The Buffet Bet

Published in The Sunday Times on October 22nd 2023.

I can’t figure out what’s going on in financial markets and the economy right now. Take oil for example, even before the calamitous state of affairs in the Middle East, it was all over the place. In mid-September, the price of crude oil topped $95 a barrel against a backdrop of supply cuts and stronger than expected economic growth. This fuelled industry predictions that it was heading to $150.

Then in early October, the price of crude oil saw its largest one-day decline in over a year. In only six trading days it dropped 13.5% on concerns that slowing global growth will weaken consumption. This was despite announcements from Saudi Arabia and Russia that voluntary production cuts would remain in place through to the end of 2023.

So, in the space of a fortnight, we saw the increase in prices being attributed to a stronger economy, with the narrative swiftly shifting to an economy that’s slowing to explain the subsequent declines.

The market outcome drives the narrative, not the other way around

I think most people would demur from reading too much into the daily moves of a volatile commodity like crude oil. But I can’t help being drawn into the associated narratives.

Oil markets and the associated financial market commentary are symptomatic of a much broader problem. Our desire to believe a compelling narrative that draws a comforting line between cause and effect is an inescapably human trait. It gives the illusion of clarity and seems to make investment decisions easier as we think we have an understanding of what’s really going on.

I work in financial markets. It’s my job to have a view of what is happening in global economies and the associated investment implications. I’m doing this long enough to know that the market moves generate the narrative and not the other way around. However, it’s important to see through the noise and distraction and come to a reasoned decision regarding investment strategy. Excuse the cliché, but long-term thinking is paramount.

'In it for the long term’

The majority of investors I’ve met are ‘in it for the long term’. But pointing to the summit of Everest and declaring that’s where you’re heading is easy from the vantage point of base camp. 

The main challenge in capturing the benefits of long-term investing is that the long-term is comprised of many short terms. And those short terms are filled with spurious narratives about what’s going on in the world. However, I think I may have stumbled upon a potential solution to seizing the benefits of a long-term mindset.

The Buffett bet

In 2007, Warren Buffett made a bet with a hedge fund firm Protégé Partners. Each got to choose an investment for a 10-year period and the winner got to donate $1m to a charity of their choice.

Buffett’s pick was a low-cost investment in an unmanaged S&P 500 index fund. Protégé Partners picked five “fund-of-funds” which owned interests in more than 200 hedge funds.

In December 2017, Buffett was declared the winner, having easily surpassed the return of the hedge funds.

There are lessons aplenty from this bet which I’ve written about before in this column. But here’s a more valuable takeaway. Put yourself in Buffett’s shoes. Assume you must make three investment calls and, once decided, you cannot do anything with them for ten years. You’re not betting against anyone, so you should present them as a binary bet of one investment over another. 

My Buffett bets

I’ve just done it. I’m intrigued by the mindset change in having to pick an investment and stick with it for a ten-year period. So here are my 3 Buffett bets for the next decade (which are personal views and do not necessarily reflect those of Davy). 

Equities over bonds. This seems like a cop-out. My career has taught me that this is akin to a lob at a tennis professional’s forehand. However global equity valuations are not cheap and bond yields are much more attractive than they have been for years. So it’s not a gimme. 

Small cap over large cap equities. This is more controversial. It has been an incredibly poor time for small caps versus large caps, driven primarily by the ascendancy of a group of staggeringly successful mega caps. The magnificent-seven and their ilk may represent a new paradigm, but I’m happy to lean against that trend.

Non-US over US Equities. This is probably the most controversial call. There are many reasons to believe that dominance of the US market may continue for another decade – Artificial Intelligence (AI) amongst the strongest – but I still believe that valuations matter.

You should try this. The serious point in doing so is this; if there is a void between your actual investment position and your Buffett bets, you need to understand why and the potential cost. There’s a void in my portfolio.

I’ll report back in ten years. If I’m right, I’ll write a piece about the power of long-term thinking. If not, I’ll comfort myself with the knowledge that people will forget I ever wrote this – as they seem to do for lots of prominent financial commentators who are never held to account. That’s a topic for another day!
 

Source: Data is sourced from Bloomberg as at market close 30th September, returns are based on total indices in local currency terms, unless otherwise stated.

Gary Connolly is Investment Director at Davy. He can be contacted at gary.connolly@davy.ie or on twitter @gconno1.