For years he has been advocating concentration strategy. He was saying diversification is for birds – animal and creature with small brains. Concentration strategy may work better during the period of low volatility. The following chart shows the volatility since 1928. The volatility has picked up significantly since 1997 till present.
Berkshire’s book value average annual gain during low volatility period from 1965 to 1996 is about 25%. The average annual gain from 1997 till 2008 is only about 13.7% which only half of the previous period. I certainly realize that law of large number is against him too as his portfolio has grown substantially in the last decade. Combination of both factors – volatility and size – begin to change his thinking. He is adopting diversification.
In good years and bad, Charlie and I simply focus on four goals:
(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;
(2) widening the “moats” around our operating businesses that give them durable competitive advantages;
(3) acquiring and developing new and varied streams of earnings;
(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results.
Goal no 3 is clearly talking about diversification.
Volatility and position sizing
He confessed that he made two mistakes – the gross mistake was on the terrible timing of adding ConocoPhillips at the peak of oil price and a smaller one is quoted below:
I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes “unforced errors.”
This is another departure of Warren’s style of making a big bet in high probability event. The fact that he swung his bat show his convictions of a high probability win but unfortunately it was amiss. The damage to his overall performance was very little but painful though. He is taking much smaller position in highly volatile environment or higher risk bet. In this case, he is putting up only $ 244 million for two companies which is relatively small by his standard.
He has scaled up his bet very slowly on POSCO. He took the first shot of about $ 572 million in 2007 and added another $ 196 million last year. That bet is still less than $ 1 billion. This is understandable as he perceives commodity is highly cyclical and not to mention emerging market stock has higher volatility. I remember when he took a position in PetroChina, it was only $ 488 million, again below $ 1 billion.
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