CKBlog: Strategies

Tuesday, February 28, 2017

My Wager with Warren: A Reaction to Berkshire Hathaway’s 2016 Annual Letter to Shareholders

It was another classic. Warren Buffett covered everything from colonoscopy prep to the limitations of GAAP accounting. He took me through a range of emotions. For the hour or so I spent with Buffet (figuratively of course), I experienced curiosity, surprise, frustration, reverence, bewilderment, laughter, and respect.

The one thing I did not do was cry although it would not have been the first-time Buffett has made me cry. I challenge you to watch the newly released HBO documentary, Becoming Warren Buffett, and not shed a tear. Here’s the trailer: http://www.hbo.com/documentaries/becoming-warren-buffett/video/promo.

One constituency that may have been reduced to tears by his letter is the hedge fund community. If you have been following Buffett over the years, you would know of his famous “$1 Million Wager.” In a nutshell, back in 2007, Buffett challenged any person to pick a set of five hedge funds that would beat an S&P 500 exchange-traded index fund for a ten-year period. Ted Seides of Protege Partners assembled a group of funds and took the other side of the wager. Each side put up $500,000.00 and after 10 years, the winner earned the right to choose which charity gets the $1 million prize. That wager expires December 31st of this year, and it’s clear that Buffett will win by a long shot: $1 million is surely on its way to the Girls Inc. of Omaha (his charity).

The Oracle of Omaha spent a good portion of his letter bemoaning the fees charged by what he calls the financial “helpers.”  He is mostly right. Far too many fund managers charge far too much in fees. Very few have truly earned the right to charge the customary “2 and 20” hedge fund fee structure.

Investment management fees eat away at investors’ returns. Very few folks have been blessed with the talent, intelligence, work ethic, and risk management skills required to “beat” the markets for meaningful periods of time.

For the retail investor, investing in a low-cost index fund and holding it forever, in theory, might be an optimal investment strategy. But as we have noted before, this is nearly impossible for the average investor. Studies have proven that individual investors in general get market timing wrong. They tend to invest in the market at or near its highs and sell out of the market when prices are low. In our view, investors receive far more value by the 1% or so they pay for quality investment advice to construct a sound financial plan AND the guidance to stick to it—especially during stressful times.

As Buffett puts it, “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.” Unfortunately, during these downpours many investors do the opposite and seek to sell their copper washtubs and silver teaspoons as scrap metal.

Making the best financial decisions is even hard for Buffett himself. He is famously humble in his annual letters as he routinely laments his big mistakes and shortcomings when it comes to investment decisions. In this letter, examples were his “egregious error, acquiring Dexter Shoe for $434 million in 1993.  Dexter’s value promptly went to zero.”  Next was the “terrible mistake on my part to issue 272,000 shares of Berkshire in buying General Re ... my error caused Berkshire shareholders to give far more than they received.” There have and will be many more. So how does he try and mitigate the damage from his ill-fated ideas? He turns to Charlie Munger for advice.

I do not pretend to have the intelligence and wisdom of Munger. But as we wrote in our 2016 Annual Letter to clients, in many ways, we try to act like him when providing advice to clients and their families. In fact, our Founder and CEO is even named Charlie!

All kidding aside, if I had the opportunity to sit down and chat with Buffett, I’d ask him the following; “If Charlie Munger was your Investment Advisor, how much would you be willing to pay him? 1% a year?” 

On page 15 of the 2016 letter, Buffett states, “I will commit more errors; you can count on that. Fortunately, Charlie—never bashful—is around to say ‘no’ to my worst ideas.”

So, would Buffett be willing to pay his “advisor” 1% per year to help him manage large and impactful investment decisions? I’m willing to wager that he’d say “yes.”

The Berkshire Hathaway 2016 Annual Letter to Shareholders can be found here:
http://berkshirehathaway.com/letters/2016ltr.pdf