Discussions on investments follow a modified Godwin's law. The longer the debate progresses, the probability of someone mentioning Warren Buffett is approaching 1.
Yet, Buffett is rightfully a living legend, as few, if any money managers can demonstrate a better track record. While many know about his massive positions in Apple (NASDAQ: AAPL), Bank of America (NYSE: BAC) or a multi-decade position in the Coca-Cola company (NYSE: KO), his approach to currencies is less popular. Read on to find out how Buffett profits from the currency markets.
Who is Warren Buffett?
Over the decades, Warren Buffet became a synonym for a successful investor. After an education at the Wharton School at the University of Pennsylvania, the University of Nebraska, and finally at the Columbia Business School, he started working in finance in the 1950s. Yet, by 1965 he was running Berkshire Hathaway.
His track record of 20.3% in annualized returns since 1965 is twice that of an S&P 500 historical return.
This kind of success is seldom seen in finance, especially at the large-scale institutional investing, which is much less flexible than an average retail account. Along with billions of dollars, he earned the nickname, “The Oracle of Omaha.”
Buffett is a student of Benjamin Graham, who wrote the bestseller “The Intelligent Investor,” founding the school of value investing. This investment style looks for quality securities that are cheap compared to their intrinsic worth and then holds them for long periods.
Buffett’s approach fits within these guidelines:
- Invest in what you understand. Buffett keeps the focus on the industries where he feels competent. His favorite areas are financials and consumer staples. He prefers strong brands and simple business models and refuses to invest in companies he doesn’t understand.
- Buy and hold. As a value investor, his approach is to find a quality company at a good price and keep it for a long time. One of his oldest portfolio holdings is Coca-Cola. He has been holding it since 1988.
- Focus on yield. Dividend stocks play a huge role in Buffett’s portfolio. If you focus on mature businesses with a wide economic moat, they will likely be paying dividends. Collecting and reinvesting the dividends while compounding the profits is one of the secrets of his impressive growth.
- Seek out competent management. The company is its people, and it is crucial to evaluate who manages those people carefully. Buffett seeks out and supports capable leaders, like Tim Cook, who runs Apple, one of Berkshire’s most significant holdings. Yet, things tend to change over time and when they do, Buffett won’t hesitate to exit the position, like with Wells Fargo(NYSE:WFC). Once the largest shareholder, he sold the last of his stake earlier this year, following the fake accounts scandal fallout.
What is Forex?
Foreign exchange, often abbreviated as FX or forex, is a decentralized global market for exchanging currencies.
Unlike stock exchanges that operate through clearing houses, the forex market works over-the-counter (OTC) with each transaction closed between the parties. No institutions act as intermediaries between the parties; however, institutions provide the infrastructure to conduct the OTC trades.
The foreign exchange market operates 24 hours a day, 5 days a week. It is the largest market in the world, with $6 trillion in volume every day.
Although it is usually not the primary focus for long-term investors, the forex market offers unparalleled liquidity and valuable hedging opportunities.
What is Buffett’s Forex Strategy?
Buffett is an institutional investor, managing hundreds of billions of dollars. In contrast to typical retail traders, institutional investors of this size are hardly ever short-term speculators. They are long-term position traders that often use currencies to hedge their bets.
In institutional investing, this is the responsibility of the tactical asset allocation team who operates the cash reserves for their institution, shifting focus between the basket of currencies (usually within G10) to stay in line with trends.
While stocks are Buffett’s primary focus, back in 2002, he grew worried about the growing trade deficit and its impact on the U.S. dollar. As an institutional investor, he held a lot of cash and short-term equivalent in U.S. dollars to use for future acquisitions, and now that money faced erosion of value.
By 2003, he held about $12 billion in foreign currency contracts and $1 billion in high-yield euro bonds, betting that the dollar will fall. While he did experience a short-term setback in 2005, when the dollar rallied 14%, he still made over $2 billion on that single trade.
This example shows us that Buffet is a position trader — a long-term investor who has an excellent understanding of the fundamentals. This investing style requires significant capital to withstand any short-term fluctuations and patience until the situation resolves itself. A short-term market is a voting machine, but it is a weighing machine in the long term.
How Does Value Investing Impact Forex Trades?
Forex is fundamentally different from the stock market that created the concept of value investing.
Currencies are not businesses. They have no cash flow and rely on a promise of one country to honor the agreement and use it as a legal tender. Furthermore, currencies trade as a fluctuating ratio, while stocks have a strong historical upward bias.
When it comes to value investing, Buffett's positional approach comes as close as possible. Yet this requires the ability to recognize a shift in macro-economic trends and then holding the position for a long time — in his case, 3 years. This approach is helpful for multi-asset investors who benefit from currency hedging. Still, it is probably not the best approach for smaller investors as it ties up the capital for a long time.
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Lessons from the Oracle
Buffett will enter the history books as one of the greatest investors of all time. His ability to consistently outperform the market through the decades and sit on his hands and do nothing when appropriate is second to none.
However, it is hard to classify him as a forex trader or a forex investor. He takes on forex positions when he needs to hedge the risk and then holds them for a long period of time.
Over many years, Buffett proved himself a strong patriot — believing in America, investing and endorsing some of the most prominent American companies when they needed him (like General Electric(NYSE:GE). Yet, he still made a bet against the U.S. dollar when he had to, following in the footsteps of his mentor, who wrote that the intelligent investor is a realist who sells to optimists and buys from pessimists.
Frequently Asked Questions
Is Warren Buffett a forex trader?
Warren Buffet is not a trader. He is a long-term-oriented investor who sticks with his ideas for long periods, often decades. His approach is to buy and hold productive assets — businesses that he understands and generate returns — and preferably pay them out in dividends. Yet, asset classes like currencies, commodities or cryptocurrencies as “the latest fashion” are not generating yield.
Thus, Buffet cannot be classified as a forex trader. He is a value investor who has a track record of hedging his bets using the currency market, when appropriate.
Has anyone become a millionaire from forex?
While many forex millionaires are secretive, making billions is a bit harder to conceive. Back in 1992, after Great Britain joined the European Exchange Rate Mechanism (ERM), George Soros figured out that the pound was overvalued against the German mark. Over time he amassed a $1.5 billion short position.
Brits responded by raising the interest rate, but, as you might already know, that is an unpopular measure as it clogs up the stock market and makes the debt expensive. Soros kept increasing the position up to $10 billion by September. Eventually, the British government let the currency float freely in mid-September. The pound lost 25% against the U.S. dollar in 1 single day and Soros made around $1 billion on 1 single currency trade.
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