Opportunities . . . from Problems
My constant worry is about risk lurking in the portfolios Core manages. As I see it, Core's primary duty to clients is to preserve the value of your capital. With the many threats, potential and real, to the investments we hold, I am alert to the things that can go wrong. Discussion of these risks forms the customary subject of these investment letters. The litany of woes I have addressed in my letters to you the last year include Iran’s nuclear programs and the problems associated with our dependence on foreign oil, the restrictive monetary policies of the major central banks, high prices of risky assets, the risk of terrorism in an anti-American world, and America’s unsustainably large indebtedness to the rest of the world.
Happily, many of these problems create low-risk investment opportunities. This less gloomy aspect of our work is the fun part. In this letter, we first offer a brief review of some of these investments that have earned very attractive returns in the last few years. Then, let us give consideration to those opportunities that offer themselves to us now.
Then: Risk of deflation, opportunities in inflation. From the latter part of 2002 and for several years, the markets and the Federal Reserve Board were very concerned with the risk of deflation. During the depression in the ‘30s in the United States and for much of the last fifteen years in Japan, deflation--falling prices--caused real economic hardship and it proved quite difficult to overcome. The Fed’s policy of very low interest rates was maintained for so long in the early part of this decade chiefly to overcome the risk of deflation. Of course, the remedy was policies that would promote inflation. In 2003 and 2004, we took note of some investment opportunities offered to us by these inflationary policies and made a series of investments that paid off quite handsomely. (We retain some of these investments today.) We recognized that “real assets”, like commodities, oil stocks, and utilities, would thrive in the inflationary period that lay before us. Since we made these investments, we have earned more than 50% from them.
Now: Risks in oil dependency and global warming, opportunities . . .The problems created by our voracious appetite for oil scarcely need elaboration. We continue to hold our oil-related investments. Demand for oil remains high and growing while supplies are limited and vulnerable to disruption by hurricanes, war, and politics. But, the solutions to oil dependency are known and achievable. We have begun to invest in companies engaged in alternative energy development and production. Universities, companies and countries around the globe are developing technologies to meet the world’s energy requirements from sources that do not cause carbon emissions and do not put us in the thrall of foreign oil-producing countries whose interests are hostile to ours. The future of alternative energy industries is virtually certain to be robust and profitable.
In addition to alternative energy investments, two other areas offer very promising futures and good investment opportunities: water and biotechnology. The ever-growing demand for clean and accessible water affords investment opportunities in water-related industries, including filtration, environmental controls, industrial uses, water utilities, and electronics.
Biotechnology, as an investment term, refers generally to companies engaged exclusively in drug development. It does not include the big pharmaceutical companies like Merck and Pfizer, which have enormous drug development programs, but are in every other phase of the drug business. As promising drugs emerge from biotech companies, the development companies typically enter into marketing agreements with the big pharmaceuticals, or the biotech companies are purchased outright by the big companies. Research into the genetic code of humans offers extraordinary promise for drug development; technological advances accelerate the process.
The rewards for investment in alternative energy, water, and biotech may not be realized in a short time. Our oil-related, utilities, and commodity investments bore fruit quickly, but these investments may not reward us so quickly. To employ a common metaphor, I suggest that we view the investments we make this year as the orchardist views the planting of seedlings. We are making small investments now, and can expect to harvest the fruits of these investments for many years in the future.
A brief review of markets and returns. Despite worsening global political conditions, horribly exacerbated by the fighting in Lebanon, stock markets have recovered their poise after turbulence in May and June. We hold large positions in US and non-dollar money market funds, because of our sense that investment risk is high. Despite these cash holdings, our returns are far higher than the broad US stock and bond markets this year. Our large cash positions enable us to begin to plant our investment seedlings. We will tend them carefully.