Montag, 2. März 2009

Warren Buffett

Berkshire Hathaway's annual report makes for some interesting reading.

Net profit of 5.0 bn US$. At first glance, that sounds as if BH has managed to make money in 2008. Less than in 2007 (13 bn $), but still a decent profit.

Unfortunately, a look into the balance-sheet reveals that net equity has gone down by 11.5 bn $. The reason is a drop in unrealized earnings (what BH calls "accumulated other comprehensive income"; it seems to be related to the investment assets held by his insurance companies, a large part of which are invested in stocks) of 17.6 bn $. In other words: The profit of 5.0 bn $ is only an accounting convention. If profit is measured as "increase in net assets", BH made a loss of 11.5 bn $.

He does highlight the decline of net equity in his customary comparison of Berkshire's performance vs. the S&P 500: BH lost 9.6 % of its book value in 2008, whereas the S&P dropped by 37 %. Though I wonder how many of his devotees realize that he is comparing apples and oranges: The S&P index measures the change in market value of its member companies. Berkshire's book-value measures the change in Berkshire's net equity. But BH is not just a mutual fund. It owns real-life business, and the change in market value of these businesses is not reflected in the change of BH's book value. It's quite simply meaningless to compare the two for any given year (in fairness, BH uses the table to compare long-term performance over 43 years, not just the one year 2008).

Another interesting item: Derivate losses of 6.8 bn $. That's serious money by any yardstick.

How did that come about? Well, essentially, Buffett made a bet that world stock-markets will not go down in the longer run (i.e. between now and 2019-2028): He wrote long-term put options. Unfortunately, stock prices continued to fall, and volatility went up, so the fair value of his derivative position as of 31/12/08 tanked. Buffett is unimpressed: As he points out at length, he thinks he made the right decision, but the option pricing formulas make no sense. His main point seems to be that he doesn't think the implied volatilities currently seen in the market are appropriate. In the long run, things will calm down. Mean reversion and all that. He may or may not be right, that remains to be seen. But the fact is that he departed from his traditional value-oriented stock-picking approach, and placed a large bet on the level and volatility of world stock prices.

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