Why did Buffett not just select one or two of the best, but instead bought five companies in a 'basket'? Is this for risk diversification or are there other intentions?

Analysis of Buffett's Investment Strategy in Japan's Five Major Trading Houses

Warren Buffett invested in Japan's five major trading houses (Itochu, Marubeni, Mitsubishi Corporation, Mitsui & Co., and Sumitomo Corporation) through Berkshire Hathaway, opting for a "basket approach" by purchasing all five rather than selecting just one or two "best" companies. This was not a random choice but a deliberate strategy aligned with his long-standing investment philosophy. Below is a multi-faceted analysis of the rationale.

1. Risk Diversification: A Core Motivation

• Mitigating Single-Company Risk: Although these trading houses share similar business models as Japanese Sogo Shosha (spanning diversified sectors like trade, resources, energy, and food), each faces unique risks, such as management changes, geopolitical impacts, or industry-specific volatility. Investing in only one or two firms could expose the portfolio to significant losses if a company encounters issues (e.g., supply chain disruptions or market downturns). By buying all five, Buffett effectively diversifies these idiosyncratic risks.
• Sector Correlation and Overall Stability: The five trading houses are highly correlated, benefiting from Japan’s global economic influence, but diversification cushions cyclical fluctuations. For instance, during the 2020 pandemic, resource-related businesses might have struggled, while trade and consumer segments remained more stable. Buffett likened this approach to "buying the basket, not betting on a single egg."
• Alignment with Buffett’s Style: Though known for concentrated bets (e.g., long-term holdings in Coca-Cola or Apple), Buffett adopts measured diversification in high-uncertainty arenas (like overseas markets). This resonates with modern portfolio theory’s risk management principles, akin to asset allocation diversification.

2. Strategic Intent Beyond Diversification

• Capturing Industry-Wide Opportunities: The five trading houses represent the "backbone" of Japan’s economy. They are not mere traders but critical nodes in global supply chains, involved from raw materials to finished goods. Investing in all five provides diversified exposure to Japan’s—and the global—economy. Focusing on one or two might miss unique strengths (e.g., Mitsubishi’s dominance in energy or Itochu’s expertise in consumer goods). This "theme investing" strategy targets the sector’s long-term growth rather than stock-picking.
• Valuation and Opportunity Cost: At the time of investment (2020), these firms traded at low valuations (P/E ratios of 5–10x), offered high dividend yields (~4–5%), and had stable cash flows with share buyback programs. Amid a global low-interest-rate environment, Buffett saw this as a "cheap buying opportunity." The basket approach maximized capital deployment efficiency, avoiding delays in selecting the "best" company. It also strengthened Berkshire’s presence in Japan, potentially paving the way for future collaborations (e.g., M&A).
• Long-Term Holding and Compounding: Buffett emphasizes "buy-and-hold" investing. These trading houses boast wide "moats" (e.g., government ties and global networks), making them ideal for long-term holdings. The basket strategy enhances portfolio resilience: even if one company underperforms, others can drive returns and compound growth.
• Cultural and Geopolitical Factors: Buffett admires Japanese management practices (e.g., shareholder-friendly policies and conservative finance). Investing in all five may also reflect a "show of confidence" in Japan’s market while mitigating cultural or regulatory risks (e.g., forex volatility or policy shifts).

3. Link to Buffett’s Broader Investment Strategy

• This investment constituted a small portion of Berkshire’s assets (~$6 billion), reflecting its asset allocation principle: concentrated core holdings (e.g., Apple) with peripheral diversification for risk management.
• Key Takeaways: It combines value investing with diversification, risk management via the basket effect, equity investment in high-dividend stalwarts, and asset allocation expansion into international markets.

In summary, Buffett’s "basket approach" primarily aimed to diversify risk while capturing broader industry opportunities and long-term value. It was not an abandonment of his "concentrated bets" philosophy but a flexible adaptation to specific markets (e.g., Japan). To date, this investment has delivered substantial returns for Berkshire, validating its effectiveness. For investors, applying similar diversification principles aligned with personal risk tolerance is recommended.