Asset Management: Berkshire’s days of ‘eye-popping’ gains are over

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The challenges confronting Buffett’s successors

The passing of Berkshire Hathaway’s acerbic vice-chair Charlie Munger in November turned investors’ attention towards the company’s prospects without Warren Buffett at its helm. Greg Abel, Buffett’s anointed successor, and Todd Combs and Ted Weschler, his investment deputies, are lined up to steer the giant. 

Buffett’s annual letter on Saturday laid out in no uncertain terms the challenges they will confront, my colleague Eric Platt in New York reports. 

The so-called Oracle of Omaha warned Berkshire shareholders that his sprawling $905bn conglomerate had virtually “no possibility of eye-popping performance” in the years ahead. There were, he said, few deals that offered the kind of transformative impact past takeovers have had, such as its purchases of insurers Geico and National Indemnity or the BNSF railroad. 

“There remain only a handful of companies in this country capable of truly moving the needle at Berkshire, and they have been endlessly picked over by us and by others,” he said. “Outside the US, there are essentially no candidates that are meaningful options for capital deployment at Berkshire.”

It is a problem that Buffett has been staring down for almost a decade as the growth of Berkshire’s operations and cash levels have compounded.

The company spent billions of dollars acquiring truck-stop operator Pilot Flying J and insurance conglomerate Alleghany in recent years, adding them to a portfolio that includes ice cream purveyor Dairy Queen and utility behemoth Berkshire Hathaway Energy. 

But those outlays put only a small dent in Berkshire’s cash pile, which continues to climb. It hit a record $167.6bn at the end of 2023, up $39bn over the course of the year. 

“Size did us in, though increased competition for purchases was also a factor,” Buffett said. “For a while, we had an abundance of candidates to evaluate. If I missed one — and I missed plenty — another always came along. Those days are long behind us.” 

Buffett also used his letter to memorialise Munger as the architect of the modern-day Berkshire Hathaway, describing the 99-year-old’s relationship to him as “part older brother, part loving father”. 

“In the physical world, great buildings are linked to their architect while those who had poured the concrete or installed the windows are soon forgotten,” Buffett said. “Berkshire has become a great company. Though I have long been in charge of the construction crew, Charlie should forever be credited with being the architect.”

Crisis at Hargreaves Lansdown

In November 2020, a frenzy of trading among retail investors rushed to cash in on a sharp market rally triggered by positive Covid-19 vaccine news.  

Hargreaves Lansdown was one of at least 10 of the world’s largest brokers that found its systems overwhelmed. The UK’s largest DIY investment platform and so-called funds supermarket experienced outages as well as thousands of duplicated trades, leaving some accounts in debt and causing extreme stress to investors. 

In this Big Read, Arjun Neil Alim and I explore how criticism of its ageing IT infrastructure is just one of many challenges facing Hargreaves Lansdown and its new-ish chief executive Dan Olley.

Its dominant position is now under threat from sweeping changes to the investment landscape, most notably tighter regulation and intensifying competition from a new generation of digital platforms — among them the likes of Robinhood, eToro and Trading 212 — which aim to make better use of technology and charge much lower fees.

These shifts in the industry are compounding the company’s own struggles, including the reputational fallout from its entanglement with disgraced star fund manager Neil Woodford that continues to haunt it.

In December, Hargreaves Lansdown was pushed out of the FTSE 100 index for the first time since 2011. Its share price is down two-thirds from its May 2019 peak. And in a sign that investors think its stock has further to fall, the company is the third most shorted stock in the UK. 

One hedge fund manager who has a short position in Hargreaves Lansdown said its business model was “structurally challenged . . . it has a very high market share, but it provides an inferior product and overcharges for it”. He estimated that the combination of fee cuts to bring itself more into line with competitors and an end to a temporary rise in profits it makes from holding client cash could herald a 70 per cent drop in earnings.

Crucially, higher interest rates have come to Hargreaves Lansdown’s rescue. “Earnings would have collapsed if rates hadn’t gone up and they hadn’t overcharged clients for their cash,” the short seller added. This is something the UK regulator, the Financial Conduct Authority, is now looking at.

Read the full story here 

Chart of the week

European investors have been piling into the region’s risky corporate bonds to scoop up the chunky yields on offer, as they grow more confident in companies’ ability to refinance their debt, writes Mary McDougall in London.

A record $1.2bn has flowed in to European-listed exchange traded funds investing in the region’s high-yield bonds this year to Thursday, according to BlackRock data. That compares with flows in to European-listed ETFs investing in US high-yield bonds of just under $200mn.

This marks the first time that European ETF investors have favoured “junk” bonds in their home market over the US since 2019. Many believe that the slightly better than feared performance of regional economies means a more painful recession can be avoided, while falling inflation will allow central banks to cut interest rates, creating a supportive backdrop for junk issuers.

In contrast, the strength of the US economy and high levels of government spending relative to taxes could persuade the Federal Reserve to keep interest rates high for some time, say investors, which could hurt lower quality companies.

“The European economy has been weak and diverging from the US over the past couple of quarters but, with the exception of German manufacturing, we think that’s starting to bottom and pick up,” said William Vaughan, associate portfolio manager at Brandywine Global. Bond yields have “come down enough from their peak that we see demand [from companies and households] for credit going forward”.

Five unmissable stories this week

Chris Rokos’s hedge fund has racked up profits of more than $1bn this year after a bet on US interest rates paid off. Rokos Capital Management, which manages about $16bn of assets, is up 8.8 per cent in 2024 to February 16. It told investors that the gains were largely driven by the recent sell-off in bond markets.  

Billionaire Michael Dell’s investment vehicle has agreed to back two former senior Goldman Sachs executives, Tom Connolly and Mike Koester, who are launching a private credit investment company. Dell’s family office, DFO Management, has agreed to provide the first outside capital to 5C Investment Partners. The company’s first fund plans to provide senior loans to mid-sized and large businesses. 

Private equity firms are increasingly raising money to buy individual companies on a deal-by-deal basis, as they struggle with a downturn in the market and investors look for ways to cut management fees. A record $31bn was deployed by “deal-by-deal” investors last year, according to private equity advisory firm Triago, defying a broader dealmaking and fundraising slump in the industry.

Our US financial editor Brooke Masters asks whether a US pensions revolution might be on the cards. IBM’s decision to reinstate its defined benefit scheme makes good business sense — other companies should follow, she argues. The results of a shift to defined contribution plans, or 401k schemes in the 1980s are not looking pretty. The typical Gen X household has just $40,000 saved for retirement, and 40 per cent of their 401k plan balances are zero.

Meanwhile, the UK’s £1.4tn DB pensions industry has been switching to corporate debt for its higher yields and to prepare the schemes for potential sales to insurers. Pension funds are piling into UK corporate bonds, encouraging some French and German companies to issue sterling debt for the first time. This has driven the busiest start to the year in a decade for European investment-grade issuance from non-financial companies.

And finally

Five buzzing urban addresses for your next weekend escape, courtesy of HTSI.