Warren Buffett, the “Oracle of Omaha” and one of the world’s most successful investors, published his annual letter to shareholders a few days ago. While the coronavirus, also known as COVID-19, was not mentioned, his thoughts on managing risk provide valuable lessons for businesses during the disease’s deadly outbreak.
Whether or not the coronavirus plays out to become a global pandemic remains to be seen, but it has so far spread to dozens of countries outside of China, including almost all the G20 countries, with over 80,000 confirmed cases. It is worth analyzing Berkshire Hathaway’s approach to risk, and trying to find some cues there.
Buffet’s focus on risk in his letter centered on a topic of huge importance to Berkshire Hathaway investors: Buffett and his partner Charlie Munger’s age. Buffett is 89; Munger is 96. Buffett addresses this risk by writing:
“Charlie and I long ago entered the urgent zone. That’s not exactly great news for us. But Berkshire shareholders need not worry: Your company is 100 percent prepared for our departure.”
He then proceeds to list the succession planning and structural safeguards that exist to mitigate the risk (actually, a certainty) that both of them will not be around for too many more years.
In light of the progress of COVID-19, and the impact it is having on business and markets, the virus could also be said to have entered the urgent zone.
Of course, Berkshire Hathaway, is heavily invested in the insurance sector, so risk assessment and management are very much part of everyday business. But this focus on risk informs the entire portfolio, valued at some $560 billion, and Buffett underlines the criticality of risk management at every stage of his communication.
With decades of experience, he has been around long enough to understand that risk can become reality in a heartbeat, and that good investors should plan for that, not ignore it.
“A major catastrophe that will dwarf hurricanes Katrina and Michael will occur – perhaps tomorrow, perhaps many decades from now. “The Big One” may come from a traditional source, such as wind or earthquake, or it may be a total surprise involving, say, a cyber-attack having disastrous consequences beyond anything insurers now contemplate,” Buffett said in his 2019 annual letter.
In other words, if you accept that disruption and crisis are inevitable, you are more likely to respond in the right way for staff, shareholders and society.
COVID-19 may become what Buffett refers to the “The Big One.” The shipping industry, often the forerunner of macro trends, has taken a significant hit due to the coronavirus. Tim Huxley, founder of Mandarin Shipping, an Asian operator, recently noted that the oil tanker market has “really fallen off a cliff” as consumption in China dropped significantly in response to the virus dampening demand.
“There was one report of 600,000 barrels a day being cut from Sinopec’s daily refinery production, which is about 12 percent of their capacity. You have earnings on VLCCs (Very Large Crude Carriers) – which were pretty good at the start of the year at $100,000 a day – dropping back to $25,000 now,” Huxley said.
And it is not only the demand side that is suffering. China provides 14 percent of all container shipping crews in the world. When those crew are unavailable, there is an impact on the supply side. Meanwhile, factory closures have forced companies including Apple to issue a rare profit warning on product availability and product demand in China.
While markets had shrugged off the risk of a pandemic, on Monday they fell in unison as the impact of the virus began to materialize. When the Italian authorities took drastic measures, the west took fright. Closer to home, investment firm EFG Hermes canceled next week’s flagship frontier and emerging markets investor conference in Dubai.
All of which comes together to force some hard questions in the boardroom: Are we prepared for a major public health crisis? Is our disaster recovery plan robust? How will we safeguard our people? What do we do if major disruption occurs? Do we have a crisis communications plan?
While the fallout from COVID-19 continues to grow, there are more unknowns than knowns on the investment landscape. Risk has risen, stock prices have fallen, and many investors will continue to position themselves accordingly, moving portfolios into safe haven assets. Companies need to be urgently addressing this new risk. Management and investor relations teams need to be planning and preparing to explain the situation and actions taken to their shareowners.
The single most important factor in any successful investment strategy is the prudent management of risk. Investors take a risk with every asset class; the only difference is degree.
As the world faces up to the shocking scale of COVID-19’s public health risk, businesses, investors and market participants need to remain calm as they factor this new element into their strategies. However, they also need to focus on preparation, planning and risk mitigation should the global economy wake up one morning and find itself in the urgent zone.