Defending Warren Buffett
- Joshua M Brown
- May 27th, 2013
My friend and blogger colleague Cullen Roche at Pragmatic Capital posted a 7-point takedown of the deification of Berkshire Hathaway. It is a tongue-in-cheek post ostensibly teaching the reader “7 Easy Steps to Invest like Warren Buffett” while it sardonically catalogs the most well-known contradictions between Warren’s business style and his public statements.
As an unabashed fan of the Oracle and a firm believer that he is indeed “the Mozart of Investing”, I’ve offered up a point-by-point defense.
Cullen’s one of the sharpest knives in the draw, so it was not without trepidation that I embarked on this task. You’ll find my refutations below for each of his (italicized) statements, wish me luck:
1) Talk all sorts of smack about hedge funds but first spend the initial 10 years of your career running a hedge fund that charges 25% performance fees on top of 6% gains.
Buffett eventually found that there was a better vehicle to align his interests with his those of his shareholders and the types of long-term investments he wanted to make. And so he abandoned the hedge fund structure and spent the next few decades urging others to do the same. Why is learning and evolving one’s business a negative? I spent my first ten professional years as a commission-based stockbroker charging 2.5% for buy and sell orders. And then when I realized how counterproductive a structure that was for my clients, I dashed my Series 7′s head against the rocks and left it to drown in the river. Warren wised up, too. This is not a negative, it is a positive.
2) Amass enough capital (by charging massive fees) to buy multiple entire companies. Do it in a distressed debt/activist strategy, but later on spin it off as “value investing”.
In Warren’s youth, he was precocious and could even be vindictive, as he was in the case of the Berkshire acquisition. But are we to hold this against him four decades later? Is there any famous investor who can honestly say he is proud of every single moment of his career? Did not Mark Twain tell us that “a clear conscience is the sure sign of a bad memory”? If you’e going to make an omelette, you’ve got to crack a couple of eggs. Buffett had certainly cracked his share.
3) Use your insurance arm (from the company you bought in a distressed debt play) as a massive cash flow machine in which you’re essentially a leveraged covered call option writing operation.
Buffett has told us that his preferred holding period for an investment is “forever.” Well, good luck finding a source of investment funs that aligns with this timeframe outside of the eternal cash flows of an insurance operation. And lo, doth my eyes deceive me or is that David Eimhorn’s Greenlight Capital also in the reinsurance business, through a Cayman Islands holding company no less! And hark! Is that Third Point’s Dan Loeb, also setting up a half-billion dollar reinsurance operation as well? They’re all doing it because it’s a good idea – given their investing style – to insulate their portfolios from the effects of un-sticky investor capital in times of turbulence.
4) Tell the world that they should just buy index funds and then spend most of your time building a portfolio around individual equities.
Buffett (and Munger) have been explicitly clear on the index fund versus active management debate. They are dyed-in-the-wool believers that hard work and homework and good old fashioned common sense can combine to produce successful equity portfolios that beat The Street. Their own record proves that this can be done consistently over long stretches. But they’ve also made it clear that they don’t believe a majority of investors have what it takes and so they, rightly, recommend that people who are ill-equipped simply keep their risks spread out and their transaction costs and taxes low. How could this not be the sanest possible advice they could give to the masses hanging on their every word? What should they tell the average investor – to speculate?
When you run insurance businesses, energy utilities and over fifty private companies with ongoing expense and cashflow obligations, using fixed income to meet the periodic costs involved isn’t an option – it is a requirement.
Buffett’s derivative activities are tied to the reinsurance work he does and are largely a bet on future, long-term prosperity. He is taking the other side of the trade, in most cases, against those who would make the catastrophe bet. These long-term bets on the world’s future have been additive to returns and are not of the reckless variety of the timebomb contracts written by AIG and Wall Street last decade – bets which were unpayable by the underwriters as we eventually found out.
7) Obtain a red phone to the US Treasury department so you can help them arrange a rescue plan that starts by rescuing your operation when it looks like the economy is collapsing.
The most powerful man in the financial markets and one of the world’s wealthiest is always going to be listened to by the pols. This is the way of thew world. J Pierpont Morgan, when he occupied a similar position of influence one hundred years ago, was actually picking presidents and deciding elections over cigars on Madison Avenue. So if anything, Buffett’s role, comparably speaking, is a benign and helpful one in times of distress. Don’t hate the player, hate the game.
Thanks again to my friend Cullen for laying out this list, the exercise was a fun one to be sure.
What do you guys think?
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.