The question many investors are now asking is: Does BRK.B actually belong in the Financial sector? If BRK.B behaves like a Financial, for all practical purposes (including portfolio construction and risk management) it should be treated as a Financial. However, our analysis of BRK.B’s historical returns shows it behaves more like a Consumer Staple stock than a Financial.

BRK.B’s sector classification is of particular importance to both long-only and long-short portfolio managers attempting to manage sector exposure. For example, consider a long-short portfolio manager attempting to construct a sector neutral portfolio. If the portfolio manager is long BRK.B and it behaves like a Consumer Staple and not a Financial, this portfolio will have unintended, potentially large sector tilts towards Consumer Staples and away from Financials.

Based on monthly return correlations, it appears that, in recent years, BRK.B behaves more like a Consumer Staple than a Financial.

As the chart below clearly shows, not only are BRK.B’s returns more closely correlated with Consumer Staples, but the magnitudes of its returns are more similar to Consumer Staples than Financials.

The results from this simple correlation analysis were further supported by more rigorous, quantitative analysis done using MPI’s proprietary Dynamic Style Analysis (DSA) model. When using a multi-factor model comprising of the S&P 500 sectors, Consumer Staples is the dominating factor driving BRK.B’s returns. Since 2001, the exposure of BRK.B’s returns to Consumer Staples is much larger than its exposure to Industrials and Financials combined.

Why does the market treat BRK.B as a Consumer Staple instead of a Financial when, according to Berkshire itself, their primary business is in the insurance and reinsurance sector? We posit that three different considerations, when viewed together, provide a plausible explanation. First, a large chunk of Berkshire’s insurance businesses are viewed as Consumer Staples not Financials. Second, Berkshire’s reinsurance businesses impact BRK.B’s idiosyncratic returns, but do not have a significant impact on its systematic returns. Finally, and most obviously, Berkshire has large public holdings in companies like Coca-Cola and P&G.

Interestingly, looking at the exposure chart above, prior to 2001, BRK.B traded more like a Financial than a Consumer Staple. What explains this apparent shift in how the market perceives Berkshire Hathaway? We will continue our investigation into BRK.B and Berkshire Hathaway in future blog posts.