It was just over 10 years ago and I had gone to Omaha, Nebraska, to hear the wisdom of Berkshire Hathaway chairman, Warren Buffett. Instead, the most memorable line came instead from Buffett’s deputy, Charlie Munger. It still resounds – even more strongly – today.
Buffett talked in paragraphs; Munger talked in headlines. In May 2004 – still more than three years before the global financial crisis began to rumble – a shareholder sought Munger’s advice on investing. He gave a three-word reply: “reduce your expectations.”
As a market timer, it turned out he was two and a half years too early: the stock market kept rising until the Dow Jones peaked at more than 14,000 points in October, 2007. Since then, markets have recovered to fresh peaks but caution and lowered expectations still seem investors’ almost constant companions. And Australians have had several recent cautions on risk from Reserve Bank governor Glenn Stevens, with financial inquiry chairman David Murray adding his warnings.
With US investors spurred on by zero interest rates and a slowly improving economy, local share prices seem supported and, as long as interest rates remain very low, investors will keep chasing dividend yields. As the Reserve Bank governor noted in his recent testimony to parliament, companies are operating with their eyes mainly on shareholders [and are] “intent on sustaining a flow of dividends and returning capital to shareholders and less focused on implementing plans for growth”.
This may not suit the economic policy needs of the Reserve Bank or Canberra but company boards know that as long as they keep doing this and invest just enough to keep profits ticking upwards, investors will continue to buy income plays. This means those boring stocks on everyone’s list are: the big four banks, Telstra, BHP, Woolworths and Wesfarmers, which make up much of the ASX index. And who would complain? These stocks may be boring but they also are dependable, especially with dividends and capital returns top of mind with directors.
These often are the sort of stocks favoured by Buffett and Munger – those companies with a monopoly or oligopoly market status or other “moats” that protect their market, and companies that focus on cost control the efficiency.
As for Glenn Stevens’ concerns, there’s a good argument in favour of putting money back in the hands of the owners of the capital to do what they want with it, rather than retaining it in the company. This means companies then have to compete on the capital market if they want fresh funds for expansion, ensuring capital goes to the most efficient users.
Investors may be able to spread their portfolio a little wider, if they follow the Buffett-Munger approach. For instance, companies running infrastructure assets like Transurban and Sydney Airport have the advantage of monopoly or near-monopoly powers, while groups like ASX, Aurizon, Brambles, Computershare and CSL have “moats” that protect them from competitors.
Most stockbrokers continue to search for growth stocks, which will provide capital gains, but more SMSF trustees increasingly are focused on the boring income stocks, simply because more than half SMSFs are now pension-paying funds and trustees are under constant pressure to maintain the level of their income.
There’s still scope to find and invest in growth stocks; what is important in the new, low growth era is that investors don’t over-reach and chase returns from areas or assets outside their risk profile or outside of what Munger calls their circle of competence. He also suggests investors learn from past history, quoting Roman philosopher Marcus Cicero that a man who doesn’t know what happened before he was born goes through life like a child.
If lower economic growth (with the occasional burst of stagnation) is possible in the medium term, then the advice of Buffett and Munger to maintain lower expectations for investment returns may well channel SMSF investors in low risk investments. But this accords with Buffett’s two investment rules: the first rule is don’t lose money; the second rule is don’t forget the first rule.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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