Buffett Cuts Bond Allocation as Berkshire Warns on Yields

Warren Buffett cut the allocation to bonds at Berkshire Hathaway Inc. (BRK/A)’s insurance units to the lowest in more than a decade as the company warns that low yields will hurt results.

Fixed-income assets made up 14 percent of investments at the insurers as of Dec. 31, according to the company’s annual report. The year-end figure has typically been 20 percent to 25 percent since 2002, according to Berkshire documents. The $186.8 billion portfolio included $114.8 billion of stocks.

Buffett “is trying to maximize the total return,” said Cliff Gallant, an analyst at Nomura Holdings Inc. He “sees more opportunity in his stock purchases than he does in his cash and bond holdings.”

Buffett has said low yields mean that insurers and other bond investors are holding “wasting assets.” To counter that, he struck private deals for higher-paying securities and added equities. Omaha, Nebraska-based Berkshire also made acquisitions and invested in its railroad and energy utilities.

“Our appetite for either operating businesses or passive investments doubles our chances of finding sensible uses for our endless gusher of cash,” Buffett, 83, wrote in his annual letter to shareholders, which was published March 1.

Photographer: Daniel Acker/Bloomberg

Berkshire Hathaway Inc. shareholders gather prior to the start of the Berkshire shareholders meeting in Omaha on May 4, 2013. Close

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Photographer: Daniel Acker/Bloomberg

Berkshire Hathaway Inc. shareholders gather prior to the start of the Berkshire shareholders meeting in Omaha on May 4, 2013.

Still the cash pile was $48.2 billion as of Dec. 31, compared with $47 billion a year earlier and $30.6 billion at the end of 2009. Any amount higher than $20 billion is too much, Buffett told Bloomberg Television’s Betty Liu last year.

Buffett also has been favoring shorter-duration bonds. As of Dec. 31, Berkshire had about $8.5 billion of bonds that were due in a year or less. That compares with $6 billion at the end of 2012. The holdings typically offer lower yields than longer-duration securities while providing more flexibility.

‘Historic Extremes’

Corporate bonds sold by the riskiest to most creditworthy borrowers in the U.S. returned 0.34 percent last year, the least since 2008. That compares with an annualized 13.5 percent from 2009 to 2012, according to Bank of America Merrill Lynch index data.

“The valuations of corporate bonds are close to their historic extremes courtesy of the rally,” Edward Marrinan, a credit strategist at RBS Securities, said in a telephone interview from Stamford, Connecticut. “There is some concern that the Federal Reserve’s policies are going to lead to inflationary pressures.” The Fed has kept its benchmark rate near zero to stimulate the economy.

‘Significant Cash’

Investment income at insurance units such as Geico and General Re may drop from the $3.7 billion that the company posted in 2013, Berkshire said in its annual report. The portfolio’s profit came under pressure amid the wind-down of deals that Buffett struck in the financial crisis with firms including Mars Inc., Swiss Re Ltd., Goldman Sachs Group Inc. (GS) and General Electric Co. (GE)

“Investment opportunities currently available will likely generate considerably lower yields,” Berkshire said in a regulatory filing on March 3. “We continue to hold significant cash and cash equivalents earning very low yields.”

Mars last year retired bonds bought by Berkshire that paid 11.45 percent interest. Buffett has been able to replace some of the lost income by striking privately negotiated deals for preferred equity stakes. Berkshire earns a 6 percent dividend from a 2011 investment in Bank of America Corp. and 9 percent on the $8 billion of preferred shares he got in a deal to help take HJ Heinz Co. private.

‘Unforced Error’

The fixed maturity portfolio at insurance units was valued at $27.1 billion at the end of Dec. 31, with most of the holdings in corporate bonds and debt of foreign governments. The figure has been less than $36 billion at the end of every year since 2003, while the value of equity holdings more than tripled in that span on market gains and new investments. The insurance portfolio is divided into cash, stocks, fixed-maturity securities and a group that includes preferred stakes.

Berkshire last year sold bonds tied to Energy Future Holdings Corp. for $259 million after the debt lost most of its value, contributing to impairments for at least four straight years. Buffett has called the bet a “major unforced error” and said the power company will probably go bankrupt unless natural gas prices spike.

He also scaled back holdings of municipal bonds and said in the letter that pension obligations are a “financial tapeworm” that will pressure the finances of some state and local governments.

Instead of bonds, Buffett has been turning to infrastructure investments for what he expects to be steady returns. Berkshire’s MidAmerican Energy last year acquired electricity provider NV Energy and had $4.3 billion of capital spending. The expenditure at the BNSF railroad was $3.9 billion, and Buffett said he expects the outlay to climb this year.

“We will spend considerably more in 2014,” Buffett wrote in his letter, referring to the railroad’s capital spending. “Like Noah, who foresaw early on the need for dependable transportation, we know it’s our job to plan ahead.”

To contact the reporters on this story: Zachary Tracer in New York at ztracer1@bloomberg.net; Noah Buhayar in New York at nbuhayar@bloomberg.net

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net

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