In case you haven’t been watching, ESPN has been airing “The Last Dance”, a 10-part documentary series about the legendary Chicago Bulls teams of the 1990’s. For those of us sports fans dying for a little action, it has been a welcome respite from an otherwise bleak sports calendar at the moment. The series centers on the team’s 1998 season, its final one with Phil Jackson at the helm and the one that ended with Jordan’s now famous stepback jumper over Bryon (yes, I spelled that name correctly!) Russell to beat the Jazz in the NBA Finals. You know… this one…
(The guy kneeling down in front of MJ is Russell, who is picking his shoes up off the floor after getting faked out of them.)The series gets a pretty decent look at Jordan’s psyche, analyzing a lot of the stories from his perspective. Jordan is the same now as he was for much of his career, a somewhat odd combination of combative and welcoming in his engagement with the media. One particular moment in episode one struck me, when Jordan and Bulls owner Jerry Reinsdorf take turns telling a story about when Jordan broke his foot early in his career. After rehabbing the injury, MJ wanted to come back quicker than his doctor was recommending. In response to this, the doctor had a sit down with Jordan and Reinsdorf, explaining that there was a 10% likelihood of reinjury if he came back too soon… and if he reinjured it, that would likely end his career. Even armed with that information, Jordan was insistent that he come back immediately. His competitive fire burned too hot and the Bulls were in playoff contention after all.
The documentary relays the ensuing conversation between Reinsdorf and Jordan as follows:
Reinsdorf: "Michael, you don’t understand the risk/reward ratio here. If you had a terrible headache and I gave you a bottle of ten pills, nine of which would cure you but one of which would kill you, would you take a pill?"
Jordan: "It depends on how bad the f**king headache was."
Jordan is such a legendary badass and that response, given the circumstances, only cements that status.
Warren Buffett is the Michael Jordan of investing.
Buffett hosted the Berkshire Hathaway annual meeting this past weekend, the first time he’s ever done so in a virtual format because… well, you know. As Josh Brown so eloquently laid out in his most recent missive, this year’s meeting didn’t contain the normal pomp and circumstance nor the usual pearls of wisdom from Buffett; it was almost a little depressing for us Buffett devotees. Buffett was noticeably vague about the current state of affairs in markets. He didn’t comment much on what he planned to do other than to say he thought some of their businesses would suffer and others would probably be ok. He talked a little about some deals that could have materialized in March had the Fed not stepped in to support credit markets. Then he dropped a (kind of) bombshell…
Berkshire has been selling equities rather than buying of late. In fact, they sold over $6 billion from their portfolio in April.
A net seller?!?! This is Uncle Warren we’re talking about here… the man that comes to the rescue when corporations need saving. In 2008, he made deals with GE, Bank of America, and Goldman Sachs that are almost the stuff of legend. He made the B of A deal while sitting in his bathtub one night.
This is the guy who writes the annual letter telling you everything will be fine over the long haul.
The guy that steps up every time the market has a hiccup.
The man who wrote the New York Times op-ed Buy American. I Am. at the bottom of the 2008 crisis for crying out loud! He always swoops in to buy when everyone else thinks he’s crazy. Always.
No such luck this time.
No, Buffett took a look at their portfolio and decided that something had permanently changed in the airline business and sold all of the airline stocks. As a result, Berkshire’s cash pile grew to an eye popping $137 billion during the course of the last month.
He’s talked in previous years about the difficulty inherent in managing a larger portfolio than in his early years, one which requires far larger acquisitions to move the needle. Because this indelibly means that there are fewer targets, he knows buying something on the cheap will be even more difficult and so he just hasn’t done it. If you listen to and read his comments over the past few years, it’s become increasingly clear that he knows the cash pile is a problem for the outside world (investors, analysts, etc.) but he also doesn’t really care a whole lot what they think.
He’s going to fire his “elephant gun” (as he so aptly refers to it) when he is good and ready and sees the shot he wants to take. No sooner, no later.
Like I said… legend.
Unravelling greatness is tough because it’s so hard to identify one thing that makes someone great at something. It can be God-given ability, luck, ingenuity, or plain old hard work that gets them there. It can be hours spent in the gym or just simply being in the right place at the right time and then capitalizing on it. The truth is it’s really some combination of all of that. But there is one common trait that permeates greatness and that is an almost preternatural ability to understand risk. Whether it’s basketball or bonds, anyone who’s ever achieved greatness has understood risk and used it to dominate the competition.
Consider the following Buffett quote on risk from the Berkshire annual meeting in 1994:
We do define risk as the possibility of harm or injury. And in that respect we think it’s inextricably wound up in your time horizon for holding an asset. I mean, if your risk is that if you intend to buy XYZ Corporation at 11:30 this morning and sell it out before the close today, in our view that is a very risky transaction. Because we think 50 percent of the time you’re going to suffer some harm or injury. If you have a time horizon on a business, we think the risk of buying something like Coca-Cola at the price we bought it at a few years ago is essentially so close to nil, in terms of our perspective holding period. But if you asked me the risk of buying Coca-Cola this morning and you’re going to sell it tomorrow morning, I say that is a very risky transaction.
Simple but so true. Buffett has understood and capitalized on the fact that, as he so famously stated, “no one likes to get rich slowly” better than perhaps any other human being in history. His timeline has been way longer than almost anyone else’s out there and he’s used that as a risk mitigation technique. There’s no real secret sauce other than that.
Buffett’s comments on Saturday included one about “betting on America” longer term but he punctuated it by saying “anything can happen in terms of markets” and “you don’t know what might happen tomorrow”… not exactly a ringing endorsement of the current state of affairs. Some may worry but I think this is just Buffett being Buffett. He’s unsure of the big risks out there and he’s not willing to fire until he gets a little daylight. He’s twelve years older than he was in the last crisis and, as a result, his personal timeline is obviously shorter. The GOAT is going to wait and see because, on a risk-adjusted basis, that’s probably the right thing for him to do right now.
That’s one of the things that I see people struggling with the most right now. We all see markets moving and feel the need to do something to take advantage of that on either side of the trade. I’ve already suggested one thing that you can do… and I still think that makes sense. But getting the overall risk positioning right in the portfolio is still the most important (and difficult!) task for any investor because it helps you sleep at night… which in turn helps you stay in the game longer term. That’s where you should be focusing your energy right now rather than worrying about what markets will do.
Markets have been crazy lately. I feel like I say that pretty much every week now but it’s true. Equities had their worst month in a long time in March and their best one in decades in April… I’m going to go out on a limb here and say May will be somewhere in between the two. No one is really sure of what might happen in terms of the path of the virus or the reopening of the economy and that anxiety creates headline risk and, in turn, a huge amount of volatility.
Earnings by and large have been ok but, remember, things didn’t really turn ugly until about two weeks before quarter-end so that doesn’t really tell you much. The earnings guidance is usually the more important factor to watch anyway. Thus far, I can sum up this quarter’s guidance like this:
Yea, no one really knows what will happen and that’s ok… they never really do anyway.
So what can we learn from Buffett’s and Jordan’s forays into risk management? I would say it's the way that they use information to stack the odds in their favor.
Jordan assessed the odds a few different ways. He did it by sneaking in a few workouts before reporting back to the Bulls and seeing how his foot would respond. He started with 3 on 3, then 4 on 4, and so on. He then knew his foot wasn’t bothering him and he knew the Bulls would limit his playing time anyway. Add in a 90% probability from the doctor that things would work out and the most aggressive path was the only one that made sense. It’s easy to say that with hindsight, knowing how well his decision worked out, but his logic and decision-making process were both actually incredibly sound.
Give me the pill… I’ll take the risk.
Buffett, on the other hand, is privy to a vast amount of economic information given the breadth of Berkshire’s company holdings. He’s able to assess consumer spending patterns, corporate access to credit, and the general mood of some of the largest and most powerful corporate titans in the world. He gets first crack at the best deals and uses his name as a corporate seal of approval so he’s gotta be careful. But more important than that, he knows the financial state of the businesses owned by Berkshire and what their needs might be over the coming months or years. When assessing this aspect of his risk, he’s much like the rest of us: determining future goals and liabilities and evaluating how his assets are situated to meet them given a variety of different potential outcomes. He’s taking the more conservative route for now with the caveat that he could change his mind at a moment’s notice. Dude is smart but he’s cunning. Don’t sell him short nor think of him as a scared old man who hasn’t had a haircut in eight weeks. He’s ready to go… he just needs a big enough target. He also has to make sure that he can balance what will surely be a greater need for cash from their operating businesses with a desire to do a deal. Not so different from the rest of us in our investing lives, huh?
I get a lot of questions from clients and prospective clients as to why I spend so much time talking about and assessing risk. The answer is really threefold:
1. No matter where you are in your investing lifecycle, it matters.
2. Risk encompasses the unknowable and no matter how much time I spend studying it, I will never fully understand it.
3. A good understanding of risk helps us accept a variety of different portfolio outcomes without getting too worked up. It keeps us in our seats through a lot of different market environments. OK results compounded over a long period of time are generally preferable to fantastic results that can’t be repeated. Staying power matters.
So how has your risk changed since the last crisis? Just like Uncle Warren, you’re twelve years older but certainly other circumstances have changed as well. Spend more time thinking about how changes in markets will impact your plan rather than what markets themselves will do (helpful hint: that's the unknowable part!).
And finally, when you're ready to make some portfolio decisions… ask yourself how bad the headache is. Is it worth taking the pill?