The Investment Industry投资行业

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”.

I'll tell you what I think of hedge funds. Hedge funds are a huge fad. You can pick any ten hedge funds and I'll bet that o­n average they will underperform the S&P over the next ten years. You can't create more money out of American business than the business itself creates; so most of these hedge funds will not be able to justify their outlandish fees over the long-term and they will disappear. o­n Wall Street, there are innovators, imitators, and total incompetents. I'm afraid that the majority of hedge funds around the globe now are run by the latter two categories of people.

[CM: We have this investment discipline of waiting for a fat pitch. If I was offered the chance to go into business where people would measure me against benchmarks, force me to be fully invested, crawl around looking over my shoulder, etc., I would hate it. I would regard it as putting me into shackles.]

I would hate it. In 1956 [when I started the Buffett Partnership], I passed out the ground rules, which said "here's what I can do and can't do." The idea of setting out to do what you know you can't do [is terrible].

[CM: The general systems of money management [today] require people to pretend to do something they can't do and like something they don't. It's a terrible way to spend your life, but it's very well paid.]

The question of finding investment advisors is a hard one. When I was winding up my partnership [in the early 1970s], I was returning a fair amount of capital to people, and they asked me what to do with it. I recommended two people who I felt were exceptionally good and honest: Sandy Gottesman, who just joined Berkshire’s board, and Bill Ruane [of the Sequoia Fund]. They were contemporaries of mine, so I knew their results and how they’d achieved them, which is critical. I don’t know today’s managers, so I can’t recommend anyone.

The fact that I only knew two shows the difficulties of finding someone good. The promotional types going around to institutions today are not likely to be good – or have high integrity.

I read an article [in the Wall Street Journal last week] about the two fellows who founded Google and all the problems they’ll have with their new-found riches – I almost sent a sympathy card. [Laughter.] They don’t have a big problem. They’re smarter than the people coming to them. The people with the problem are the people trying to sell them services and want to convince them that they have a problem.

It’s merchandising. You don’t need these people at all in investing – all these professionals who say you’re going to be in big trouble if you don’t listen to them. They’re selling.

It reminds me of when I asked my former brother-in-law: “How do you get farmers to pay you to sell their cow to Swift or Armour?” He replied, “Warren, it’s not how you sell ‘em, it’s how you tell ‘em.”

[The Investment Advisory Business]

[CM: Mutual funds charge 2% per year and then brokers switch people between funds, costing another 3-4 percentage points. The poor guy in the general public is getting a terrible product from the professionals. I think it’s disgusting. It’s much better to be part of a system that delivers value to the people who buy the product. But if it makes money, we tend to do it in this country.]

[Hedge Funds]

I think people who invest in hedge funds, in aggregate, are unlikely to do well. Hedge funds are in the midst of a fad. It’s distinguished by an extraordinary amount of fees. If the world is paying hedge funds 2% and a percentage of the profits, and the losers fade away, then it won’t be good for all investors. Obviously, some will do well, but not in aggregate.

[CM: Why would you want to invest with a guy whose thought process says, “If a second layer of fees is good, then let’s add a third layer.”]

Maybe [high fees] are what the traffic can bear, but that reflects an attitude. It’s a basically unfair arrangement. In effect, [hedge fund managers] are getting four times standard fees. And I’d bet they don’t have all of their own money in their own funds.

Charlie and I both ran partnerships that would generally be classified as hedge funds. There are some similarities, but I don’t think we had quite the same attitude that the present managers have.

The fund of funds stuff – it’s really unbelievable, piling on the layers of costs. People don’t become geniuses because on the door it says “hedge fund.” But they may be good at marketing – in fact, if they’re good at this, they don’t need to be good at anything else.

[CM: The business of selecting investment managers was recently shown to be even harder by the revelation that a significant fraction of mutual fund managers took bribes to betray their own shareholders.

It was as if a man came up and said, “Why don’t we kill your mother and we’ll split the insurance money?” And many people said, “Why, yes, I’d like some of that insurance money.]

And they were already rich.

[CM: And many of them think what happened to them was unjust.]

Many people had to know what was going on. Many people at the big funds, even if they were not doing it themselves, had to know. The Investment Company Institute was patting itself on the back and getting cozy with legislators, but nothing was done until a whistleblower went to Spitzer and he publicized it.

Hundreds of people knew and it went on for a long time, but nobody did anything.

[Responding to a shareholder’s suggestion that they get into the money management business, Buffett replied:]

There would be too many conflicts. We’re managing too much money as it is and we can’t wear two hats. I certainly wouldn’t want to start a fund management company and then pro-rate purchases. I’ve been pitched many times [to start a fund company] and we could certainly sell it, but once we did so I don’t know what we’d do with it. Do you, Charlie?

Munger: No. That’s why we don’t do it. But that doesn’t seem to bother other people.

[CM: I think money management is a low calling relative to being a surgeon. I don’t like the percentage of our GDP and brainpower and professional effort that’s in money management. I don’t think it’s a good thing for our country, and don’t expect it to end well.

The present era has no comparable precedent in the history of capitalism when so many people are trading pieces of paper. We have a higher proportion of the intelligent sections of society involved in buying and selling bits of paper and trying to make money doing it. There are more people doing this than at any time in history. A lot of this reminds me of Sodom and Gomorrah.]

When we’ve seen baby versions of this in the past, there have been future [very negative] implications [for the stock market].

[CM: When you get so much nonsense going on, it feeds on itself and creates a frenzy. [When this has happened historically,] there have been serious implications.]

Munger: There are certainly a lot more helpers. The ones who come here [to the Berkshire annual meeting] are the best of them, so don’t judge the class by the ones here.

The best thing you can do as you think about following in Warren’s footsteps is to reduce your expectations.

Buffett: If your wife is going to have a baby, you’d be better to call an obstetrician than do it yourself. If your pipes leak, you should call a plumber. Most professions add value beyond what the average person can do for themselves. But in aggregate, the investment profession does not do this – despite $140 billion in total annual compensation. It’s hard to think of another business like that. Can you, Charlie?

Munger: I can’t think of any.

Buffett: It’s become a bigger and bigger business. And the more you charge, the more money you bring in. It’s useful to get into a business like that. When I speak to students, I ask them to name a great business. One answer is running a business school, because the amount you charge is a sign of prestige. No one wants to go to the business school that charges $20,000 in tuition, but if the school charges $40,000, more do.

In the investment field, you now have large portions of investment managers that charge fees that, in aggregate, cannot work out for investors. Obviously, some [investments in high-fee managers] do [work out well]. But you can’t pay 2 and 20 [2% annual management fee and 20% of the profits, standard for private-equity and hedge funds], in which you pay the manager 20% of the profits if they make money and, if they don’t, they just close up and reopen later. If you charge this in an economy that’s only growing a few percent a year, the math doesn’t work. The question for you is how to pick out the exceptions [e.g., the managers who will outperform, even after fees]. Everyone who calls on you says they are the exceptions.

I will bet you that if you name any 10 partnerships with over $500 million in assets and put them up against the S&P 500, they will trail the S&P, after fees, over time.

If you know enough about the person and how they’ve done in the past, you can occasionally find someone. But if you’re running a big pension fund, with everyone calling on you, you will likely invest in the best salespeople.

Munger: I think it ought to be a crime [for an investment manager or his agent] to entertain a state pension-fund manager, and it should be a crime for that person to accept it.

The whole concept of the house advantage is an interesting one in modern money management. The terms of the managers of the private partnerships look a lot like the take of the croupier at Monte Carlo, only greater.

Buffett: Is there anyone we’ve forgotten to offend? [Laughter]

Never has so much been managed by so few that care so much about what happens tomorrow. So much of the world of investing is people who are trying to beat indexes, and they have a willingness and eagerness to make decisions in the next 24 hours. This condition didn't exist years ago. It has created a “hair trigger” effect. An example of this hair trigger effect was Black Monday in '87. The cause was program trading and stop loss orders.