Inexpensive Dollar Hedging

If you believe my recent articles, you don’t want to hold broad index funds, nor growth stocks, nor bonds of duration greater than 1 year. You want to limit dollar assets, yet it’s too expensive to invest in foreign assets on your own. Good grief, what’s left? Finally, some answers.

In effect, the only thing left, by process of elimination, is to hold a diversified portfolio of old-fashioned value stocks and short term bonds, denominated in various currencies, including the dollar. There are three inexpensive ways I can think of to do that.

First is Berkshire Hathaway (BRK.A and BRK.B). Everyone knows Berkshire owns big chunks of many high-profile consumer brands in the U.S., from See’s Candies to Coke to Gillette. But there are some less-known features of Berkshire that make it attractive for all of our diversification goals.

* You can think of Berkshire as a sort of mutual fund in corporate form. It is diversified, though not as much as a mutual fund, and has very low expenses.
* The company’s key assets these days are actually not consumer brands, but rather well-run insurance companies, many with global operations.
* Berkshire’s chairman and vice-chairman, Warren Buffett and Charlie Munger, have been bearish on the dollar for years, and began diversifying out at least as early as summer 2002. They currently hold $20 billion in non-dollar cash and short-term instruments, though this probably understates the true number, since Berkshire’s controlled investment vehicles (again, mainly insurance companies) can be expected to be similarly hedged.

You should not expect Berkshire to deliver its historically amazing 40-year performance of over 20% compounded. Neither the company’s scale nor the pricing of the stock market support that today. However, you can think of Berkshire as a strategy to avoid losing money: it’s an inexpensive way to hedge simultaneously against risk of inflation, a dollar fall, and a fall in average PE ratios of US stocks.

Many professional managers of value-oriented hedge funds are currently holding large amounts of Berkshire Hathaway as an alternative to cash or short-term bonds, for essentially the same reasons outlined here. But they charge 1% per year, while you can easily do the same thing yourself by simply buying Berkshire into your brokerage account.

The second idea is Third Avenue Value Fund (TAVFX). Third Avenue is the only long-running, successful value fund that’s still open to new investors, as far as I’m aware (if you know of another with at least a 15-year published record of results, please write me or append a comment to this article).

Third Avenue is fanatical about buying securities on the cheap. They hold a nice mix of stocks and bonds, US and foreign assets, but above all, their basis is low for everything they own. They are an illustration of research showing that a disciplined value approach tends to outperform growth over time: their performance is something like 17% annualized for 20 years, and they’ve had only one down year. The expense ratio is quite low, which is one reason for their high performance.

A third alternative — which I offer with some reservations — is to hold a value index fund such as Vanguard Small Cap Value Index. I’m less excited about it, partly because it’s not a dollar hedge, but also because their definition of value is, I believe, relative; that is, they simply select the cheaper stocks from whatever happens to be available.

The risk in Vanguard’s relative value index approach is that, in today’s expensive market, even the cheapest half of public stocks are still pretty expensive. Higher-than average PE results in lower-than-average return (see this recent article). Better in my view to hold a disciplined, managed value fund, that is truly buying things cheap on an absolute basis, at least until the market as a whole approaches a historical norm.

Ask your investment adviser if you’re likely to lose a lot of money by putting a third of your assets in Berkshire, and two thirds in Third Avenue.