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Market Update

Berkshire New Hires Continue to Put Money to Work

The company has been active over the last several quarters selling legacy positions in order to free up cash for new managers Weschler and Combs to invest.

Berkshire Hathaway's (BRK.A) (BRK.B) second-quarter 13-F filing, which details the firm's equity holdings, continued to show evidence of the primary theme that we expect to drive portfolio movements over the near to medium term. With Berkshire's appointment of Ted Weschler and Todd Combs as lieutenants to Warren Buffett, the company has been active over the last several quarters selling legacy positions in order to free up cash for the two managers to invest, with purchases made by Weschler and Combs making up the bulk of the buying activity.

During this transition phase, which could take several years to accomplish as Weschler and Combs take over more and more of the stock investment portfolio, we expect Berkshire's equity holdings to fluctuate much more frequently than investors have become accustomed to over the years. Furthermore, based on early evidence, it looks like these two managers may not be such strict adherents to the buy-and-hold strategy preached by their boss and mentor, with portfolio turnover likely to be much higher longer term, in our view.

Some of the most notable moves in the most recent quarter were sales of legacy positions that can be tied directly to Buffett. Among these were significant sales of both  Johnson & Johnson (JNJ) and  Procter & Gamble (PG). Berkshire sold close to 19 million shares of Johnson & Johnson, equivalent to 64% of the shares that the firm held at the end of the first quarter, and worth around $1.3 billion based on today's closing price for the stock.

As is typical, we do not have any direct information or commentary as to why specific securities were bought or sold, but Buffett has had less than glowing praise for not only Johnson & Johnson, but also Procter & Gamble and  Kraft Foods (KFT) in the recent past, with each of these names being viewed as sources of cash as Berkshire raises capital for Weschler and Combs. So it was not too surprising to see the firm raise more than $900 million by selling more than 13 million shares of Procter & Gamble, and another $750 million from the sale of 19 million shares of Kraft.

Buffett did, however, put some money to work during the quarter, picking up close to 17 million additional shares of  Wells Fargo (WFC), which has been his favorite place to put capital over the last couple of years, and buying another 2 million shares of  International Business Machines (IBM). We also think that Buffett was the primary force behind the purchase of Lee Enterprises (LEE), a regional newspaper firm based in Davenport, Iowa, which was first disclosed in an amended 13-F in June.

The rest of the transactions during the quarter were, in our view, initiated by the new investment team of Weschler and Combs. While we cannot parse and attribute all of the specific transactions to one of the two managers, many of the purchases made during the second quarter were made in existing holdings. In fact, there was only one new purchase during the quarter, of  National Oilwell Varco (NOV), with the emergence of Phillips 66 PSX being the product of that firm's spin-off from  ConocoPhillips (COP), a legacy holding at Berkshire. Additions to existing positions include  DIRECTV , DaVita (DVA),  Liberty Media ,  Bank of New York Mellon (BK), and  Viacom .

As we note above, we are not surprised to see additions and fluctuations to some of these positions, as they fall into the realm of Weschler and Combs, who continue to build up their portfolios over time. Buffett has seemed pleased with the performance of both managers, and continues to allocate marginally larger amounts of capital to their investment responsibilities. This has happened much faster than we expected when the appointment of these managers was originally announced, which increases our confidence in a smooth succession when Buffett eventually passes the reins, at least within the investment management segment of Berkshire's business.

Somewhat surprisingly, a few of the investments that Combs or Weschler had made in previous quarters have already seen their positions reduced or eliminated. Most notably, Berkshire sold its entire position of  Intel (INTC) after initiating it in the third quarter of 2011, then reducing about one quarter of the firm's position in the first quarter of this year. While the shares did appreciate considerably during that time, it is a rare sight to see a stock in Berkshire's portfolio make such a quick exit after first being purchased. While investors have grown accustomed to the firm holding positions for years, if not decades, in spite of market prices, we believe that the future will be somewhat different, expecting these two managers to be a bit more active about moving in and out of stocks, something that Buffett has been loath to do over the years.

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