Derivatives, famously labeled “financial weapons of mass destruction” by Warren Buffett, are now damaging shareholder wealth in Berkshire Hathaway.
The company has seen its stock price decline 25 percent in just eight straight days. At $83,500, the shares are at a three-year low. Just a year ago, one share of Berkshire Hathaway sold for more than $151,000.
The company has posted four straight quarterly profit declines, its worst performance in 13 years. Berkshire's shareholder equity, Buffett’s preferred measure of his management ability, declined by $9 billion in October alone.
Some analysts, such as Mohnish Pabrai of Pabrai Investment Funds, are troubled by losses on Buffett’s $37 billion bet on world equity markets that come due starting in 2019. Buffett sold contracts for $4.85 billion protecting buyers against declines in the S&P 500 and three other stock indexes.
By Sept. 30, Berkshire had been forced to write-off more than $6 billion as stocks declined. Stocks have fallen an additional 25 percent since then.
Not just stock investors are worried about Buffett’s investment portfolio.
Credit default swaps (CDS) price the credit risk of companies. Now even Berkshire’s sterling reputation has suffered a punishing price move in that market.
Protection from Berkshire defaulting on its debt payments has more than tripled in price recently.
The swaps traded as high as 475 basis points on Nov. 19. According to CMA Datavision, those same derivatives were priced at 129 points two months ago.
That means investors are now willing to pay $475,000 a year to protect $10 million of Berkshire’s debt for five years, compared to just $129,000 previously.
Higher default swap prices often signal investor concern about a company.
Some, however, blame Berkshire’s price decline on the economy, not Buffett’s choices.
“There's nothing fundamentally wrong with Berkshire, what's really happening is people are wondering if there's something fundamentally wrong with the economy, and Berkshire is in some ways a bit of a proxy for that,” says Michael Yoshikami, president of YCMNet Advisors.
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