where they’re not really making any interest income… 

Today, 50% of the revenue is now non-interest, primarily from fees as a lot of customers, including ourselves might have noticed, they’re really good at making money like that. So, it was just something I found interesting. 

As you go through that specific episode, I don’t want to sit and repeat everything that Bill Nygren talked about. Though I would really concentrate on some of the arguments about having that concentration between the biggest banks in the US. There are just a lot of interesting things going on. They have combined to have around a market share of 30%, but they’re capturing 50% of the new deposits. 

You see the same type of banking concentration in the US. We have seen that for some time that you have been seeing in other Western countries for some time. There are just a lot of structural changes and their networking effects and the *inaudible* scale. But I don’t want to talk too much about that because Buffett did other things here recently. 

Preston, I don’t know if you have any thoughts here before we talk about the Japanese investment that he made.

Preston Pysh  9:41  

When I’m thinking about Bank of America and thinking about the future, your comment earlier about the interest rates going up is the thing that just kind of has my mind just turning because I don’t think anybody really has a good idea as to how this will play out in the coming two years, as far as interest rates. 

The reason is because when you’re talking about a bank and you did a great job talking about how the fees are the real selling point here with Bank of America, compared to some of the other banks. They’re not reliant on that interest rate income. 

However, in a world where we’re talking about MMT. I guess from my perspective, I think that they’re going to actually be able to implement this for I don’t know how long. I think that’s the question. I think they’re going to be able to implement MMT. I think they’re going to try this whole negative interest rate thing. I don’t think it’s going to work. I think it’s going to fail miserably, but I don’t know when it’s going to fail miserably. 

Another part of this too is I expect UBI to be a really huge part of what’s going to happen next. In the coming 12 months and 24 months, UBI checks are going to ramp up. I think the fiscal stimulus to small businesses and mid-sized businesses are going to ramp up. 

When you look at how these banks have kind of benefited from these fiscal and monetary policies, even though there are no interest rates, they’re still crushing it on the revenues. When I’m looking at the valuations on this thing, and it appears like the price is being penalized, because the rest of the market is kind of seeing things through a similar lens of what I just described, as far as my confusion over how this is going to play out. 

A lot of market participants are saying, “I’m just not going to get near that because I just can’t understand what the future will hold as far as interest rates, and whether the Fed will be overprinting. It’s going to blow up a bond market.” So, the market is looking at that and saying, “I’m not getting near this thing.”

Well, you can see it in the valuation, because when I’m looking at this and doing an intrinsic value on the company based on free cash flows, and not even having a growing free cash flow, just something that’s flat. I mean, you’re talking easily double digits on this by a lot. I don’t even want to say the number because it’s so high, based on the free cash flow. 

When you’re looking at the math on how much they’re earning, and how much they’re banking on to their balance sheet for the shareholders, it’s significant right now. I mean, really significant. It makes everything else look like you’re in a completely different universe as far as the numbers go. So do I own this? I don’t own this, mostly because of my confusion as to what’s going to play out. 

Plus, I think that there’s just a lot changing in this sector. I don’t think that that’s going to change abruptly, as far as we’re still going to have a need for banks, even though everyone knows I’m a big fan of Bitcoin, right? That is a bank you can put on your smartphone. 

However, I think that there are still going to be custodial pieces to all of that, especially when you’re talking about large businesses. They’re not going to want to be managing their private keys. They’re going to be outsourcing that to a big bank to do a lot of those things. 

I still see there being a world for this. Now, whether they had the technical chops to step in and start securing private keys and stuff like that in the crypto space, I don’t necessarily think that they have that right now. They’re probably going to have to outsource it to like Gemini, and some of these other big crypto cracking just became… Got to charter for a bank. 

I think there’s a lot changing in this sector. Technologically, there’s a lot changing. I am not so sure where Bank of America sits relative to all the other ones. It seems like Fidelity has kind of got to jump on the transition to be able to go into this cryptographic world that it seems like we’re going towards in the banking sector. 

Anyway, those are some of my thoughts. Again, I don’t own it, but I can tell you looking at the numbers, this thing is ridiculously juicy. So if any of those comments pique your interest, I’d tell you to dig into it more

Stig Brodersen  13:49  

About the comment you had there about the interest rate, the reason why I wanted to bring that up, because I don’t necessarily see a high interest rate being a big catalyst or anything like that. I don’t really see it going that way. 

I guess one point is that it’s always been very difficult to predict where the interest rate is going to go. The other thing is, there’s a lot of leverage companies right now. They will be in a world of pain if interest rates went up. That was kind of like my point. They have to build in this thing called a hatch. I don’t know if that’s the right term to use. 

With Bank of America, keep in mind that even though it will increase their income, there will obviously be discounts because high interest rates would make the value of other assets go down. I just feel that’s an interesting thing to consider too as you evaluate the risk of this business.

Preston Pysh  14:33  

I think it’s extremely important if you’re trying to buy various banks that are discounted severely because of all the things we mentioned. What probably needs to be at the top of the list is how much of their revenue is based on things that are outside of interest rate income, because my impression is in the coming year and in the short duration, interest rates are just going to keep getting pushed lower. 

These governments cannot allow interest rates to go up, even though you get the Fed Chairman going out there and saying, “Hey, we’re going to start hitting our inflation goals and if it’s running a little bit hot, we’re going to let it run hot.”

That still doesn’t mean that they’re going to allow that, although they’re trying to make inflation go up. Historically, interest rates are based on a premium above that inflation. I don’t think that really is going to be the case, because they’re just going to keep buying the debt to keep the interest rates low. 

The reason is because fiscally, they can’t afford interest rates to go up. I mean, I think everybody knows that. I think they know that they can’t allow interest rates to go up just because the economy could not even begin to handle that right now.

I think the trend for interest rate income for banks is they better expect rates to even go lower from here, which is crazy. However, I think that’s probably the most likely scenario. 

Stig’s point was to find something else. You better have that at the top of your list, if you’re looking at the revenues and find something that they’re making money from something, other than interest rate income.

Stig Brodersen  15:58  

Going back to Mr. Buffett, I think the Bank of America purchase is very interesting for most retail investors, because it’s so easy to follow that specific pick, if you want to do that. 

He also made an interesting purchase in Japan. He recently deployed $6.5 billion. It was announced here August 30, on his 90th birthday. The way the deal was structured was not as applicable to most investors. 

Simply he issued debt in *inaudible*. He used the proceeds from that. He only paid 0.67% interest rate on that on average. He matched that with his investment into those five major Japanese trading houses. 

Just a quick note to that, because you might be thinking, whenever you hear a trading house, that sounds risky. Buffet and trading shouldn’t go hand-in-hand. 

Keep in mind that trading houses in Asia has a very different construction than what we think of here in the West. It’s really a thing that’s ingrained in the culture and the trading houses… First of all, the trade is almost any product you can think of. So, it’s not financial derivatives necessarily. That’s not what you think. It should be corn or toys, or really whatever you can think of. It’s really not a boom and bust thing.

Specifically, the yield on these companies is in excess of 4%. It’s generally perceived as one of the safest investments you can make because these companies are so systemic to the economy. 

It’s a very different thing, if you’ve been to Japan or….perhaps some of our comments would make a slight more sense, but it doesn’t seem as far out when I heard it, I guess as it might to other investors. I just found that interesting. 

Let’s say the yield on those, I’m not talking about the dividend yield, but the type of returns… I would probably be surprised by the way it has been prized. Let’s say it’s 6% or 7% return and he’s paying .6% or .7% for that. I mean, he can get say 5% spread or whatnot back with a lot of safety. He’s found a place to park his cash in an intelligent way. 

I definitely see it more like that, than something you should try to mimic or any type of  “this is going to be a fantastic trade.” I don’t think it will be fantastic. It’s just like a strong downside with median single digit return, which is not too bad these days.

Preston Pysh  18:14  

My only question is this Buffett’s way of doing the VIX, as far as volatility? I mean, that’s the only way that I see this is he’s taking a position on increased trading. He expects that to continue and it seems like these companies that he invested in have kind of a stranglehold on that over in Japan. So, to me, it seems like a really smart play. 

Okay, so we’re going to go ahead and transition over to just talking about some of the things that are coming up on the radar for the TIP finance tool. Stig will kick it off first with Liberty Global and talk about this one.

Stig Brodersen  18:52  

The ticker is LBTYA, and then the last letter, they had different asset classes, but the name of the company is Liberty Global. That’s a company that really stood out to me. It’s the second cheapest stock that we have in our last cap filter. It has a TIP multiple of 2.3 and a TIP median of 5.4. In other words, it’s not just cheap on absolute numbers, but also in relative numbers. 

Just introducing Liberty Global. It’s an international broadband and television company with operations and more than 10 million customers in Europe. It’s not a small company. The market cap is $12 billion dollars and they have an enterprise value of $20 billion. So it carries a lot of debt too, but it is a stock that has been on my radar for quite some time. 

As you guys know, I follow a lot of different prominent investors, just sort of like having… I think Mohnish Pabra jokes about this and refers to [checking super investors] as having the best investors as his unpaid analysts, which I found to be a funny way of looking at it. 

Seth Klarman is an investor I really respect. He bought this company back in Q3 2018. He recently bought more here in Q2 2020. Keep in mind that even though we’re sitting here in Q3, we don’t have any data for what he’s been doing here in Q3 just yet. That will be out in mid November.

Even since then, the stock has generally continued to decline. It’s now 14.7% of his portfolio. So the conviction from him is definitely high. Talking about what other prominent investors have been doing, Berkshire has also owned the stock for quite some time. However, the reason they trimmed their positions slightly… In all fairness also, it did look like a bet that either Todd or Ted made, given that the current market value of the Berkshire position is only $400 million.

The last investor that I just want to mention here before taking more into the stock is that in Q1, Howard Marks bought $2 million shares of the company equivalent to just above 1% of his portfolio. 

Now, again, my disclaimer is always that I don’t want this to sound like you should only buy stocks that super investors would buy. But it just really serves as a filter to perhaps where you might start looking. Then, you can make up your own mind, especially here in the situation with Liberty Global, where you have investors who you might also really respect who bought a lot of the stock. It’s now selling at an even higher discount. It might be worth your time. 

It’s sort of like a weird thing as a value investor, I can almost not help myself feeling FOMO, but I feel FOMO in a very different way. Of course, I’m saying this in a goofy way, because I don’t see it as when something goes up, that’s not how I feel. It’s like if something really goes down, I think I should really buy into this? 

I do want to say for the record, though, that most frequently, it’s actually not a good idea, because there is a good reason why they’re dropping and why the momentum is shifting. Though whenever you see such a problem in investors, perhaps continue buying and buying when the price goes down. Again, it might be not a place for you to invest, but it might be a place for you to start looking. 

Again, it’s not a pick for the faint of hearts. The momentum of the stock has turned red since February 2018. So keep in mind that you might be looking at a falling knife here. As you look closer at the stock, the pick might look like it’s all over the place when you look at some of the key ratios, especially some of the margins. 

Keep in mind that over the past five years, Liberty Global has made five major strategic acquisitions. They also sold a lot of businesses. It’s not the same business they have now which they had five years ago. It can then be a little tricky to compare it as apples to apples. 

Initially this has been fueled by debt and for the massive issue is yes. But together with a strong focus on free cash flows, you really see those reserves quickly building up. At the same time, the company has aggressively been buying back stocks, they haven’t been paying out in dividends. 

Since 2016, as many as 27% of the shares outstanding has been bought back. So if you do have a lot of faith in the management and in the business, you would definitely like that aggressive approach. 

The other thing I also want to mention is that as you value the business… When I see some of the things that the management are saying and talking about the synergies, I would probably be a bit wary about that. They work in European and very fragmented markets. I would go in and look at Telenet specifically or Vodafone SIGOS, specifically. Then say, “What’s the sum of the parts here more than anything else?”

When you do decide to do your intrinsic value calculation, I guess I would be quite conservative in your estimates. Looking forward, I definitely do not expect the price to free cash flow to continue to move around five. That’s not what I’m seeing, but they have *inaudible* the industry is facing. Short term though, you will definitely see different earnings and cash flows coming out from Liberty Global. 

However, I wouldn’t be surprised if this is a stock with an expected return that could be double digits, if you can withstand the volatility that you might see. So I just wanted to mention that that’s one of the stocks that’s been on our radar, the second cheapest stock in our filter. 

Preston, I don’t know if you have seen anything in TIP Financial that you wanted to share with the audience.

Preston Pysh  23:58  

My comments on the Liberty Global… So two things really kind of jumped out at me. I guess I’m a little bit more hesitant on this one. I think the numbers when you’re valuing the free cash flows, it’s exceptional, similar to what we were seeing with Bank of America.

Where my concern on this one is really the momentum because this thing’s been in a downtrend, like Stig said, but it’s really been in a downtrend since the middle of 2015. 

When you look at the volatility of the downtrend, I mean, it’s right inside of that volatility trend. Our momentum tool is still saying this is red. I would be watching this, but I definitely wouldn’t be taking a position until that thing would turn green. 

My concern is less from an evaluation standpoint. It’s just when the market is going to start to recognize and realize the value that you’re clearly seeing and I’m seeing, and all these other super investors are seeing. Though I do think you’re going to be kind of in a falling knife scenario until the market just starts to recognize the value of it. So that’s my concern with this pick. 

I agree with you, Stig, I think there’s a lot of value there. It’s just a matter of when it starts to get recognized. 

I’ve got kind of an odd one. I don’t own this, but I do want to highlight it because it is coming up in the filter. This is coming up in the mid cap filter. Stig, I’m curious if you even know this company. Have you ever heard of Big Lots? 

Stig Brodersen  25:21  

No. Never heard about it.

Preston Pysh  25:23  

So here in America, I would argue most people probably know what Big Lots is. It’s a retail store. It’s like a T.J. Maxx. Have you ever heard of T.J. Maxx? 

Stig Brodersen  25:33  

No. God, I’m so ignorant.

Preston Pysh  25:34  

No. It’s just an American thing so you wouldn’t know. It’s like a retail store. Let’s say Polo and I don’t think you’d find this at Big Lots. But let’s say you have a Polo shirt and there’s a small amount of damage or they have overstock or whatever, they sell it to these retail stores that then go and sell them at a significant discount, even though they’re kind of like branded things. They’re really popular here in America. 

So Big Lots came up on the filter and because it has such a strong enterprise value. It has strong earnings, and it’s hitting the filter. When I’m looking at the top line, it’s really flat. I mean, this thing has literally not moved in 10 years at all. It makes $5 billion a year is pretty much the answer key. 

This really got crushed in the march sell off. This went down to $10 a share. Today, it’s up at $46 a share. I can’t imagine what the intrinsic value was in March when this thing hit $10. It had to have been like 30% to 40% return based on that price because so the company’s making $5 billion on their top line. Then on their net income, they’re making about $200 million a year consistently at this point. That’s what I would use. 

So when I’m doing the intrinsic value on something like that and I’m using around $200 million, I’m coming up with a 14% return. That’s at a recovered $40, this $44 price, I’m still getting a 14% return. So I think this is a company that’s going to perform well in the environment that I kind of expect us to be moving towards here in the coming five years. 

It appears like the company is very sound in their financials. They got a current ratio of 1.22, and an interest coverage ratio of 19. The debt-to-equity recently jumped up a little bit. I think it’s mostly because they moved from a structure where they used to own the buildings to now where they’re leasing. I see on their balance sheet that capital leases have gone up significantly from where they were before. 

People on Twitter, hit me up if you have a better insight into this but I kind of see that as being a smart play as far as leasing the properties because it gives them a little bit more flexibility. Maybe to not have all these CAPEX of sustaining buildings. If they start running into problems, they can just shut it down. It gives them that ability to be a little bit more flexible on how they manage their really expensive part of the business, which is all the infrastructure. 

I don’t know. I see it as an interesting pick. The momentum on it has been good ever since March, it turned green. I don’t know when our tool turned to green. But it turned green shortly after the march because it had a meteoric rise from the $10. But something to check into. I don’t own it, but I do find the pic kind of interesting.

Stig Brodersen  28:29  

Yeah and the other thing to note here, Preston, I am really happy you highlighted the green momentum. I tend to highlight the ugliest businesses with a red momentum. I guess people should also keep that in mind as they’re using the filter. Those are the cheapest of the cheapest companies. Think about intuition. If something is very, very cheap then if it is the cheapest in the universe, it’s probably because the price has gone down. The momentum has turned red. 

Especially what Preston is looking for, and correct me if I’m wrong here, Preston, you’re looking at “Okay, so this has been very cheap but now, the market sort of like found his bottom and now it’s on the way up.” That’s what you’re looking for?

Preston Pysh  29:07  

That’s exactly it. Your pick that you have from a fundamental analysis standpoint, I mean, it’s hard to find anything better. The thing is just crushing it. It’s pumping out so much profit for how much you pay for each dollar profit. It’s amazing. 

For whatever reason, the market is just continuing to say based on the momentum, it’s continuing to say, “Yeah, it’s got more to fall.” 

I mean, you could have bought the bottom. I just don’t feel like I have the skill set to be able to say, “Right here is the bottom I’m going in and I’m going to buy it.” I’m just looking for statistics. 

When I say statistical, what I’m saying is, we’re looking at the volatility of the price action for Liberty. So you’re looking at the volatility of the price action on a long term basis. 

For Liberty, their annual volatility is around 23%. You should see the price action move within a 23% range on an annual basis. When the price is moving, as long as it continues to move inside that, call it 23% trough, and it’s moving down in this 23% trough, my expectation is that it’s going to continue to do it until the price demonstrates that there’s a change on the horizon. 

This might be a good example. Let’s say we were tracking the temperature outside, right? The volatility in the temperature is 5%, over a three month period of time. I use three months, because we’re talking about something that’s an annual event. So, we’re looking at a 5% volatility in the temperature and as long as that temperature just keeps going down… I’m saying, “Hey, it’s still winter, it’s still going down.” 

Now, we just hit a low of 20 degrees, because we’re up north or whatever. Then, it’s kind of staying in that volatility range. All of a sudden, it starts going back the other way, and it breaks out of that, let’s just call it, 5%. I have no idea what these numbers would actually be, but when it breaks out of that 5%, I’m saying, “Hey, something just changed. I think we’re out of winter and we’re about to go into the spring.” 

It’s a very similar thing when you’re trying to look at momentum for stocks. You can look at the momentum in an hourly chart or you can look at momentum at a long term chart. Since we’re value investors, we’re looking at the momentum from a very long period of time. That way, we can say, “Hey, there’s something here that has changed in the market.” 

It could be a false breakout but you can go in and look at the charts, they’re pretty darn accurate as to being able to forecast long term momentum trends. So that’s just my concern when I’m looking at something that is saying and that’s just screaming value, but it’s still within that momentum trend trending down. I’m just not going to buy it until it turns green.

Stig Brodersen  31:49  

Alright guys, so now that we had our billionaire segment, and we talked about TIP Finance, now is the time to answer a question from the audience. This question comes from Yuri.

Uri  32:00  

Hey, Preston and Stig. I’m a big fan. I’ve been listening for about two and a half years. I started listening right around an episode that mentions Ray Dalio’s All Weather pPortfolio, where there’s a 40 to 60 equity to bond portfolio split. So with that, I want to know over the last six months to 12 months, how did your preferred portfolio allocation between different asset classes change over that time period? 

I know, Preston, you’ve mentioned in previous episodes. You’re almost exclusively invested in Bitcoin. Stig, you seem to not be on board with that. So I want to know, if you’re like me, someone who’s not really interested in investing in bonds, or what are some other options that you’re seeing? How does that tie into some of the conversations you’ve had with professional asset managers, that may also agree that bonds aren’t yielding enough to justify that continued investment? 

Again, the question comes down to what are some different suggestions you have for portfolio allocation given the current environment that we’re in? Thanks a lot. 

Preston Pysh  33:06  

Yuri, fantastic question. I don’t know that I’m going to give you a good answer. I’ll start off with this. I definitely don’t own any bonds. I’m looking at Stig and he’s nodding his head. You don’t own any bonds. Right, Stig? 

Stig Brodersen  33:15  

No. I don’t.

Preston Pysh  33:15  

Yeah. Let’s start with the easy part. It’s interesting, because at the start of the show, we were talking about our expectation for interest rates to go even lower. So if you own bonds, that’s the dream scenario, right? The interest rates just keep going lower, and the price of your bond just keeps going up. I just don’t trust how much longer they’re going to be able to. They, being central banks, are able to keep this farce alive. 

From my vantage point, if you have something that has a lot of counterparty risk, which bonds have complete counterparty risk, that is the last place I want to be in the market right now. Like March was a perfect example, when you see these big giant liquidity events where the market just melts down. I think your amateur investors will say, “Oh, it was just an emotional thing.” 

Yeah, the emotions got the hold of a lot of people because they were looking at the supply and demand shock that was going to come and then what it was, was it was all counterparty risk. It was derivatives blowing up. It was debt blowing up. It was a complete impairment on a lot of balance sheets. It was forced selling. 

People had to sell positions that didn’t have counterparty risk, in order to come up with the cash, the US dollars, or whatever fiat currency that they had their derivative or their counterparty risk denominated in. They had to come up with that fiat money in order to make good on the impairment that they had in their other positions. 

I would then stay away because I think that these shocks are going to continue. In fact, we might even be experiencing one right now for all I know. The market has had… I don’t know how much of a pullback but it’s happening quickly and these things can kind of unravel really fast because once that impairment starts to roll, it just trickles down into all the other counterparty risk positions for everybody else. It just unravels itself. 

My expectation is, when it happens again, the central banks are going to step in with an even bigger bazooka than they stepped in with March. Then they’ll reflate it through more fiscal stimulus straight into the population. They’ll also do more QE so that they can continually push the interest rates lower, because they can’t afford for them to go up. 

Now, how does this impact my portfolio? Well, you already mentioned it. I am heavily exposed to Bitcoin. For people that are listening to this and saying that sounds absolutely nuts. Maybe it is. I don’t have a good answer for you. So far, it’s worked out for me extremely well. I mean, I’ve absolutely murdered 2020 thus far, but that doesn’t mean that it’s going to end that way. 

Though my anticipation is that it will. However, instead of getting into all the nuances of that position that I have a very high concentration in, I would just tell you to really focus primarily on sticking with the things that you understand and that you know. 

Stick with things that don’t have a lot of counterparty risk because if you don’t understand something. I tell people this all the time, especially with respect to Bitcoin, if it’s not something that you understand, you’re not going to have the temperament to continue to hold it when the price action goes in a direction that you’re not prepared for, especially when it’s that volatile. 

I have a lot of conviction in it because I feel like I understand technically what’s happening with the code. I understand kind of the backdrop of what’s going on, at least that’s my impression. Of course, I have a bias and like anybody who has any position has a bias. 

I would then tell you to focus on things that you understand, things that you’re comfortable with, and things that don’t have counterparty risk. That’s why you look at Buffett and what is he doing? He’s in a lot of stocks and he’s in stocks that he understands.

You go back to looking at Buffett’s portfolio back in the 2007-2008 timeframe. He had a lot of bonds on his balance sheet because his anticipation was into the long term trend of interest rates, where they just keep going down. 

Ever since the 1980s, they have just kept going down. So of course, he’s going to own that but now where you look at where he’s at? He’s just sitting in cash and cash equivalents and stocks. That’s what he’s doing with all the retained earnings from his operational businesses.  

I would recommend people do something very similar, if you need to have something which doesn’t have the counterparty risk. You have the risk that the company can dilute their shares, right? That’s your counterparty risk. I guess you could claim that that’s counterparty risk that the company could step in and dilute their shares.

In general, there’s no counterparty risk there when you’re dealing with stocks. So that’s where I would tell you to look. I would focus on things that have good valuations like Stig and I just talked about on this episode, when you are buying equities. Then try to give yourself that advantage of if you are wrong, you had a large enough margin of safety in the price. 

Those are the things that tell you to focus on and then the correlation is really important. This is coming from a guy that has a very highly concentrated portfolio. So here I am saying one thing and doing something different but I’d tell you, if you can try to uncorrelate your positions, that is vital. That is really important. 

If you’re wrong, if you’re dead wrong on one pick, and it’s uncorrelated everything else, your whole portfolio doesn’t move in that direction. It’s going to be compartmentalised is kind of the way that I would think about why correlation is so important in our TIP Finance tool, which we’re going to give you access to. It helps you piece out the correlation between your picks as well. 

Stig Brodersen  38:44  

I think that’s a good segue to what you asked there, Yuri, about Ray Dalio. If anyone Ray Dalio talks about having uncorrelated assets. So I think that’s very timely. When you talk about the All Weather Portfolio, just briefly outlining that for the audience, really what Ray Dalio talks about when we talk about the All Weather Portfolio, is a different portfolio mix.

I just want to clarify that first, 30% stocks, 15% in medium-term bonds, *inaudible* and long-term bonds, and 7.5% in commodities, and the last 7.5% in gold. Like Preston, I would say that, that is likely not the right way to structure your portfolio right now. 

However, I also want to say that it really depends on who you are, like different portfolios for different people. Preston and I follow the financial markets. We have an opinion about financial markets. We also make concentrated bets.

I recently talked with a few friends who have been in this wonderful situation that they have sold their company and they had a very different objective than what I would imagine Preston and me have, which is about compounding our portfolio.

They’re all about not losing principle, but they’re also about how they didn’t like volatility. They would much rather have lower return and low volatility. If that’s the case, something like the All Weather Portfolio will definitely help you in terms of low volatility. That’s the way it’s been structured. It gives you a decent return. It does give you the highest upside you can think of. But again, that’s not the objective. 

I would say that a person could consider the All Weather Portfolio as an alternative to dollar cost averaging, just with a lot lower volatility and perhaps slightly lower return, if they do not want to follow the financial markets. If you don’t want to be active investors, that could be a way to do it.

Though now that you are asking, so how do we see this and what we suggest? For the record, now we are talking about Ray Dalio. Ray Dalio doesn’t recommend the All Weather Portfolio to invest in general. He also has a very strong opinion right now about how he should be positioned in the market. More than anyone he is an active investor. The All Weather Portfolio is a different portfolio mix for different investors. 

My approach really hasn’t changed too much during COVID-19. I would say the bonds are even less attractive, but they’re already unattractive going to the pandemic. So the thesis for that really hasn’t changed at all. 

As I’m sure many of you know, I’m primarily in equities and are diversified away from the US, not fully. I still have US stocks, but I’ve diversified away to a bigger extent to international markets. 

Having said that, I also just want to give a hand off to another resource, our friend Rich Shaner. He recently this month published his latest research on pricing and the return of the US international markets. It’s published over at Alpha Architect and we’ll make sure to link to that in the show notes. 

If anyone would be more interested in learning more about investing in international markets, we’ve covered investing international markets quite extensively here over the past few months. So I don’t want to repeat myself too much. 

I also want to say that, if it is possible for you, Yuri, if you have someone in your network who you really trust, perhaps now’s the time to look into private companies. It’s sort of difficult to come up with a guide to how can you invest in private companies because it depends on what’s your own circle of competence, who are your friends, who do you trust, but you can definitely find higher yield than what you can in the stock market and not just speak of the bond market right now. 

If you find the right people, that will come with even lower risk. If you do not have any network, you can also go through different investment platforms. There are a lot of great investment platforms out there. So that’s a way to do it. 

Clearly, here’s a middleman and they have costs with some pros and cons if you want to do that. Perhaps one day we can do an episode about how to go into private deals, even though that’s kind of like beyond the question this time. 

But given the current environment, I guess my point is that if you’re not dealing with Warren Buffett billion-type of money, it can be a very good approach to compound your wealth and protect your downside. Of course, also diversify away from the financial markets. So there it is again, that correlation piece. 

Given the current market conditions, I would argue that you should consider having exposure to a fixed monetary baseline. Gold could be an example of that. That is what Ray Dalio said earlier this year. It’s also included in his All Weather Portfolio, but he really talks about the antithesis of cash. Gold being one example. Preston mentioned Bitcoin. That’s another example of that, and then Dalio. You can even put Buffett in that when you mention equities. 

I’m primarily an equities guy. I’m more familiar with that. I like that play right now. But really, I see my portfolio in three buckets right now: equities, private deals, and then exposure to a fixed much higher baseline. 

For me, the latter would be smaller than the public and private ownership, partly because I do see it as a hatch, but I also see it as a very interesting value to risk ratio and less as, call it, steady growth compounder.

Preston Pysh  43:57  

I’m just going to quickly explain Ray Dalio’s All Weather Portfolio for people that are listening if they’re not familiar with what it is. So what Yuri was describing there, 60% bonds, 40% stocks. What Stig was describing was more accurate, because he included the commodities and gold piece actually encompassing about 15% of the portfolio. 

What Ray had effectively discovered was that when the bond market was going up, the equity market would lag. However, when the equity market would go up, the bond market would lag. So like there was this inverse correlation between bonds and stocks. 

What was happening was the stocks were twice as much volatile than the bond market. What he did is he levered up the bond position so that it became more volatile. It was still producing those returns because we were in this long term declining yields in the bond market, which makes the bond prices go up for 30 or 40 years. 

I’d be really curious if anybody out in the audience that’s listening to this, you can hit us up on Twitter, I’m really curious how he’s managing this right now, because I know he’s come out publicly and stated that he thinks bonds are a terrible place to be right now. 

It would just shock me to see such a significant portion of his All Weather Portfolio still in bonds, levered bonds. I would suspect that that’s probably not the case right now. But I’m sure there’s somebody in our audience that knows the answer. If you do know it, please tweet at me and I will retweet it so people can kind of see your response.

However, based on historical interviews that he’s done, that’s how the All Weather Portfolio works. Though I’m really curious to see what they’re doing nowadays. 

All right. Yuri, a fantastic question. It’s a really important one for people to think about. Stig’s point about it being a personal choice and has to fit your personality, and all the other things you have going on in the backdrop as far as your earnings, power, and all those kinds of things. Those are really important considerations when you’re designing your portfolio and the volatility that you’re allowing yourself to step into. 

So to help you manage this, we’re going to give you free access to our TIP Finance tool. It helps you with the correlation. It helps you with the momentum. It helps you with the intrinsic value estimates. It helps you filter the best valued companies for the profits that they’re making. It does all those things and we’re really excited to be able to give this to you. 

If somebody else wants to check this out, just go to Google and type in TIP Finance. It should be the first thing that pops up. It’s right there on our website. If anybody else wants to get a question played on the show, go to asktheinvestors.com and you can record your question there. If it gets played on the show, you get access to our TIP Finance tool.

Stig Brodersen  46:38  

Alright guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Outro 46:45  

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