Learning from the Oracle: Buffett's Zero-Cost Strategy

According to a Bloomberg report on April 10, Berkshire Hathaway, led by Warren Buffett, intends to issue yen-denominated bonds globally once again. A week later, on the 18th, Berkshire announced that the scale of this bond issuance amounted to 263.3 billion yen, marking the largest issuance of its yen bonds since their debut in 2019.

Of particular note, Berkshire's decision to borrow yen comes at a time when the currency is plunging, sparking a global frenzy to short the yen. Given Buffett's renowned acumen, the question arises: why would he choose such a moment to borrow yen so prominently?

In simple terms, the core logic behind Buffett's move is "borrowing yen to buy Japanese stocks" – against the backdrop of Japan's long-standing negative interest rates and expectations of continued yen depreciation. The Oracle of Omaha leverages his U.S. assets as collateral to borrow yen at extremely low rates for investment in Japanese equities. This strategy not only allows him to "reap" dividends and distributions from Japanese firms but also exempts him from any foreign exchange risk. Furthermore, it presents an opportunity to earn additional gains from currency fluctuations.

On one hand, although Japan has exited its era of negative interest rates, it still boasts among the lowest interest rates in the world's major financial markets. Since 2019, Buffett has continuously sought financing in Japan, primarily due to the exceptionally low, near-zero cost of capital available there. Berkshire's large-scale issuance of yen-denominated bonds is a strategic move to lock in this inexpensive funding ahead of potential future interest rate hikes in Japan, which would otherwise increase the cost of borrowing.

On the other hand, since the Bank of Japan announced its interest rate hike, the yen has been falling continuously. Due to the widening of the US-Japan interest rate differential, trade interest rate differential, and other reasons, the market is generally bearish on the yen in the medium and long term, believing that the yen will continue to depreciate in the future, and the possibility of rapid appreciation in the future is also very low. In this case, borrowing yen has the possibility of obtaining exchange rate benefits. To give an exaggerated example, borrowing 10,000 yen (worth $65) at almost zero cost now may only require repayment of $60 due to the depreciation of the yen in three years, which can obtain additional exchange rate benefits.

Buffett once explained in his 2023 shareholder letter the important reasons for favoring the five major trading companies: "diversified business, high dividends, high free cash flow, prudent issuance of new shares", "the friendliness of the five major trading companies to shareholders far exceeds that of the US". Overall, these five companies are very consistent with the investment logic of the stock god - investing in high dividends, strong monopolies, and diversified operating assets.

Overall, these five major trading companies are all long-standing and large-scale groups in Japan, playing a pivotal role in the Japanese economy. The business operations of these companies cover various industries in Japan, and they are all oligarchic chaebol enterprises in Japan. Coupled with the relatively conservative society in Japan, these enterprises are difficult to withstand the impact of emerging enterprises and have shown stable returns.

At the same time, these five companies control most of Japan's import and export business and have a large proportion of overseas business.

Figure: Revenue composition of the five major Japanese trading companies by region in 2023 ( trillion yen)

As shown in the above figure, except for Itochu Corporation, the overseas income of the five major Japanese trading companies exceeds or equals the domestic income. That is to say, in the case of Japan's economic downturn, these companies still have abundant US dollars or other foreign currency inputs. Even if the yen continues to depreciate in the medium and long term, the foreign currency earned from overseas will only become more valuable, and the profitability of these companies denominated in yen will continue to reach new highs.

From the perspective of Main Business, most of their income comes from upstream resources such as minerals and energy, mainly from the import and export trade of bulk commodities. Compared with the currency itself, the mineral resources in the import business can be regarded as a hard currency that resists inflation. In the tide of the US dollar, these bulk commodities can always maintain price stability. Export business can also enable these companies to earn US dollars. In the medium and long term, under the background of the depreciation of the Japanese yen, their profitability continues to improve. It can be seen that another logic of Buffett's investment in the Japanese market is to bet on energy and commodity prices, which coincides with Buffett's other main investment target, Western oil.

Figure: Main Business Composition of Mitsubishi Corporation

With the end of the US dollar interest rate hike cycle at the beginning of this year, more and more investors not only pay attention to dividends, but also choose to invest in some high dividend products to resist the Downside Risk of stock prices. Obviously, the stock god Buffett realized the importance of stable dividends a long time ago.

According to statistics, due to the continuous growth of corporate profits, the total amount of dividends and stock buybacks in Japan in 2023 is estimated to reach about 25 trillion yen, equivalent to about 165 billion US dollars, reaching a historical high. In an environment where Japan as a whole pays more attention to dividends and shareholder returns, the average dividend yield of the five major trading companies in 2023 is about 5.2%, far higher than the overall dividend yield of the Japanese stock market of 2.7%. That is to say, these five companies all follow a shareholder-friendly strategy and are willing to reward shareholders.

The injection of Wall Street funds led by Buffett into Japan has significantly boosted the Japanese stock market and directly promoted Listed Company's measures to increase shareholder returns. In February of this year, Mitsubishi Corporation announced a buyback of up to 10% of its stock for up to 500 billion yen, while Itochu Corporation announced in April that it plans to repurchase up to about 150 billion yen of stock.

As Buffett's late golden partner Munger said, "Buffett raised yen to invest in Japanese trading companies, and the logic was to borrow money at low interest rates to buy high-dividend assets." In summary, Buffett's investment is unlikely to lose money as long as the yen does not experience a large-scale appreciation in the future, and the difference between the investment company's income and the cost of funds is his safety margin. Currently, based on the attitude of the Bank of Japan and market expectations, the possibility of a strong appreciation of the yen in the future is not high, and the success rate of this investment by the stock god is quite high.