Warren Buffett, the billionaire investor known for buying companies at low prices, made a bet on bonds last year that's paying off.
The finance unit of Buffett's Berkshire Hathaway Inc. more than doubled its assets last year to $42 billion by buying U.S. Treasury and agency bonds, according to annual and quarterly filings with the Securities and Exchange Commission. This year, Buffett has been selling, taking advantage of surging prices to boost the unit's pretax income for the first nine months of the year to $793 million from $325 million in the corresponding period a year ago.
Buffett, who has told investors to expect lower returns from U.S. equities this year, focused on bonds as their returns beat stocks for a third year - something that hasn't happened since 1939-1941. The benchmark 10-year U.S. note has returned 12.3 percent this year while the Standard & Poor's 500 Index has lost 20.4 percent.
"He has evolved his strategies over the decades to suit market conditions and also to suit Berkshire's mission," said James Armstrong, president of Henry H. Armstrong Associates Inc., a Pittsburgh-based money management business that owns $50 million of Berkshire stock, its largest single investment.
BH Finance, a division of Berkshire's finance group, last year purchased Treasuries and bonds sold by government-chartered companies such as Freddie Mac and Fannie Mae, according to the filings. The unit uses "a small number of proprietary trading strategies" to invest in bonds on a "substantially leveraged basis," the filings said.
A leveraged investment is one partially financed with borrowed money to increase the return on the invested capital. Buffett - who personally oversees BH Finance's trading - used repurchase agreements to take advantage of the gap between his cost to borrow money and yields on Treasury bonds.
Buffett borrows through such agreements by selling securities and buying them back at a specified price and date, typically within days of the sale. Some repo rates have fallen below 1 percent, less than one-fourth the 4.07 percent yield on benchmark 10-year notes, after the Federal Reserve cut benchmark interest rates to a 41-year low.
"It's certainly a good game right now, given that borrowing costs are expected to remain low for the immediate horizon," said Anthony Crescenzi, chief bond market strategist at Miller Tabak & Co.
Berkshire, which owns car insurer Geico Corp., business insurer General Reinsurance Corp. and a collection of businesses including Dairy Queen and Benjamin Moore, said BH Finance had "significant earnings increases" over the prior year.
Shareholders have benefited. Berkshire's stock is up 5 percent in the past year, compared with a 21 percent decline in the Standard & Poor's 500 index.
Pretax income in the financial products group during the third quarter alone was $409 million, Berkshire said in the filing. Aside from BH Finance, the unit includes a derivatives business the company is winding down and Berkadia LLC, a joint venture with Leucadia National Corp. set up to provide a $5.6 billion term loan to help Finova Group Inc. emerge from bankruptcy. The derivatives unit lost $121 million in the first nine months, the filing said.