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Toronto Life is out with an article on Prem Watsa, who heads Fairfax Financial (NYSE: FFH) and is sometimes referred to as the Warren Buffett of Canada. Watsa has proven his investing ability over a long time and is someone to be studied.
Robert Huebscher of Advisor Perspectives has written an article on Tobin's Q entitled "The Market Valuation Q-uestion." Read it here.
Has multitasking run its course? We're being bombarded with information (the irony of this post is not lost on us), and we're forced to multitask. Perhaps we would do better by cutting down on some activities.
The following is a CY08 performance update from the Yale Investments Office, which manages the Yale endowment fund and is headed by highly respected investor David Swensen.
As a matter of long-standing practice, Yale releases information on the performance of its Endowment only following the close of the University’s June 30 fiscal year. Because the current economic crisis altered the financial landscape in dramatic fashion, Yale decided to release interim performance information to provide context for evaluating the University’s investment, spending, and borrowing activities.
On December 16, President Levin delivered a message to Yale’s faculty and staff that stated: "Our best estimate of the Endowment’s value today is $17 billion, a decline of 25 percent since June 30, 2008." President Levin’s estimate incorporated returns on marketable securities through October 31 and projections of write-downs on illiquid assets. Based on marketable security returns through December 31 and illiquid asset projections, the estimated investment decline remains at 25 percent.
Even though the significant decline in Yale's Endowment disappoints, it should not surprise. If a portfolio produces gains of 41 percent (as it did in the year ended June 30, 2000) and 28 percent (as it did in the year ended June 30, 2007), the possibility of suffering the symmetry of double-digit losses should be anticipated. That said, the fact that Yale last suffered an investment loss two decades ago (0.2 percent in the year ended June 30, 1988) makes the current decline in value all the more unwelcome.
Consider Yale’s estimated decline of 25 percent in the context of returns for stocks and bonds. For the six months ending December 31, 2008, the broad U.S. equity market declined nearly 30 percent, developed foreign equity markets fell more than 36 percent, and emerging equity markets dropped more than 47 percent. Risky bonds provided no safe haven as the high-yield market declined 25 percent. Only U.S. Treasury bonds protected investor capital, returning just over 11 percent as investors sought the risk-free security of government obligations.
Based on investment results in the current crisis, some skeptics questioned the University’s fundamental approach to portfolio management, which rests on the principles of equity orientation and diversification. These principles continue to support thoughtful and carefully considered management of Yale’s Endowment.
Equity orientation makes sense for investors with long time horizons. In the midst of financial crises, some argue for higher allocations to risk-free assets, no doubt wishing after-the-fact for the now unattainable before-the-fact protection. Yet those who argue for greater protection against financial trauma ignore the opportunity costs of maintaining a substantial allocation to fixed-income assets. Recall that in the ten years ending June 30, 2008, the Yale Endowment returned 16.3 percent per year in contrast to 3.6 percent annually for U.S. stocks and 5.7 percent annually for U.S. bonds.
Diversification, called a free lunch by Nobel laureate Harry Markowitz, allows construction of portfolios with superior risk and return characteristics. In the midst of a capital market dislocation, investors hoping for the protection provided by a diversified portfolio of assets frequently express disappointment at the crisis-induced tendency of risky assets to move together. The correlations between risky asset classes move toward one during periods when investors dump holdings of risky assets of all types to fund purchases of risk-free U.S. Treasury bonds. In a binary world where only risk and safety matter, otherwise dissimilar risky assets behave similarly. In the Crash of 1987 and LTCM crisis in 1998, flights to quality led to temporary market disruptions that caused diversification to lose its power. After the panics subsided, diversification once again mattered, as fundamental drivers of return determined results, not the overriding concern with safety. The crisis of 2008 differs from the crises of 1987 and 1998 in breadth, depth, and intensity. Yet, after the current crisis passes, prudent investors will reap the benefits of a well-diversified portfolio.
While the decline in Endowment value in the current financial crisis caused some observers to question the tenets of Yale’s investment strategy, when evaluated with a time horizon appropriate for a long-term investor, the University’s equity-oriented, well-diversified portfolio continues to provide the best foundation for future investment success. After the financial trauma recedes, Yale will once again benefit from the prospect of superior returns generated with prudent levels of risk.
Blackstone (NYSE: BX) is defying the SEC by refusing to provide return information for its funds in public filings with the SEC, according to a Bloomberg article.
We are surprised Blackstone hasn't had to provide this information ever since it went public. After all, fund performance is a large determinant of anticipated capital inflows/outflows. Even more surprising is Blackstone's gall to refuse this request now. Why did they become a public company if they evidently had little intention of behaving like a public company? Did they simply sense an opportune time to cash in at the top? And would Blackstone be refusing the SEC's request if its recent performance was something to advertise?
Fairholme Capital Management is hosting a call with the CEO of Pfizer on Monday. Here is the announcement:
Pfizer CEO Jeffrey Kindler will join Bruce Berkowitz, Fairholme Capital Management's Chief Investment Officer, for Conversations with Bruce on Monday, March 30th, from 3:00 to 4:00 PM Eastern Time. Charles Fernandez, President of Fairholme and an authority on restructurings and healthcare, will also join the discussion.
Before Jeff updates us on Pfizer's overall progress and the Wyeth merger, Bruce will quickly update you on Fairholme's portfolio of cash generating companies in today's tough times and then answer why Pfizer is now Fairholme's largest holding.
If you have questions about Pfizer, please submit them to agustin@fairholme.net in advance of the call. Jeff will answer the ten toughest questions submitted before we open the call to participants.
We hope that this and future conversations with managers of portfolio companies will lead to a better understanding of our companies and our firm. For details to participate in the call, visit www.fairholmefunds.com
It's always interesting to find out what makes fellow investment managers tick, not just from a business perspective but also in their lives. In this vein, we enjoyed a recent post by highly respected value-oriented fund manager Aaron Edelheit on his blog, Investing in a Life of Value. Writes Edelheit on the cultural treasure that is the 1959 movie Rio Bravo, starring John Wayne, Dean Martin and Ricky Nelson:
"I love the movie Rio Bravo, and I actually never knew anyone else enjoyed it as much as I do. So today’s Wall Street Journal article by Allen Barra took me by surprise. Here is a snippet:"
"French director Jean-Luc Godard called “Rio Bravo” “a work of extraordinary psychological insight and aesthetic perception.” British film critic Robin Wood wrote, “If I were asked to choose a film that would justify the existence of Hollywood, I think it would be ‘Rio Bravo.’” Quentin Tarantino, whose “Pulp Fiction” was also both popular and hip, told an audience at a 2007 Cannes screening of “Rio Bravo” that he always tested a new girlfriend 'by taking her to see ‘Rio Bravo’ — and she’d better like it!'”
Here are some scenes from this must-see piece of Americana:
The author of this post is hedge fund manager Nick Gogerty.
The dog illustration shows metrics that may be important to wiener dog specialists. I look at a dog, smile and walk on. A specialist sees a whole set of parameters I don't. I usually look at the tail. Dogs smile by wagging their tails, so if the dog is happy, I am happy.
The business of running a hedge fund is getting tougher on the performance side and the day to day office routine. Due diligence requests are up, redemptions are coming in and the staff is upset that the high water mark is receding faster than AIG's popularity. It can feel a bit like being the captain of the nautilus in 20,000 leagues under the sea.
Many hedge funds don't think much about inflation at the business level and assume the quant guys will come up with a strategy or the trend following commodity approach you just started applying will cover it.
The problem is that if inflation comes back you are going to get hit with a metric shock at the business level and the market level. Many funds promised to deliver whatever would get people to buy them. Fund allocators, family offices, pension funds, seeders etc. would ask for relative returns or absolute returns. The benchmarks would be set and everyone would be on their merry way until the quarter or year end review.
The metric shifts with the fashions of finance. Those who thought relative performance to equities would keep them high and dry are surprised that 1,500 bps of alpha over a -30% S&P index is met with redemption calls instead of a pat on the back.
Because most investors in hedge funds bought the feel good story and didn't understand the process driving the returns, they are heading for the hills.
The metric of absolute positive returns has now come into fashion. Alpha shmalfa, liquidity, absolute returns and transparency are the watch words of the day.
So if you run a hedge fund here is something to think about from a business perspective, Inflation. Rarely will your allocators or investors mention real vs. nominal returns in today's conversations. That could change, yesterday's 15% absolute return with 1.0 Sharpe may not make such a bold statement if inflation spikes in the US greater than 10%. Historical Sharpe ratios could be viewed through the lens of CPI instead of t-bills if inflation returns. You may want to run the figures now to see how others could be looking at your returns when they fire up the Barra type tools for their annual CYA process reviews. Co-variance using CPI or another inflation metric could become an important factor (pun intended) in your business.
From a fund business perspective the smart FoF's or hedge fund manager may wish to consider an inflation linked exposure today before things get crowded. If inflation rears its head, the returns of hedge funds may start to look less appealing in a relative context. A stable 15% return looks pretty risky in a high inflation environment if the process driving returns isn't understood and that 15% is invariant with respect to inflation.
Yale chief investment officer David Swensen has become an outspoken advocate for investor education and protection in recent years. His 2005 book, Unconventional Success: A Fundamental Approach to Personal Investment, included a recommended asset allocation for individual investors.
According to an interview in the March/April issue of Yale Alumni Magazine, Swensen has revised his recommended asset allocation as follows:
|
| 2005 | 2009 |
| Domestic equities | 30% | 30% |
| REITs | 20% | 15% |
| U.S. Treasury bonds | 15% | 15% |
| TIPS | 15% | 15% |
| Foreign developed market equities | 15% | 15% |
| Emerging market equities | 5% | 10% |
Equally noteworthy, Swensen has some choice words for CNBC’s Jim Cramer. As the Yale Alumni Magazine points out, Swensen writes the following in the new edition of Pioneering Portfolio Management: “Educated at Harvard College and Harvard Law School, Cramer squanders his extraordinary credentials and shamelessly promotes stunningly inappropriate investment advice to an all-too-gullible audience.”
Elaborates Swensen:
“Jim Cramer exemplifies everything that's wrong with the advice -- and I put advice in quotation marks -- that is given to individual investors. Investing is a serious business. We're talking about retirement security of American citizens, and he turns it into a game. It's a game where his listeners lose. It's ridiculous. These high-turnover, rapid trading strategies enrich the brokers. If you look at Jim Cramer's approach on an after-fee, after-tax basis, the individual doesn't have a chance.”
While some may dismiss Swensen’s comments as an extension of the recent ripping of Jim Cramer by Jon Stewart, David Swensen is no Jon Stewart. Not only is Swensen as serious as Stewart is happy-go-lucky, but Swensen is also a consummate investment professional. This makes Swensen’s indictment of Cramer all-the-more noteworthy.
Former Federal Reserve Chairman Alan Greenspan writes in the Financial Times that "some financial institutions have become too big to fail as their failure would raise systemic concerns." He goes on to say,
"This status gives them a highly market-distorting special competitive advantage in pricing their debt and equities. The solution is to have graduated regulatory capital requirements to discourage them from becoming too big and to offset their competitive advantage."
Lest you believe that Greenspan has shed his Ayn Rand clothes as a result of the failure of our hitherto laissez faire financial system, consider Greenspan's conclusion:
"In any event, we need not rush to reform. Private markets are now imposing far greater restraint than would any of the current sets of regulatory proposals."
Wonderful. Let's leave it up to the private market to fix the mess that the private market created! George Soros calls this blind faith in unregulated commerce "market fundamentalism." The word choice is deliberate. When it comes to religion, faith is a positive force, providing healing and sustenance. Religious fundamentalism, however, is something altogether different. The analogy applies quite well to the free market.
Which brings us to our final point: Here we are debating the latest policy advice of a man whose policies as Chairman of the Federal Reserve arguably pushed us to the edge of collapse. This is symptomatic of what is still happening in many business circles: The same actors who got us into the current mess are now arguing that we should listen to them on how to get us out. Let us restate this: They are not arguing we should listen to them; they are assuming it. And we are, for the most part, buying into this notion.
Well, here is some advice for Mr. Greenspan and his ilk: Write an honest assessment of what you did wrong, what the conflicts of interest or misjudgments were that caused you to do wrong, and what you have learned from your mistakes. Then -- and only then -- will we start listening to your policy prescriptions.
Zain Griffith of The Manual of Ideas presents a compelling microcap investment idea as a special bonus for our subscribers:
AlarmForce Industries (TSE: AF) operates in the security alarm industry. The shares represent an interesting opportunity to invest in an underfollowed, somewhat illiquid and undervalued Canadian micro-capitalization company (market value of ~C$50 million). While AlarmForce conducts most operations in Canada (~90% of subscriber base), it commenced a U.S. expansion effort in late 2004.
The thesis is to buy into a terrific business that generates maintenance free cash flow (MFCF) of more than C$6 million and returns on invested capital of 30-40%, with regional competitive advantages that appear to be replicable and defensible in various markets across Canada and the U.S.
The company has grown subscribers at a 19% compounded annual rate over the past decade and has a business model that lends itself to similar results in the future.
The AlarmForce model differs from the models of larger competitors such as ADT Security Services, a subsidiary of Tyco International (NYSE: TYC), and Brink’s Home Security (NYSE: CFL). AlarmForce acquires customers solely through TV, print and other forms of direct-to-consumer marketing. As a result, the entire investment in new subscribers is expensed in the current period instead of being capitalized and amortized over the estimated customer life. This conservative approach understates the true economic profitability of the AlarmForce business model, as current-period expenses boost revenue in future periods. Growth has been almost entirely financed through retained earnings, with minimal use of debt.
To read the full report on AlarmForce, subscribe to Downside Protection Report. Start your 30-day free trial now.
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Disclosure: The author of the above-referenced report, Zain Griffith. has a long position in AlarmForce.
The British paper The Telegraph reports on Steve Cohen's past indulgences at the auction house Sotheby's (NYSE: BID) as well as Cohen's current interest in the auction house itself.
We've taken cursory looks at Sotheby's in the past and find the current valuation quite interesting. After all, Sotheby's is one of only two dominant high-end auction houses, enjoying a wide moat around their businesses.
Of course, as with all companies that relaxed their business practices during the recent boom period, Sotheby's has gotten in some trouble for essentially guaranteeing minimum auction sales prices to some providers of highly prized auction merchandise. While these contingencies likely had a negative impact on the stock, they do not appear to have threatened Sotheby's existence.
When art prices inevitably recover, especially under an inflationary scenario that appears increasingly likely in the U.S., Sotheby's revenue and profits should also rebound nicely. Finally, the company owns its significant headquarters building in New York City, giving investors a small stake in another inflation hedge -- real estate.
Sotheby's: SEC filings; trading overview; investor relations website
Disclosure: No position.
One of our favorite non-fiction authors, Roger Lowenstein, recently wrote an interesting article for New York Times Magazine. Here is an excerpt:
Is there such a thing left as a safe investment? Stocks have been massacred, real estate all but wiped out. Each was promoted in its day — as was gold — as safe and secure, appropriate for widows and orphans.
If there is a truly last bastion of safety, it would be, of course, the U.S. Treasury bond, that venerable instrument with the full faith and credit of the United States behind it. Perhaps it is esteemed so highly because we think of it not as an “investment” per se but as an article of faith in Washington and, by extension, the entire country. It is our tax dollars, after all, that stand behind it — the accumulated output of our citizens. And ever since the Wall Street meltdown, as investors have fled from any security carrying a whiff of danger, Treasuries have been in hot demand.
So it is an eye-opener, and rather depressing, to report that even Treasuries bear risk, in particular, the risk that flows from crowd psychology. Last month, in his annual letter to shareholders (of which I am one), Warren Buffett wrote: “When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s. But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary.”
Pretty strong words for an investment that has outperformed stocks over the past 25 years and is widely referred to as “riskless.” Yet according to Buffett and other investors of a cautious bent, “risk free” Treasuries of longer maturities are anything but. None other than China’s prime minister, Wen Jiabao, expressed worry about the safety of China’s big stake in U.S. bonds.
Not since World War II has the government borrowed anything close to what it is borrowing now. Because of the economic slowdown, the stimulus package and various financial-relief measures, pundits estimate this year’s federal deficit at $1.75 trillion. To put the figures in (alarming) perspective, over the past half century and regardless of the party in power, federal tax receipts have usually provided 80 to 90 percent of the money needed to fill the budget; thus, the government has had to borrow only the remaining fraction. But this year, it will need to borrow 45 percent, virtually half, of what it is projected to spend. This means that the U.S. government is looking much like a homeowner at the tail end of the boom: too hooked on spending (even if, hopefully, for a worthy cause) to stay within its means.
When you buy a Treasury security, you are actually lending the government money for a set period of time — from 30 days to 30 years — at a fixed rate of interest. Few people worry that Uncle Sam will go the way of a defaulting subprime borrower because the government, unlike other debtors, can always print the money it needs.
But as James Bianco, who runs an eponymous bond-research firm, explains, investors in fixed-income securities face two types of risk. One is credit risk — the risk of default. The other is what bond geeks refer to as “duration” risk. This is the risk that, even if the bonds are paid in full, the promised rate of interest will turn out to be worth less over time.
Inflation destroys bond values. It’s not a big deal over one or two years, but if you hold a long-term bond and inflation takes off, the present value of the security will plummet. Bonds also lose value as interest rates go up. If rates on 30-year U.S. bonds, recently 3 percent, were to rise to, say, 6 percent, the value of bonds issued at the lower rate would fall nearly in half. (The reason is largely intuitive: if the market rate is 6 percent, nobody would be interested in a 3 percent bond, and its price would fall.)
According to this article about Deutsche Bank's annual Alternative Investment Survey, over 50% of hedge fund investors will only invest in funds with $1 billion or more in assets under management:
“There is a magic number where economies of scale really kick in,” Mr. Ang adds. “It’s at about $2 billion to $3 billion. With funds smaller than that, it’s much harder to get significant rewards.”
I disagree with Professor Ang, and with any hedge fund investor that limits itself to $1 billion+ funds. Taking Professor Ang's points in turn:
1) Why are big funds in a better position to have good risk management? What does he mean by good risk management? If he means larger funds are more able to hire dedicated risk managers, I think that's more likely to provide only the appearance of risk management rather than the reality, as Ken Akoundi explains in detail. The ultimate guarantor of good risk management is when the investment process is joined at the hip with the risk management process, which is usually truest when one very competent person is doing both.
2) Bigger funds can borrow more cheaply than smaller funds. With "advantages" like this, it seems to me, you don't need disadvantages.
3) Bigger funds are more likely to have a track record. Yes, but fund size is a very lazy heuristic to use to screen for track records. If you the hedge fund investor wish to confine yourself to funds with longer track records--a legitimate aim--the way to do that is to screen for funds with longer track records, not to use fund size as a proxy for track record.
4) Larger hedge funds benefit more from economies of scale. Yes, but the benefits of these economies of scale accrue to the hedge fund itself, not to the hedge fund investors. If anything, hedge fund investors face diseconomies of scale as the size of their funds grows:
a) As a fund grows its universe of opportunities shrinks.
b) If a fund grows by adding new investors, those investors are less likely to share the investing philosophy and expectations of the original partners.
c) Because of a) and b), larger funds are more likely to experience unfavorable style drift.
The author of this post is Nadav Manham, president of Elera Advisors LLC, an investment advisory company focused on value-oriented manager selection. Mr. Manham is also editor of The Investor's Consigliere.
Today's rally makes March the biggest up-month since 1987, according to Bloomberg. Who would have thought only a few weeks ago that we would be nearing the 8,000 mark on the Dow as of today? We certainly didn't think so, but neither did we prophesy otherwise. We were enticed by the undervaluation of individual companies, and so we were buyers of several companies that had fallen to irrational valuation levels.
We still see plenty of bargains out there, but we have no clue which way the market will go. Neither does Buffett -- who readily admits this -- and neither do market prognosticators who claim to know. What we do know is that there are plenty of ways for investors to profit in this volatile market, but in order to do so, one needs to have a set of investment principles and stick with them.
We invite you to try our "Margin of Safety"-inspired monthly newsletter, Downside Protection Report. Read the latest issue now with your 30-day free trial.
Sources and related resources:
The New York Post reports today that,
"AIG got shut out yesterday in its latest court attempt to seize $365 million in stock held in a charity the insurance giant wants to tap so it can pay additional bonuses to AIG executives."
The paper also reveals that,
"AIG has battled for the stock on two legal fronts simultaneously, in federal and state courts, with mixed results for 3½ years, running up a legal tab nearing $100 million."
Despite the legal defeat, AIG apparently plans to fight on -- at taxpayers' expense.
The Manual of Ideas has just launched a new bi-weekly screening service, the 10x45 Bargain Hunter.
The Manual of Ideas is pleased to make its flagship research publication, Portfolio Manager's Review, more accessible to investors worldwide.
Portfolio Manager's Review is highly acclaimed by some of the most well-known and widely respected value-oriented investors in the U.S. and internationally. The Review is now published monthly and available via online subscription.
We suspect we'll be hearing a lot more about Quantitative Easing in the coming months and years.
Here's a good article to give you an overview of QE, the "nuclear option" of central bankers.
Cialdini is author of the Charlie Munger-recommended Influence: The Psychology of Persuasion.
There's more at The World I Know.
Bloomberg is out with an article on companies currently meeting Berkshire Hathaway's stated takeover criteria. While the likelihood that Buffett will end up acquiring any specific company on the list is low, the likelihood appears high that the companies as a group will outperform the broader market over a 2-3 year period. Here is the list:
Disclosures: None.
With gold up roughly $50 per ounce yesterday on the Fed's announcement of massive liquidity infusions [read: money printing], Bloomberg interviews Jim Rogers, Marc Faber and others on the outlook for gold.
The Manual of Ideas recently published a special edition of Downside Protection Report, putting a spotlight on gold. Read the special issue.
In the just-released quarterly issue of Equities and Tobin’s Q, John Mihaljevic, CFA, managing editor of The Manual of Ideas and former research assistant to Economics Nobel laureate James Tobin puts the so-called Q ratio in historical context and draws timely conclusions for equity investors:
For information on purchasing the full report, visit The Manual of Ideas.
J.C. de Swaan of Princeton University recently wrote a cover story on hedge funds for Caijing, the Chinese business/financial magazine. We are grateful to J.C. de Swaan for his permission to republish the article in English for the benefit of our readers. Excerpt:
What a difference a year makes. Between 1989 and the end of 2007, hedge funds returned an annual average of 14%, with some hiccups, but none worse than one down year in 2002 with a negative average return of 1.5% when global markets were down 21%. Even in 1998, when Long-Term Capital Management (LTCM) famously collapsed, hedge funds generated positive returns on average.
2008 proved cataclysmic. Hedge funds returned an average negative 18%, according to Hedge Fund Research. The poor performance was pervasive across strategies, except for Global Macro strategies, up an average 5%, and those that had a short bias, up an average 29%. Almost every other strategy ended the year in the red, with Convertible Arbitrage posting the worst performance, down an average of 35%. Emerging markets performed worse than the developed world, with Asia ex-Japan focused funds down an average of 34% and Russia/Eastern Europe focused funds down an average of 58%. Weak performance also carried across hedge fund sizes, humbling many of the most storied managers.
Performance of selected hedge fund strategies (Percent annual returns)
| Strategy | 2004 | 2005 | 2006 | 2007 | 2008 |
| Event-driven | 15.0 | 7.3 | 15.3 | 6.6 | (21.3) |
| Macro | 4.6 | 6.8 | 8.1 | 11.1 | 5.2 |
| Relative-value | 5.6 | 6.0 | 12.4 | 8.9 | (16.8) |
| Convertible arbitrage | 1.2 | (1.9) | 12.2 | 5.3 | (34.7) |
| Fixed income - Corporate | 10.5 | 5.3 | 10.8 | (0.7) | (21.7) |
| Fund composite index | 9.0 | 9.3 | 12.9 | 10.0 | (18.4) |
| Fund of funds composite index | 6.9 | 7.5 | 10.4 | 10.2 | (20.7) |
Source: Hedge Fund Research
Around minute 8 of his 60 Minutes interview, Fed chairman Ben Bernanke admits to printing money and says it needs to be done. Of course, he believes we can avoid inflation despite the Fed's actions. We'll see.
Part 2:
View stocks picked by Barron's as good long-term investments. We note that, of the companies presented, Microsoft, EMC and WellPoint are owned by value investors we respect.
Disclosure: None.
GMO's Jeremy Grantham has published an excellent piece on deploying capital in financial markets even when fear of losses might prevent one from doing so. Writes Grantham:
It was psychologically painful in 1999 to give up making money on the way up and to expose yourself to the career risk that comes with looking like an old fuddy duddy. Similarly today, it is both painful and career risky to part with your increasingly beloved cash, particularly since cash has been so hard to raise in this market of unprecedented illiquidity. As this crisis climaxes, formerly reasonable people will start to predict the end of the world, armed with plenty of terrifying and accurate data that will serve to reinforce the wisdom of your caution. Every decline will enhance the beauty of cash until, as some of us experienced in 1974, ‘terminal paralysis’ sets in. Those who were over invested will be catatonic and just sit and pray. Those few who look brilliant, oozing cash, will not want to easily give up their brilliance. So almost everyone is watching and waiting with their inertia beginning to set like concrete. Typically, those with a lot of cash will miss a very large chunk of the market recovery.
There is only one cure for terminal paralysis: you absolutely must have a battle plan for reinvestment and stick to it. Since every action must overcome paralysis, what I recommend is a few large steps, not many small ones. A single giant step at the low would be nice, but without holding a signed contract with the devil, several big moves would be safer. This is what we have been doing at GMO. We made one very large reinvestment move in October, taking us to about half way between neutral and minimum equities, and we have a schedule for further moves contingent on future market declines. It is particularly important to have a clear definition of what it will take for you to be fully invested. Without a similar program, be prepared for your committee’s enthusiasm to invest (and your own for that matter) to fall with the market. You must get them to agree now – quickly before rigor mortis sets in – for we are entering that zone as I write. Remember that you will never catch the low.
Sensible value-based investors will always sell too early in bubbles and buy too early in busts. But in return, you may make some important extra money on the roundtrip as well as lowering the average risk exposure.
The blog Underground Value has published notes from two meetings Warren Buffett recently had with business school students. The blog contains a caveat that the notes represent the best recollection of the authors but may not reflect exactly what Buffett said.
Buffett:
Did you hear they called off the Wall Street Christmas Pageant this year? They had trouble finding three wise men…and a virgin. There are many opportunities right now. The markets are very inefficient at times, and this is one of those times.
Kansas:
Berkshire has invested in several insurance companies, would you go into the health insurance business?
Buffett:
No. Health insurance is so ingrained into national policy that it is a tough business. It’s pretty adversarial. I’m not really that excited about it from a business perspective. I don’t want to write policies with high loan loss ratios. That being said, I would buy the stock of an undervalued healthcare insurer.
Insurance is an interesting business. You know, we underwrote a two year life insurance policy on Mike Tyson. I wanted an exclusion against women shooting him, but they wouldn’t let me.
South Dakota:
You’ve recently invested in Goldman Sachs and GE. Is the financial sector a good buy right now?
Buffett:
No sector is a good buy unless you understand the business. However, I do believe that there is good value and great opportunity now in the financial sector because it is extremely unpopular. Sector’s themselves don’t make good buys, companies that are undervalued make good buys. You know how to value a business, you project the future cash flows discounted to present and buy with a margin of safety. The earnings prospects need to be greater than the current value. Anything that is unpopular is always great to look at. If I was getting out of school right now, I would take a look.
Creighton:
How much and how does risk factor into your investment decisions? Would you invest in emerging markets?
Buffett:
In general, emerging markets are not great for me because I need to put a lot of money to work. Risk does not equal beta. Risk comes around because you don’t understand things, not because of beta. There are normally 10 filters or so that I go through when I hear an idea. The first is can I understand the business and understand the downside not just today but five to ten years from now. There have been very few times that I’ve lost 1% of my net worth. I might be risk averse but I am not action adverse. Mrs. B saved $500 over the course of 16 years to start and build Nebraska Furniture Mart. Tom Watson Sr of IBM said, “I’m smart in spots and I stay in those spots.” I just stay within my circle of confidence. When I bought Nebraska Furniture Mart in 1983, Mrs. B took cash and not Berkshire stock. Why? She didn’t understand the value of stock. She understood cash and that is what she took. I need only need to be right a few times and can let thousands of ideas go by.
Ted Williams, who wrote the “Science of Hitting,” broke the strike zone into 92 ball shaped sections. He knew, if hit in his sweet spot, he’d hit 430, a little further out, and he’d hit 350. You have to know your sweet spot. The beautiful thing about investing is that it’s a “No called strike game” where unlike baseball the only strikes in investing are when you swing. I don’t have to swing.
When I do invest, I don’t care if the stock price goes from $10 to $2 but I do care about if the value went from $10 to $2. Avoid debt. I decided early on that I never wanted to owe more than 25% of my net worth, and I haven’t… exept for in the very beginning. I like to play from a position of strength. I always try to have the odds in my favor. When I go to Vegas, I don’t go around putting $5 dollars on the blackjack tables. If someone wants to come to my room and put $5 on my bed, well that’s fine. I like those odds better.
Emory:
How do you think about value?
Buffett:
The formula for value was handed down from 600 BC by a guy named Aesop. A bird in the hand is worth two in the bush. Investing is about laying out a bird now to get two or more out of the bush. The keys are to only look at the bushes you like and identify how long it will take to get them out. When interest rates are 20%, you need to get it out right now. When rates are 1%, you have 10 years. Think about what the asset will produce. Look at the asset, not the beta. I don’t really care about volatility. Stock price is not that important to me, it just gives you the opportunity to buy at a great price. I don’t care if they close the NYSE for 5 years. I care more about the business than I do about events. I care about if there’s price flexibility and whether the company can gain more market share. I care about people drinking more Coke.
I bought a farm from the FDIC 20 years ago for $600 per acre. Now I don’t know anything about farming but my son does. I asked him, how much it cost to buy corn, plow the field, harvest, how much an acre will yield, what price to expect. I haven’t gotten a quote on that farm in 20 years.
If I were running a business school I would only have 2 courses. The first would obviously be an investing class about how to value a business. The second would be how to think about the stock market and how to deal with the volatility. The stock market is funny. You have no compulsion to act and a bunch of silly people setting prices all the time, it is great odds. I want the market to be like a manic depressive drunk. Graham’s Ch. 8, in the book Intelligent Investor, on Mr. Market is the most important thing I have ever read. Now think about the NYSE. You have thousands of companies to choose from. For me, that universe has shrunk because I need to put large dollar amounts to work. Attitude is much more important than IQ. You can really get into trouble with a high IQ, i.e. Long-Term Capital. You need to have the right philosophical temperament.
Penn State:
Why did you invest in Harley-Davidson?
Buffett:
I like the 15%. I measured that 15% against other credits and it looked attractive on both a relative basis and an absolute basis. Also, we have to have a certain amount of the portfolio go to debt. Lately, the government has become the guarantor for some companies but not for others and the “haves” and “have-nots” determined by certainty of government assistance rather than the credit quality. These finance companies have a problem getting funded, not with their customers. Any company where you can get your customers to tattoo your name on their body has quite a strong brand. For this investment I had to think what is the probability that they will not pay me back and would I want to own the company if they did not, basically that the equity isn’t worth zero. Risk premiums in the corporate bond market went from real low to real high. Right now, they’re out of whack. The flip side is that governments are overpriced. We have a bubble in governments. T-bills actually had a negative interest rate. I never thought I’d see that. A mattress is a better investment than the US 10 Year. Buying corporates and shorting the 10-year is a great idea and smart guys went broke doing it because even if you’re right, you need to be able to play out your hand. I always think about what I would do if a nuclear bomb went off or if Bernanke ran off with Paris Hilton to South America.
Texas:
Do you feel that the might of America has changed?
Buffett:
You can bet against the dollar, but I would never bet against America. The system in the U.S. has allowed the country to unleash more for the world than any other country. Since 1776, the U.S. had a different system than the rest of the world and that system unleashed the human potential. We were not the smartest nor did we have the best resources. This is the same system we have in place today with people of similar intelligence. I have and would bet against the U.S. currency, stocks, etc. but the United States prevails over time. There are all kinds of rocky roads but we have rule of law, equality of opportunity, and a meritocracy. We have a market system and people apply energies and imagination to come up with things someone would want. Everyone in this room is working far below his/her potential.
Kansas:
We know that you are a big bridge player. Do you think that bridge correlates to investing? Are there any traits or characteristics that might carry over from one to the other?
Buffett:
Bridge is the best game there is. You’re drawing inferences from every bid and play of a card, and every card that is or isn’t played. It teaches you about partnership and other human skills. In bridge, you draw inferences from everything and that carries over well into investing. In bridge, similar to in life, you’ll never get the same hand twice but the past does have a meaning. The past does not make the future definitive but you can draw from those experiences. I think the partnership aspect of bridge is a great lesson for life. If I’m going into battle, I want to partner with the best. I was playing with a world champion and we were playing against my sister and her husband. We lost, so I took the scorepad and I ate it.
South Dakota:
What are your views on derivatives and how do you think they have affected the global market?
Buffett:
In my 2002 letter to shareholders I referred to them as “weapons of mass destruction.” Derivatives are really just a way to create a product with a very long fuse, for example, 100 years, as opposed to stocks which settle in 3 days. That kind of system allows claims to be built up. AIG called me in September and told me they were about to get downgraded which would have required higher posting requirements. Now this is an enterprise that has been built up over decades and was effectively destroyed in 48 hours by these products. With derivatives, you’re exposed to counterparties and thus reliant on others. These claims built up over time to the tune of billions of dollars and when one falls, the whole system falls. Derivatives are not evil by themselves but rather everyone needs to be able to handle them. System wide, they’re rat poison. Berkshire holds many derivatives but we always hold the money at Berkshire.
Creighton:
What do you think about the stimulus package? Would you rather see tax cuts or government spending?
Buffett:
We obviously have a problem, but we’ll come out of this just fine. The idea of a stimulus is to do things that will have an impact quickly and the current proposal won’t do that. When dealing with situations like this, you can’t do just one thing but always need to ask yourself what is the next question. We have utilized monetary policy and guaranteed everything in sight. It’s a standard Keynesian prescription. Tax cuts benefit people differently in the short term. We are basically saying, we’re not going to pay for what we’re doing in terms of government spending and that we’ll just mail you some money but it’s better than doing nothing. In the end, you should buy stock in a business that any idiot could run because someday, one will. You know, our country is similar.
Emory:
How do you think differently today than you did twenty years ago? Where do you expect to see the greatest differences in 2030?
Buffett:
The fundamental things about investing that I learned when I was younger haven’t changed. I am lucky to have picked up a book at 19, The Intelligent Investor, that gave structure to investing and investment decisions. Over time, I learned different ways to apply it. I have learned what it is outside my circle of confidence. I bought See’s in 1972 and I think understanding the value of brand helped drive the decision to buy Coca-Cola in 1988. Through experience, I have gotten smarter on predicting and evaluating human behavior. My wife put me together in terms of human behavior. I really enjoy doing what I do and I get to do what I want. I enjoy talking to groups like these. Irv and Ron Blumkin are some of my best friends and I continue to add friends by buying businesses. I don’t want a boat or 12 houses. I’m almost fully depreciated, down to my residual value. Age doesn’t affect my ability to my job though, as opposed to Arnold Palmer, he can’t play his game.
Penn State:
What advice would you give the average person in the U.S.?
Buffett:
It’s hard to give advice to someone who might lose their job. My Dad went to work on August 13, 1931 to find out the bank where he worked and held all our money had closed. He had no job and no money and two kids. You want to be as prepared as you can and you just don’t want to have debt. Medical problems cause a lot of the grief and lots of credit card debt. Credit cards are poison. If you make a dollar, only spend 95 cents, not $1.05. You should be ahead of the game all the time rather than behind as it is harder to work your way out of a hole. You want to play the game from strength, and you have to think ahead. People don’t always want to hear advice when things are going well. People risked everything they had and needed for something they didn’t have or need. Charlie once said, “The problem isn’t getting rich, it’s staying sane.
Texas:
What are the biggest challenges that this country faces?
Buffett:
The biggest problem is probably weapons of mass destruction. We have always had people who were ill-fitted to society and wished harm on others. In 1945 we unlocked the atom, and that changed everything. The human animal hasn’t changed, you still have the same percentage that are maladjusted. The problem is knowledge, materials, and deliverability. What you could do with the wrong kind of infectious disease is incredible. You can transmit things much faster today. Governments, individuals and organizations can’t control security. It’s what I would spend all of my money on if I could fix it. Everyone here in this room won what I call the ovarian lottery. You were born at the right time and we were all very, very lucky. We are in the luckiest 1% of humanity.
Kansas:
What are some of the mistakes that Secretary Paulson made during the sub-prime crisis?
Buffett:
Hank is a great guy and great friend. He’s extremely smart about markets but not so smart about politics. I sympathize with Hank. Hank Paulson was not the supreme commander. He had to work through at least 535 people with different incentives. The whole situation has developed faster and at an extreme pace, more than anyone thought. The first TARP program got voted down, which changed the dynamic. All variables affect other variables. Congress did not appreciate how severe the problem was. I call it an “Economic Pearl Harbor” in September. FDR essentially had a blank check and that what people think is important and believing it makes it so. He restored confidence in the banking system. Paulson’s job may have been almost impossible given the circumstances. He was used to operating in a sphere that did not require consensus (Goldman Sachs). People that take that on [public service jobs] are laying themselves open to be unfairly attacked, criticized and scrutinized. In hindsight, letting Lehman fail was probably not the right thing but it was difficult to tell at the time. It created trust problems as money market funds fell apart soon thereafter. When people start to worry about the money in money markets, it’s a problem. People want to be led at this point, but fall back into old habits very easily. When you think that Citi or Lehman is just a house of cards… I mean who would have even believed you. It’s like Noah before the flood, building his ark. Can you imagine the reaction he got?
South Dakota:
What do you think about the U.S. trade deficit?
Buffett:
I talked to Barack back in August, and said: “I have good news and bad news. The good news is that the economy will be terrible, so you’ll definitely get elected. The bad news is that the economy will be even worse at inauguration.” He asked, “Do you think it’s too late to throw the election?” The trade situation is there and it causes problem and could exacerbate the situation. However, all issues go on the back burner until we solve the big problem.
We create sovereign wealth funds, buying more goods and services than everyone else in the world. The decline in the oil price has helped the trade deficit but nothing will get better until everyone feels better. Every day, we buy $2 billion of goods and service more than we produce and export. We give the exporting nations USD. The trade deficit creates claims on the United States. Sometimes we’re a little hypocritical. For example, three years ago, the Chinese wanted to buy Unocal (a small oil company in California) and Congress wanted to condemn China for wanting to buy the oil company with the money we gave them (through U.S. imports). That’s a little disingenuous. The trade deficit creates a situation because we give people claim checks, then we get upset when they want to use them. The Japanese bought Rockefeller Center in the 80’s. Did we think they were going to move it? It’s not useful to fan those flames in a nuclear world, and that’s what’s wrong with “Buy America.” The trade deficit will come up big time when we get past the current problems.
Creighton:
Why do you live the way that you do?
Buffett:
Do you mean, why am I frugal? You can’t buy health and you can’t buy love. I’m a member of every golf club that I want to be a member of. I’m the highest handicap member of Augusta National. I’d rather play golf here with people I like than at the fanciest golf course in the world. I can do anything that I want, and I do. I buy everything I want to have. I’m not interested in cars and my goal is not to make people envious. Don’t confuse the cost of living with the standard of living. Bella Eidenberg was a Polish Jew who was at Auschwitz and some of her family didn’t make it. Twenty years ago she said she was slow to make friends, and that the real question in her mind was always, “Would they hide me?” If you have a lot of people that would hide you, you’ve had a very successful life. That can’t be bought. I know people that have billions of dollars and their children would say, “he’s in the attic.”
I estimate that I live on $100,000 per year, except for my plane which costs me about $1 to $1.5 million. I like the plane, it improves my life. My computer and my airplane changed my life in a big way and I’m not sure, if I had to choose, which one I’d give up. Anything beyond $50 Million doesn’t improve my life. If I took out $3 billion of Berkshire stock, I could have paid 30,000 people $100,000 per year to paint my portrait every day. I could have paid 50,000 people $60,000 per year to dress in loin cloths and haul rocks to create the Buffett tomb. That’s not me. I believe in giving my kids enough so they can do anything, but not so much that they can do nothing.
Penn State:
What do you think of the good bank, bad bank idea?
Buffett:
It is tough to do but if it were done well, it could do a lot. Call the bad bank an “Aggregator Bank.” There is a lot to be said in cleaning out past problems. There are 7,000 banks in the U.S. with such varying degrees of conditions so it is tough to provide a sweeping overhaul. The biggest thing they’re wrestling with is pricing what goes into the aggregator bank. These are smart, well-intentioned people working enormously hard on this.
Emory:
You take great pride in keeping your schedule wide open. Do you believe that corporate America is overscheduled and overstretched?
Buffett:
[Showed his blank schedule book]. Bill Gates is overscheduled. I am extremely lucky and I can say no to anything because there isn’t an entity that can use economic pressure to make me do something. A lot of CEOs get into a lot of the rituals that are part of the job. I would rather deliver papers than be the CEO of GE. They have too much stuff to do that is a big pain. Don’t get me wrong, CEOs have it pretty good. I’d imagine that every CEO in the Fortune 500 would be willing to take the job for half of the money. The 76 or so CEOs that run companies at Berkshire don’t have to deal with bankers or lawyers. At Berkshire, we’ve never had a meeting for all of them anywhere. There are no presentations and no committees. They can be more productive, and it makes it attractive when they can do what they like to do best.
Kansas:
What are three traits of successful managers?
Buffett:
Passion is the number one thing that I look for in a manager. IQ is not really that important. They need to be able to work well with others and the ability to get people to do what you want them to do. I’d say intelligence, energy, integrity. If you don’t have the last one, the first two will kill you. All you have is a crook who works hard. If a person doesn’t have integrity, you want them dumb and lazy.
If you could put 10% of your future earnings on one of your classmates, you would pick the one that’s most effective at working with people. These are qualities that are elective. If you could pick one to sell short, it would be the person that no one wants to work with. You can elect to be the kind of person you want to be. Look at those qualities of the two people you’ve selected (one long and one short). They’re all qualities that you possess. It’s like marriage. If you want a marriage that’s going to last, look for someone with low expectations. Don’t keep score. Keeping score doesn’t build organizations, homes, etc. I have never had one fight with Charlie. When I took over Solomon I had to pick the best person to run it. I interviewed 12 people for 15 minutes each and I asked myself, “Who would I go into a foxhole with?” I never look at grades or where you went to school. When I picked Deryck Maughan, he never asked me about pay or options or indemnity. He went to work.
Chains of habit are too light to be felt until they’re too heavy to be broken. In terms of picking people how do you lead your life in a way that I’d pick you?
Emory:
With the popularity of "Fortune's Formula" and the Kelly Criterion, there seems to be a lot of debate in the value community regarding diversification vs. concentration. I know where you side in that discussion, but was curious if you could tell us more about your process for position sizing or averaging down.
Buffett:
I have 2 views on diversification. If you are a professional and have confidence, then I would advocate lots of concentration. For everyone else, if it’s not your game, participate in total diversification. The economy will do fine over time. Make sure you don’t buy at the wrong price or the wrong time. That’s what most people should do, buy a cheap index fund and slowly dollar cost average into it. If you try to be just a little bit smart, spending an hour a week investing, you’re liable to be really dumb.
If it’s your game, diversification doesn’t make sense. It’s crazy to put money into your 20th choice rather than your 1st choice. “Lebron James” analogy. If you have Lebron James on your team, don’t take him out of the game just to make room for someone else. If you have a harem of 40 women, you never really get to know any of them well.
Charlie and I operated mostly with 5 positions. If I were running 50, 100, 200 million, I would have 80% in 5 positions, with 25% for the largest. In 1964 I found a position I was willing to go heavier into, up to 40%. I told investors they could pull their money out. None did. The position was American Express after the Salad Oil Scandal. In 1951 I put the bulk of my net worth into GEICO. Later in 1998, LTCM was in trouble. With the spread between the on-the-run versus off-the-run 30 year Treasury bonds, I would have been willing to put 75% of my portfolio into it. There were various times I would have gone up to 75%, even in the past few years. If it’s your game and you really know your business, you can load up.
Over the past 50-60 years, Charlie and I have never permanently lost more than 2% of our personal worth on a position. We’ve suffered quotational loss, 50% movements. That’s why you should never borrow money. We don’t want to get into situations where anyone can pull the rug out from under our feet.
In stocks, it’s the only place where when things go on sale, people get unhappy. If I like a business, then it makes sense to buy more at 20 than at 30. If McDonalds reduces the price of hamburgers, I think it’s great.
Austin:
What industry will be the next growth driver in the 21st century and what do you see that supports that?
Buffett:
We don’t worry too much about that. If you’d look at the 1930s, nobody could have predicted how much the automobile and airplane would transform the world. There were 2000 car companies, but now only 3 left in the US and they are hanging on barely. It was tremendous for society, but horrible for investors. Investors would have had to not only identify the right companies, but also identify the right time. The net wealth creation in airlines since Orville Wright has been next to zero. If a capitalist had been at Kitty Hawk and shot him down, would have done us a huge favor. Or look at TV manufacturers. There are hundreds of millions of TV’s, RCA & GE used to produce them, but now there are no American manufacturers left.
If you want a great business, take Coca-Cola. The product is unchanged, they sell 1.5 billion 8 ounce servings per day 122 years later. They have a moat; if you have a castle, someone’s going to come after you.
Gillette accounts for 70% of razor sales at 80% gross margins and it is the same over time. Men don’t change much. Shaving might be the only creative thing they do, like painting the Sistine Chapel.
Snickers has been the #1 candy bar for the past 40 years. If you gave me $1 billion to knock off Snickers, I can’t do it. That’s the test of a good business. You don’t knock off Coke or Gilette. Richard Branson is a marketing genius. He came in with Virgin Cola, we’re not sure what the name means, perhaps it turns you back into one, but he couldn’t knock off Coke. We look for wide moats around great economic castles. Growth is good too, but we prefer strong economics. In the upcoming annual report I have a section titled “The Great, the Good, and the Gruesome” where I talk about these.
Emory:
How do you define happiness and what about your life makes you most happy? When you make good on an investment, do you allow yourself to enjoy that success by getting excited - and on the flip-side, when an investment turns down, do you find yourself equally disappointed - or do you try to remove emotion from your work, as much as possible?
Buffett:
I enjoy what I do, I tap dance to work every day. I work with people I love, doing what I love. The only thing I would pay to get rid of is firing people. I spend my time thinking about the future, not the past. The future is exciting. As Bertrand Russell says, “Success is getting what you want, happiness is wanting what you get.” I won the ovarian lottery the day I was born and so did all of you. We’re all successful, intelligent, educated. To focus on what you don’t have is a terrible mistake. With the gifts all of us have, if you are unhappy, it’s your own fault.
I know a woman in her 80’s, a Polish Jew woman forced into a concentration camp with her family but not all of them came out. She says, “I am slow to make friends because when I look at people, I have one question in mind; would they hide me?” If you get to be my age, or younger for that matter, and have a lot of people that would hide you, then you can feel pretty good about how you’ve lived your life. I know people on the Forbes 400 list whose children would not hide them. “He’s in the attic, he’s in the attic.” Some of them keep compensating by joining board seats or getting honorary degrees, but it doesn’t change the fact that no one will give a damn when they are gone. The most powerful force in the world is unconditional love. To horde it is a terrible mistake in life. The more you try to give it away, the more you get it back. At an individual level, it’s important to make sure that for the people that count to you, you count to them.
What if you could buy 10% of one of your classmates and their future earnings? You wouldn’t buy the ones with the highest IQ, the best grades, etc, but the most effective. You like people who are generous, go out of their way, straight shooters. Now imagine that you could short 10% of one of your classmates. This part is usually more fun as you start looking around the room. You wouldn’t choose the ones with the poorest grades. Look for people nobody wants to be around, that are obnoxious or like to take all the credit. If you have a 500 HP engine and only get 50 HP out of it, you’ll be beat by someone else that has a 300 HP engine but gets 250 HP output. The difference between potential and output comes from human qualities. You can make a list of the qualities you admire and those you despise. To turn the tables, think if this is the way I react to the qualities on the list, which is the way the world will react to me. You can learn to turn on those qualities you want and turn off those qualities you wish to avoid. The chains of habit are too light to be felt until they are too heavy to be broken. You can’t change at 60; the time to look at that list is now.
Austin:
Why do you think that despite making your methods publicly available, that relatively few people have been able to emulate your success?
Buffett:
I asked Graham the same question. Everyone took his class at Columbia Business School. He used current examples, and by the end of the semester you would have a portfolio that would’ve made you money. Graham lived a life of sharing. He may have had more money hoarding, but lived happier because of it. The money’s just a figure in the paper, perhaps he would’ve died with 86 million instead of 42 million, but it doesn’t really matter. 90% of the people that took his class ended up doing something else.
At age 11 I started investing, purchasing three shares of Cities Service Preferred. I had read every book on investing in the Omaha library. I was really into charting and technical analysis. I loved it, but didn’t make any money from it. At 19 I read Graham’s “The Intelligent Investor” and it changed my world. Did Ben lose because I read his book? Maybe we competed and he made less money, but it didn’t matter to Graham.
The philosophy either takes immediately or it doesn’t at all. The reason gets down to temperament. People want to make money fast, but it doesn’t happen that way. Graham’s philosophy doesn’t promise enough for many people. You don’t know when it will happen, but you just wait for the fat pitches within your circle of competence. It’s not as exciting as guessing whether the stock price will go up the next day. Most investors in internet companies didn’t know the market cap. They were buying because they thought the stock would move, but if you asked them to write “I would buy XYZ company for $6 billion because”, they wouldn’t get halfway through the sentence. It’s the classic tortoise versus hare, bound to work over time. Charlie and I have educated competitors. Most don’t compete with us, though. It’s fine, we have more than enough money.
Emory:
What qualities in managers set them apart as great leaders, in essence, where do you find the right balance between "hard" and "soft" skills?
Buffett:
We have 45 managers. Some of them we communicate with once a year, some once a month, some everyday. I usually have dinner with the Blumkins every month, and we go on vacation, because we’re friends. What we look for in managers is a passion for the business. They usually come to us. I’ve never bought from a financial seller. We can’t run the business so I am counting on them to behave well; we have very little in the form of contracts. The business needs to continue just the same after I hand them the check as before. My big question is whether he will still get up at 6 AM just the same with $500 million, and continue to send money to Omaha. I have to look them in the eye and decide whether they love the business or they love the money. It’s fine if they love the money, but they have to love the business more. Why do I come in at 7 every morning, can’t wait to get to work. It’s because I get to paint my own painting and I like applause.
We bought a jeweler, Ben Bridge. It was a 4th generation company, with over 100 stores. They were only interested in selling to us. The family didn’t want to sell to others, the employees didn’t want it. I never met him. He didn’t want to sell either, but the family needed it.
At Borsheims we have a woman from Zimbabwe. She didn’t even have the benefit of an MBA. We didn’t look at a resume, or grades, or HR recommendations, but were looking for passion and we’ll pay fairly because we don’t want the resent that comes with unfairness. We want people that will work regardless.
I got a fax from Pete at Forest River saying this is the type of business you would like to own. He didn’t want to worry about if he died tomorrow, and left his wife and daughter behind. After we made the deal, we had dinner and I brought up the topic of salary. I told him to name whatever number he wanted and I would sign the check. He asked me what I made. I told him $100,000 and he said he didn’t want to make more than me, so we settled on $100,000. Pete called yesterday, and said he wanted to make an offer for another business. We talked for five minutes, I gave him some advice, but I really give them a lot of freedom. I’ve spent $1.7 billion and I’ve never even been to the company, at least I hope it’s there.
I can’t look at this group and tell you which 3 are going to be great managers. I can see it after they’ve been doing it for a while. Look at Mrs. B. She had one son involved in the business and 3 daughters not involved. She wanted a way to fairly distribute the proceeds of the business and this solved her problem. She worked until she was 103, and died at 104. She lived two blocks from the store. She left price tags on the furniture at her home because it made her feel more comfortable, like she was in the store. She left Russia and landed in Fort Dodge, Iowa. She saved $500 for 16 years to start this business that has the top 2 furniture stores in the nation. You can’t hire those kinds of people, no matter what you pay them. We’ve been lucky that we’ve never lost a manager to competitors since 1965. Some retire, some were fired, but we give them the opportunity to paint their own canvas.
Austin:
If you could have lunch with one person you have never met, who would it be and why?
Buffett:
I would have to say Isaac Newton or Benjamin Franklin. I’ve met a lot of interesting people and some uninteresting ones, too. The two men had a bigger grasp of the world they lived in. But I don’t think I would pass up an opportunity with Sophia Loren.
Emory:
Mr. Buffett, do you believe that the Federal Reserve is fostering moral hazard thereby leading to the misallocation of capital and subsequent asset bubbles? If so, what are the long term risks?
Buffett:
There is always some introduction of moral hazard when government decides to act in favor of the common good versus letting someone fail. There was moral hazard with the bailout of LTCM and there is some aspect of that with the current situation. But it’s hard to measure because the consequences are 15-20 years out. During the 1987 market crash, Greenspan was new to the job and unsure of what would happen. The specialist system got hit, most of them operated on very little capital and were broke. The Fed provided them with more capital. Will that change future behavior? Maybe, but at the time it was the right call. It’s also resulted in the “Too Big to Fail” doctrine. The big banks, Freddie Mac, and Fannie Mae figured the US Government wouldn’t allow them to fail and the managements of those companies knew that. I would be disinclined to second guess the Fed, they have more information and are trying to do what’s right.
Austin:
Given your business success, your immense fortune, and your celebrity status, how do you stay so down to earth and humble? Are there specific people or lessons you have learned throughout your life that enable you to maintain this outlook?
Buffett:
I was lucky to have the right heroes. Tell me who your heroes are and I’ll tell you how you’ll turn out to be. One of your most important jobs in life will be raising your children. They will learn more from you than they will in graduate school. My father was a huge influence, and later on Graham came along. I was also never let down by my heroes.
I had nothing to do with my own success. My father was a securities broker and after the Great Crash, he had no one to call. Consequently, I was born in 1930 in the United States during the time of one of the greatest capital markets. I was born with the wiring for capital asset allocation. I had the right wiring at the right time. Temperament is a large part of my wiring. I was naturally good at it, and I used some feedback to develop it better. There is nothing to be arrogant about. Gates says if I had been born earlier, I would’ve been some animal’s lunch. I can’t run, I can’t climb. I’d be talking about allocating capital and the animal would think, “Those are the kind that taste the best.” You have all won the ovarian lottery. There is no reason to feel guilty about it.
I have never given away a dime that has any meaning on how I live. There are people that go to church and they put money in the offering plate that truly makes a difference in how they will live their lives, what they will eat, what presents they will buy for their children. There’s no reason to get puffed up over things you didn’t control.
Emory:
Due to the credit crisis and consequently large write-downs, banks have made it more difficult to lend healthy businesses capital for increasing efficiency, expansion, new projects, etc., thereby potentially becoming the primary agents restricting growth. What are your thoughts on liquidity in the marketplace and the possibly of it contributing to a recession? Also, do you see a potential for financial institutions not currently in the lending business stepping in to take advantage of the reduced supply of capital?
Buffett:
What we are seeing is a huge repricing and evaluation of risk, correcting for problems of the past. I don’t know of good credit propositions that are going unfulfilled. There’s lots of cheap credit for sensible deals, which I don’t define as anything that happened over the last 12, 18 months. A lot of things that didn’t make sense are being washed out of the system. It is painful for bad decisions. Comparatively, this is not a credit crunch. In 1982 the prime rate was 22% and money was very expensive. In the late 60’s, we made a sound deal there wasn’t any money to be had. That’s not the case now. The Fed has opened the window, and rates are down. It doesn’t mean there won’t be a major recession.
Austin:
What are some of your biggest mistakes or regrets?
Buffett:
We’ve made lots of mistakes, but they don’t bother me. We’ve had no regrets. We are in the business of making many decisions and there are bound to be mistakes. There are $10 billion mistakes of omission that no one knows about; they don’t show up in the accounting. In 1994 we paid $400 worth of Berkshire stock for a shoe company. The company is now worth 0, but the stock is worth $3.5 billion. So now, I’m happy to see Berkshire go down since it reduces the size of my mistake. In 1973 Tom Murphy offered us NBC for $35 million, but we turned it down. That was a huge mistake of omission.
In my personal life, there are always things I could’ve done differently. But so many good things have happened. It just doesn’t pay to dwell on the bad things. Finding the right spouse is 90% of it. If you are lucky on health and lucky on your spouse, you are a long way home. Getting turned down by HBS was one of the best things that could have happened to me, bad luck can turn out to be good.
Emory:
Could you comment on the current rise of sovereign wealth funds from the Middle East and Asia and how they are playing an increasing role in how corporations raise capital. Is competition from these sources for the cash flows of corporations affecting your investment strategies or opportunities?
Buffett:
Any competition is competition. The situation of sovereign wealth funds is interesting. A lot of it is China bashing, OPEC bashing and plays right into politician’s hands. Today, the US will buy $2 billion more from the world than they buy from us. In exchange we give them little pieces of paper and they have to buy assets. As long as we consume more than we produce we have to let the rest of the world invest in us. We created sovereign wealth funds and that $2 billion gains interest. US funds feel they can get the best terms from these foreign investors and lately, enticed them into buying equity. China wanted to buy Unocal, a 3rd rate oil producer with production overseas in places like India. US Congress went ape and 395 representatives signed an anti-Chinese resolution to block the deal. For 100 years the US companies went around buying the world’s assets and bribing officials, but told China they couldn’t buy Unocal. The Chinese took it, but they didn’t like it. It doesn’t make sense that we are buying foreign assets, and giving them pieces of paper and then telling them what they can’t do with that money. We have created them and I have no objection to them. I recommend an index fund for these sovereign wealth funds. It gives them exposure to the US market, but they won’t get taken by salespeople with bad deals. In economics you always want to say “And then what?”
Austin:
Is the individual investor even capable of assessing the riskiness of securities given the large number of institutions/hedge funds in the market?
Buffett:
I don’t think there is much being overlooked now, but I’m forced to look at big things. That’s the advantage you have over me. A few years ago a friend of mine mentioned that I should look at Korea. We bought Posco for 3-4 times post-tax earnings. I found 20 other companies selling at 2-3 times earnings and strong balance sheets. I diversified because I didn’t know the Korean market as well. We are looking for the very unusual. Occasionally things will happen in a securities market that are extraordinary. I like shooting fish in a barrel, but I like to make sure the water’s drained out.
We had that situation a few years ago with the 30 year versus 29 ½ year Treasury bonds. Because of less liquidity, the off-the-run bonds were selling for 30 basis points less, which translates into 3% of principal value. LTCM entered the trade at 10 basis points originally, but they overleveraged and were forced to unwind the position. If you went long/short you could make money really quickly.
Markets are efficient most of the time about most things. But for these opportunities, nobody will tell you about them. They won’t be on CNBC and they won’t be in brokerage reports. You have to go find them yourself. In 1951, after I graduated from school, I used Moody’s and S&P manuals as my sources of information. I went through them page by page. I was like a basketball coach looking for 7-footers. I still have to find out if he’s coordinated, and can stay in school. But if someone comes up to me that’s 5’6” and says, “Wait ‘til you see me handle the ball”, I say “No thanks”. On page 1443 of Moody’s, I found Western Insurance Securities. It had earned $21.66 per share 2 years ago, and earned $29.09 last year. Over the past year the stock was selling for between $3 and $13 per share. I still had to do the work to make sure the earnings were valid. The markets will get it right eventually. But they are there. You don’t have to find too many. Finding 10 of these opportunities in your lifetime will make you so rich. But you can’t be wrong. You can’t have any zeroes. A list of big numbers multiplied by zero will equal zero. You can’t go back to “Go”.
Emory:
What do you think of aggregate infrastructure investment to stimulate the economy?
Buffett:
I think the best way to stimulate the economy is to give money to the poor. They will spend it. Don’t give it to guys like me. Infrastructure investment makes sense, but we haven’t done it in a while and it won’t do anything for the next 6-12 months. Infrastructure is not big relative to GDP. We are a consumer-driven society, spending 106% of production.
Austin:
Who do you think will be one of the next greatest investors and are you partial to favoring someone with a similar investment style as yours?
Buffett:
We just finished looking for someone. The Board has 3 candidates to replace me as CEO and 4 candidates to replace me as investor. They are all doing fine where they are, but they would be willing to come over to Berkshire for less pay.
In 1969, I wound up my partnership and I had to help people find someone to manage their money. I recommended Bill Ruane of Sequoia Fund, Sandy Gottesman, who is currently on the board at Berkshire, and Walter Schloss, who I wrote about in “The Superinvestors of Graham and Dodds-ville”. There’s no way they could miss.
But I don’t know many of the newer investors, they’re not my contemporaries. It’s not enough to just look at track records. They aren’t predictive and there will always be a few people that do well. I know guys who can make 50% a year with $5 million, but not with $1 billion. The problem with guys that do well is they attract so much money that it neutralizes their advantage. It’s hard to identify them, and even harder to make a deal to keep them from attracting other capital. It’s like betting on a 12 year old horse that won at 3 years old. It’s also important to avoid managers who use leverage. It’s the reason that investors with 160 IQs flame out.
Emory:
At the Wesco annual meeting last year, Charlie said, "The best way to get success is to deserve success". Do you recall anything from your experience which best demonstrates how you were able to position yourself to deserve success, and do you have any advice for students on how they can position themselves to deserve success as well?
Buffett:
Behaving decent is a large part of it. Out of school I offered to work for Graham for free and he said I was overpriced. I tried to be useful and visible to him. I gave him stock tips and kept up with him. Almost always good things come from good behavior. Don’t keep score in life. Tom Murphy does not keep score. He keeps doing 20 things for me and I can only hope to return the favor. Keeping score is terrible in marriage and terrible in business. I put myself in the seller’s shoes. With most humans there is a great desire to reciprocate. If you do something for them, they will do 2X for you. How rare is it to work during lunch hours and be the first one there in the morning. You’ll get noticed if you do something extra. It’s good to have a willingness to pitch in when you aren’t going to get credit for it. Charlie and I partnered up in 1959. We always both think we’re right. We disagree but we’ve never fought. And we’ve never held past mistakes over each other’s heads. I recommend reading “Poor Charlie’s Almanack”. It’s amazing, has sold 50,000 copies and it’s still sold independently.
Austin:
Have there been instances in your career where you have been tempted to deviate from your strategy and if so, how did you handle that?
Buffett:
I’m not that type. I’m not disciplined. I just naturally want to do things that make sense. In my personal life too, I don’t care what other rich people are doing. I don’t want a 405 foot boat just because someone else has a 400 foot boat. Some of my friends have big boats where 55 people are serving 14. Of those 55, some will be stealing from you, some will be sleeping with each other, and I just don’t want to deal with that. My friends have the boats, so I’m the ultimate freeloader. I don’t need multiple houses. If I wanted to do something wild & crazy I could do it, but Anna Nicole Smith is gone. Reminds me of the story of the 60 year old man that got a 25 year old to marry him. When his friends asked how he did it, he replied, “I told her I was 90.”
Emory:
It seems that the worldwide trend is towards lower corporate tax rates. Do you think that the US risks becoming less competitive if it maintains its current corporate tax rate?
Buffett:
Relative to GDP, government taxation is 18.5% and spending is 20%, so we borrow the balance. The national debt should not be a scary topic and the fact that it’s gone up is fine as long as it’s proportional to GDP. Where do we get that 18.5%? There’s 2.7 trillion in government revenues. 2.2 trillion comes from individuals, and less than 1% of that comes from the estate tax. 1.1 trillion comes from income taxes, with payroll taxes consisting of 900 billion, but it’s capped at the first $100,000 of salary. We want a tax system that encourages greater prosperity, but it needs to take care of the family.
We did an informal office survey by looking at the total tax footprint versus the total income. I earned 46 million and paid a tax rate of 17.5%. My rate was the lowest, the average was 33%, and my cleaning lady paid 40%. The system is tilted towards the rich. The Forbes 400 total net worth has gone from 220 billion to 1.54 trillion, an increase of 7-to-1. You see in legislature that there is lobbying carried on by the powerful over issues such as the estate tax and carried interest for private equity investments. We need to flatten income and payroll taxes, and those making under $30,000 shouldn’t be bothered.
Let’s imagine that 24 hours before you are born, a genie comes to you and tells you devise a social and economic system. The only catch is that after you designed the system, you would choose a paper from a barrel which would determine your demographics. What objectives would you want? You need to devise a system that creates prosperity. It needs to be a meritocracy, to put the right people in the right place. It needs to have a strong education system, and throw off lots of goods and services. It also needs to not discriminate against women or minorities. Even though the per capita GDP is $47,000, 20% of the population makes less than $20,000. We need to eliminate that fear of sickness or old age. A tax code is the codification of a country’s values. But you can’t kill the golden goose of prosperity.
Austin:
There is always mention that some of your success could be attributed to not buying in to the Wall Street mania b/c you are in Omaha—what importance do you give to balance as it pertains to work and life and what do you do to maintain your appropriate balance?
Buffett:
I have so much fun that it’s not work. I get to do what I want, where I want – on a boat, wherever. My wife was responsible for bringing up the children. Neither of us had problems with that arrangement, and it made sense from an Adam Smith “division of labor” perspective. It will be a much tougher choice for women, and always be somewhat unequal. In my own life I did virtually no social functions or meetings that I didn’t want to do. In my adult business life I have never had to make a choice of trading between professional and personal. I have simple pleasures. I play bridge online for 12 hours a week. Bill and I play, he’s “chalengr” and I’m “tbone”.
After a talk at Harvard, I told them to work for who they admired the most, so they all become self-employed. It’s important to go to work for someone or some organization you admire. I’ve not seen many males having to make tough choices. But women are the ones who have tough situations.
We encourage you to visit the blog Underground Value for other excellent posts on value investing.
Up-and-coming value investor Jason Kaspar provides interesting financial commentary in his 2008 letter to investors. Kaspar's understanding of the ongoing financial crisis enabled him to post strongly positive numbers in 2008. In his letter to investors, Kaspar argues, among other things, that acceleration of inflation is only a matter of time. We agree with this view.
Here is an excerpt of Kaspar's commentary:
The inflation, deflation question mentioned in the previous letter continues to rage. Unfortunately, it has also become probably the single most important question in investing as whichever occurs will most likely be a several standard deviation event impacting every single investment down to the microcap company. In my mind, it has become when, not if, inflation will occur. By the end of 2009 or maybe not until 2012 to 2015? The deflationary forces will continue to be massive with option ARM and consumer credit blowing up in 2009 into 2010 and the wave of corporate defaults starting in 2010 into 2012. This will spread to sovereign nation debt and emerging markets. Will the government be able to create “dollar currency inflation” while this is occurring? Basically, when inflation rears its ugly head will the result be true inflation or a “currency inflation” where real economic activity continues to decline but trust in government currencies also plummet creating a scenario of “depression currency inflation?” This type of economic environment is something that does not exist in working memory outside of maybe the very elderly in Germany. The rest of this letter will be focused on money, value, and monetary history. Some of the following thoughts will be much more theoretical and philosophical which many readers may find boring and even useless. It has been what has consumed my mind over the past few months as we enter into a new era of economics with the government saying the United States may spiral to its death but it will not be because of dollar deflation.
Marc Faber may be best known for his newsletter, GloomBoomDoom Report, and his frequent appearances on Bloomberg TV and other financial outlets. Unlike other TV "talking heads," Faber knows what he's talking about and is not afraid to say it. Lately, he has been an outspoken critic of the Fed's easy-money policies and deficit spending that will, according to Faber, lead to a bout of hyperinflation and debasement of the dollar (and other paper currencies, for that matter). Faber is also author of Tomorrow's Gold.
The following are the top six investment books recommended by Marc Faber:
Dr Marc Faber was born in Zurich, Switzerland. He went to school in Geneva and Zurich and finished high school with the Matura. He studied Economics at the University of Zurich and, at the age of 24, obtained a PhD in Economics magna cum laude.
Between 1970 and 1978, Dr Faber worked for White Weld & Company Limited in New York, Zurich and Hong Kong.
Since 1973, he has lived in Hong Kong. From 1978 to February 1990, he was the Managing Director of Drexel Burnham Lambert (HK) Ltd. In June 1990, he set up his own business, MARC FABER LIMITED which acts as an investment advisor and fund manager.
Dr Faber publishes a widely read monthly investment newsletter "The Gloom Boom & Doom Report" report which highlights unusual investment opportunities, and is the author of several books including “TOMORROW'S GOLD – Asia's Age of Discovery” which was first published in 2002 and highlights future investment opportunities around the world. “TOMORROW'S GOLD” was for several weeks on Amazon's best seller list and is being translated into Japanese, Chinese, Korean, Thai and German. Dr. Faber is also a regular contributor to several leading financial publications around the world.
A book on Dr Faber, "RIDING THE MILLENNIAL STORM", by Nury Vittachi, was published in 1998.
A regular speaker at various investment seminars, Dr Faber is well known for his "contrarian" investment approach.
He is also associated with a variety of funds and is a member of the Board of Directors of numerous companies
Every once in a while TV doesn't just report the news but becomes the news. TV coverage of the Kennedy-Nixon presidential debates may have altered the outcome of that election by helping to draw a stark visual contrast between a young, energetic Kennedy and a tired-looking Nixon. CNN's coverage of the first Gulf War made war transparent and immediate to viewers all over the world in a way that had not been done before.
While Jon Stewart's evisceration of CNBC money prophet Jim Cramer won't be remembered in the same pantheon of unforgettable TV moments, it undoubtedly struck a cord in a nation battered by Wall Street excess and duplicity.
Jim Cramer may become the face of recent Wall Street excesses in a way that Michael Douglas's character in the movie Wall Street -- Gordon Gekko -- became the face of greed in the late 1980s. Obviously, Gekko was a fictional depiction of what was wrong on Wall Street at the time. He did not exist in real life and therefore could not have been actually responsible for what went on in the Board rooms and trading floors at the time. While Jim Cramer is a character of flesh and blood, he is only a minor figure in Wall Street's backroom game. The bigger figures appear to be certain hedge fund characters who grace Fortune's list of the richest Americans yet whose portraits are harder to come by than those of undercover CIA operatives.
Even for folks such as ourselves who are engaged in the Wall Street game but try to play it in a way that has some reference to the real economy, the Wall Street "side bet," as Jon Stewart has called the unregulated -- or lightly regulated -- trading in exotic instruments, is suspect.
Wall Street was invented to channel capital to productive uses, thereby making the economy more efficient. That was the way Wall Street was supposed to earn its just reward: By providing companies with capital and then letting those companies earn satisfactory returns on that capital, Wall Street was supposed to aid in the growth of profitable industries while starving industries that would destroy wealth over time.
Not only has this not happened in many instances -- witness airlines and auto makers -- but, perhaps more importantly, by being at the nexus of savings and investment, Wall Street decided long ago to hoard a large portion of capital it was supposed to help direct to productive uses. The result was a mushrooming of the financial sector the world had never before witnessed. Instead of becoming an efficient, lean allocator of capital, Wall Street turned into a humungous industry in its own right, with "side bets" that could only be properly understood and exploited by insiders. The latter got rich while savers footed the bill.
It's high time that Wall Street got called on this -- and it's a shame no one could do it except the anchor of what's billed as a comedy show. Not funny.
If you missed Stewart's face-to-face evisceration of Cramer, here it is:
The FT reports on how the Mittelstand, the hard-to-define group of small to medium-sized businesses that all English-speaking media are required to describe as the "backbone" of the German economy, is coping with the economic downturn. Here is the money quote for me:
As a result, the engineering company wants to make use of lowly asset valuations to buy rivals and broaden its product pipeline, a counter-cyclical investment pattern typical of many a German family company - and one that highly indebted, private equity owned groups can now only dream of.
The financial conservatism of the Mittelstand is legendary. That doesn't mean it's true, but if it is I wonder why. Some hypotheses, starting with my least favorite:
1) Financial conservatism is inherent in the German character. I discount this--much of the underwater real estate in Miami Beach is owned by Germans. Plus it's always a mistake to attribute too much to "national character." Ten years ago Iceland had one national character, one year ago it had another, and today it has still another.
2) The Mittelstand doesn't need high debt because it can earn returns on capital comparable to companies outside Germany without it. I also discount this, unless there is some magic to being a car-parts supplier in Germany that automatically makes it a great business.
3) Some regulatory or tax difference that I don't know about.
4) Survivorship bias plus lessons learned. German business had a pretty rough 20th century: two World Wars, hyperinflation, the partition of the country. Those that survived tended to be financially conservative, and learned to think in terms of being able to survive calamity.
5) The tendency of Mittelstand companies to be family-owned, often in their second or third generation, creates a tendency to think long-term and to avoid catastrophe risk. Conversely, ownership by outside shareholders creates a tendency to think shorter term. The longer your time horizon, the more you have to think about catastrophe risk because its cumulative probability gets surprisingly high. If you finance your company such that it only has a 1% of going bankrupt in any one year, the likeihood you make it five years without going bust is 95.1%. Most hedge fund managers would take those odds over that time horizon. But if you have to make it 50 years, your likelihood of doing so with the same financing structure falls to less than 40%.
To the extent these last two hypotheses are valid, there are two lessons for investors, especially American family offices. The first is that nations rise and fall. The second is that you must take care that the money managers with whom you invest have the same time horizon and approach to catastrophe risk as you do.
The author of this post is Nadav Manham, president of Elera Advisors LLC, an investment advisory company focused on value-oriented manager selection. Mr. Manham is also editor of The Investor's Consigliere.
Watch Buffett's 15-minute interview with Bloomberg. Buffett talks with Bloomberg about the outlook for acquisitions by Berkshire Hathaway. Buffett also discusses the company's preferred shares in Goldman Sachs and General Electric.
By the way, we found the interviewer's style quite annoying. She was clearly hunting for dirt but there was no dirt to be found.
Two more Madoff profiles, one in New York Magazine, one in Vanity Fair. Naturally they focus not on the technical aspects of his fraud but on how he maneuvered among and affected Society (not to be confused with "society").
Bit by bit, little details emerge about Madoff's seduction tactics, which worked remarkably well on a group of people you would have thought was not vulnerable to it. Either he was extremely good at the art of con, or his victims were more gullible than I thought, or a little of both. Most people concentrate on the latter, but don't discount the former.
(What makes it even more amazing is that, unless I'm missing something, his taxable investors didn't earn all that much more investing with him than they would have in municipal bonds. The idea that Madoff "made people rich," as the VF article in particular states, doesn't seem plausible. Per the NY article his returns averaged 12% a year, which as I understand his trading strategy would have been taxed near the top marginal income tax rate. For most of his NY investors that's about 50%, so their net returns after tax were not that much more than what they could have earned in NY munis. But there's no country club for people who invest in NY munis.)
Seduction--in the non-sexual sense of persuasion based on something other than the pure merits of something--is not taught in school, and it's a highly undervalued part of investment manager selection. It's a dark art, but I think it's ultimately amoral, not immoral. Legitimate investment managers, especially those looking to raise money, should probably study Madoff's methods. Unfortunately, they work.
Not on me though . . .
The author of this post is Nadav Manham, president of Elera Advisors LLC, an investment advisory company focused on value-oriented manager selection. Mr. Manham is also editor of The Investor's Consigliere.
Related document: Text of Madoff's guilty plea (PDF file).
Chris Hohn is the founder of The Children’s Investment Fund Management (TCI). Hohn runs a concentrated portfolio that is heavily weighted in industrials.
The Manual of Ideas estimates that Chris Hohn’s top two ideas at this time are Visa (V) and CSX (CSX). Our analysis is based on a recent Form 13F-HR filed by TCI with the SEC. We also consider TCI’s past 13F-HR filings, recent 13G and 13D filings as well as the latest market prices of the portfolio holdings. Please see below for an explanation of the MOI Signal Rank™ methodology. (Click charts to enlarge.)
MOI Signal Rank™ – Top Current Ideas of Children’s Investment Fund
Top Holdings of Children’s Investment Fund – By Dollar Value
Portfolio Metrics
Portfolio Size | $1.85 billion |
Top 10 Holdings % of Portfolio | 100% |
Median Market Cap ($mn) | $14 billion |
Average Market Cap ($mn) | $20 billion |
Average Dividend Yield | 3% |
Average P/E | 12x |
Average P/B | 1.4x |
Sold-Out Positions
New Positions
About MOI Signal Rank
MOI Signal Rank answers the question, “What are this investor’s top ideas right now?” Rather than simply presenting each investor’s largest holdings as of the recently filed quarter end, MOI’s proprietary methodology ranks the companies based on the investor’s current level of conviction in each holding, as judged by The Manual of Ideas.
Our proprietary methodology takes into account a number of variables, including the size of a position in an investor’s portfolio, the size of a position relative to the market value of the corresponding company, the most recent quarterly change in the number of shares owned, and the change in the stock price of a position since the most recent quarterly filing date.
For example, an investor might have the most conviction in a position that is only the tenth-largest position in such investor’s portfolio. This might be the case if an investor invests in a small company, resulting in a holding that is simply too small to rank highly based on size alone. On the other hand, such a holding might represent 19.9% of the shares outstanding of the subject company, suggesting a high level of conviction. Our estimate of the conviction level would rise further if the subject company has a 20% poison-pill threshold, thereby suggesting that the investor has bought as much of the subject company as is practically feasible.
Disclosures: None.
Last week, we pointed you to Jon Stewart's spot-on expose of CNBC and "investing god" Jim Cramer. Ever the huckster, Cramer couldn't let Stewart's comments go unanswered, especially as the Daily Show video spread like wildfire in the blogosphere. Apparently, Cramer never learned that you should probably not attack the truth too hard because it has a way of coming back to bite you. And bite it did -- in Stewart's latest take on Cramer's omniscient attitude:
Click here to download your free copy of "Spotlight on Gold," a special edition of Downside Protection Report. This special edition includes an exclusive interview with Tom Winmill, portfolio manager of Midas Fund, along with an overview of gold market trends and other data.
Subscribe to Downside Protection Report and be alerted as soon as our top two monthly investment ideas are released. Learn more and start your 30-day free trial now.
Download full transcript in one file (49-page PDF), or watch videos below (seven-part series):
Above Video: Part 1 of 7 (transcript)
Above Video: Part 2 of 7 (transcript)
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Above Video: Part 4 of 7 (transcript)
Above Video: Part 5 of 7 (transcript)
Above Video: Part 6 of 7 (transcript)
Above Video: Part 7 of 7 (transcript)
Jim Grant, editor of Grant's Interest Rate Observer, wrote an article originally published in February 1990 that has a lot of relevance to today's crisis. Writes Grant,
The banking dilemma seems eternal, like the monetary dilemma, the tax dilemma, and the marital dilemma. The essence of the banking dilemma, however, is that the depositors' money is not in the vault awaiting the depositors' decision to withdraw it. Instead it is out on loan or invested in the money market or in mortgage-backed securities.
Some of the money is in the vault or on deposit with the Federal Reserve – these funds are called bank reserves – but only a few cents of every dollar. Depending on the specific management, depositors, and financial markets, the average bank may be prepared to accommodate a sudden demand for repayment by a sizable minority of its depositors. Almost no bank in modern times, however, has been able to accommodate a sudden demand for repayment by a majority of its depositors.
Murray N. Rothbard, the economist and libertarian philosopher, has a forcible view on the institutions of fractional-reserve banking: it is "a giant Ponzi scheme in which a few people can redeem their deposits only because most depositors do not follow suit."
Some features of the modern banking dilemma are new, notably the socialization of credit risk during the Reagan years. It was decided that no money-center bank would be allowed to fail and that no depositor, even a sophisticated one, would be allowed to lose his money in a failure, if it could possibly be helped. But other problems are cyclical and still others are chronic. Reading up on the subject, one becomes fatalistic about it.
In gaslight days, before the "too-big-to-fail" doctrine and other modern banking improvements, national banks were bound to hold reserves amounting to 25% of demand deposits. By our standards, this was a lavish margin of safety, even if, as Rothbard notes, capital reserves were often tied up in government bonds. ("[B]anks were induced to monetize the public debt," he has written, "state governments were encouraged to go into debt and government and bank inflation were intimately linked.")
Reserve requirements were reduced to 18% with the advent of the Federal Reserve System in 1913 and stand at 12% today [1990]. Loans as a percentage of assets are higher today than they used to be, however. And off-balance-sheet liabilities – such as standby letters of credit, interest-rate swap commitments, and futures-markets trading – are higher, too.
The rise in the risks attached to banking prompts numerous questions about the nature of lending and the credit cycle. How has the regulatory and monetary climate of the 1980s affected bank lending? If, as seems obvious, it has inflated it, what will be the consequences of it?
Sometimes comedy is the only way to reveal the painfully obvious:
The Manual of Ideas estimates that Tobin's Q was 0.33 as of the market close on March 4th. The ratio now hovers near the lows reached during the Great Depression, sending a strong message for U.S. equity investors
In a forthcoming quarterly report, The Manual of Ideas publishes a detailed analysis of Tobin's Q and puts the current ratio in historical context, with data going back to 1900. The new report, to be published on March 16th, will include data from the Fed's yet-to-be-published Z.1 statistical release.
Visit the Equities and Tobin's Q website for more information.
The following are links to annual reports of the Yale Investments Office since fiscal year 2000 (ended June 30th). Heading the Investments Office throughout this period has been highly respected investment manager David Swensen.
The March issue of Empirical Finance Research Newsletter has been published. We're pleased to bring it to you absolutely FREE in partnership with Wes Gray and Andy Kern of Empirical Finance, LLC. This month's newsletter includes the results of a stock screen that should not be missed.
March 2009 — Empirical Finance Research Newsletter on Information in Balance Sheets for Future Stock Returns: Evidence from Net Operating Assets, a paper by Georgios Papanastasopoulos, Dimitrios Thomakos and Tao WangAbstract:
This paper extends the work of Hirshleifer et al. (Journal of Accounting and Economics, 38, 2004) on the net operating assets (NOA) anomaly. After controlling for current profitability, we find a negative relation of NOA and NOA asset components with future stock returns. We also find that the hedge strategies on NOA and NOA asset components generate abnormal returns and survive the statistical arbitrage test of Hogan et al. (Journal of Financial Economics, 73, 2004). Our overall analysis is highly suggesting that the NOA anomaly may be present due to accounting distortions that arise from earnings management.
Conclusions:
This paper is a great step towards turning a well documented anomaly into a realistic trading strategy. The results seem to be very persistent over time, indicating that we should expect the phenomenon to continue. Further, whether we take a simple long/short approach or also account B/M, the returns are very, very large.
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Disclosure: No position.