For what it’s worth, here are some takeaways from the Berkshire Hathaway annual meeting and the various peripheral events for value junkies like us.
We were struck by the intellect, energy, transparency, memory and humor that both Warren Buffett and Charlie Munger possess. They are as sharp and witty as ever.
The audience ranged from the who’s who of value royalty to young emerging managers to mom-and-pop investors – all of whom seemed genuinely excited to be there. In addition to hearing from the oracle himself, we spent a good amount of time with clients, prospects and peers – both portfolio managers and those that allocate capital to them – to gather as much intelligence about the industry that we could capture. In particular, my interest was in understanding how BRK is dealing with its ever growing size as well as assess the state of value investing which is currently suffering a once in a generation dislocation from reality. You’ll be happy to know that our belief that value investing works has only been reinforced by our findings in Omaha, and the market is indeed a voting machine over the short run, but a weighing machine over the long run.
As you may know, we focus on concentrated, value fund managers that strive to limit AUM and use their smaller size to their advantage. Smaller funds can take concentrated positions in smaller companies which tend to be more prone to price inefficiencies. We’ve also found that smaller funds have an enhanced ability to buy, size up, trim or sell outright positions with less of a negative impact to public market prices.
Counter to that wisdom, I’ve invested in BRK because it is truly one-of-a-kind, and has unique attributes that allow Buffett to use his behemoth size to his advantage. It is hard to know how many of these positive characteristics (i.e., resources; access; reputation; scalability) are offset by the lack of nimbleness, but in Berkshire Hathaway’s case, I am willing to make an exception.
Keeping in mind that we are big fans of Warren and Charlie, we do find some of what they say hard to reconcile. We’ll start with the first question that was from an investor who referenced one of Buffett’s 1987 letters about BRK avoiding capital intensive businesses and why that’s changed. “It’s part of the problems of prosperity,” Buffett says. “We’d love to buy a company for $10 or $20 or $30 billion that is not capital intensive. And we may. But that is harder…increasing capital acts as an anchor on returns in many ways,” Buffett says. “When our circumstances changed, we changed our minds,” Munger says. “Slowly and reluctantly,” Buffett adds. “The ideal business is one that takes no capital” but still grows. But most of those are not of a size that they would move the needle at Berkshire. Buffett says the alternative to buying businesses that require less capital would mean going back to working with less money. Which Buffett doesn’t think is going to happen… as he chuckles. Buffett realizes that because of this they may miss out on investments with spectacular results, but “are quite happy with a satisfactory result,” he concludes.
The idea that size can often be the enemy of returns is not new to BRK, and in fact they’ve alluded to this before:
“If I were working with small sums, I certainly would be much more inclined to look among what you might call classic Graham stocks, very low PEs and maybe below working capital and all that…Incidentally I would do far better percentage wise if I were working with small sums, there are just way more opportunities.”
– Warren Buffett, 2011
Another topic du jour was the current turmoil at Sequoia. For those that don’t know the connection, please see attached Forbes. The short of it is that Warren has been recommending to clients to put money with his old friends Sandy Gottesman’s First Manhattan Co. and Bill Ruane’s Ruane Cuniff/Sequoia for decades.
As most of you know, we were brought up in value investing at Third Avenue Management under Marty Whitman’s tutelage, so we’ve always held Sequoia and other time-tested value managers in high regard. We also know that many of our clients have been invested with Sequoia for decades and they too are looking for answers. The current tumult at Sequoia which led to the recent ousting of one of its longstanding statesmen Bob Goldfarb has been fascinating and shocking to us.
The question came through CNBC’s Becky Quick about the outsized Valeant Pharmaceuticals position in Sequoia. Given that Charlie Munger has been outspoken about it and believes that “Valeant, of course, was a sewer,” the natural question was, should investors stay the course with Sequoia?
Warren began his answer reminding the audience of the history and that he considers himself “the father” of the mutual fund, in that he steered his early investors to Ruane, Cunniff & Goldfarb Inc. when he shut down his investment partnership, and of Sequoia’s great long term track record, despite the recent drawdown. However, he didn’t hold punches when it came to Goldfarb, the architect behind much of the firm’s success but also the dictator of this “unusually large position” in Valeant. Buffet advises investors to stay invested with these “very smart, decent people” and that the problem has been removed.
The question remains that Sequoia Fund has been hit with large redemptions, which is an experience we have lived through ourselves at past firms and understand clearly how difficult this is. The firm is also dealing with reputational tarnishing, reshuffling of roles and responsibilities, and an increase in client retention duties. Ultimately this could turn out fine for Sequoia, but they need to be transparent about ownership structure and compensation to comfort investors and give confidence that their talent is there to stay. In our conversations with managers and investors around the event, we heard conflicting reports on their willingness to be fully open about these facts.
Coincidentally, or not, Sequoia announced they were reopening the Fund to new investors in tandem with Buffett’s endorsement. I guess if the Fund has been meeting some of the massive redemptions with shares of its underlying investments, also known as “in kind” redemptions, management believes that selling such securities would hurt public market prices. Oh what a tangled web. We have our doubts about Sequoia and other large funds that run into trouble. It seems Jimmy Cliff had it right, “the harder they come, the harder they fall,” and this Fund’s saga shouldn’t be such a surprise to us…but it is. We will continue to probe and prod to get to the bottom of it, and share whatever we may find.
On Valeant, Buffett says “the business model of Valeant was enormously flawed” He said that the troubles the company has gotten into reminded him of a principle passed on to him by a friend, “if you’re looking for a manager, find someone who is intelligent, energetic and has integrity. If he doesn’t have the last, make sure he lacks the first two.” Meaning you should hope that a smart and energetic manager isn’t low on scruples. Munger didn’t mince words about Valeant, and added that he’s seen “patterns that frequently come to a bad end, but look extremely good in the short run” and that “those who created it deserve all the opprobrium that they got.”
Another topic that we found very interesting yet partially hard to square was Buffett’s multiyear bet against hedge funds. The contest, initiated by Protégé’s Ted Seides, back in 2006 pitted Ted’s top five hedge fund picks vs Warren’s pick of the S&P 500 Index fund. While we agree with Buffett that most consultants and fund-of-funds are not worth the extra layer of fees they charge, we don’t believe that the S&P is the only other game in town. Given Warren’s earlier comments about the benefits of running small pools of capital, we believe he’d agree that there’s merit in complementing BRK or the S&P with smaller, yet proven, active managers that can traffic in securities more prone to mispricings.
The bet still has two years to go and the winner will get to designate $1 million to a charity of his choice. As you can see by the chart below, this has been an extraordinary run for the S&P that could very well be erased in short order. However, let’s give credit where it’s due, and tip our hats yet again to the oracle.
Another somewhat controversial question to Warren was geared towards potential conflicts around his personal stake in Seritage Growth Properties Inc., the real-estate company split off from Sears Holdings Corp. last year. Buffett disclosed to the audience that he could not invest in Seritage in BRK because it was too small, so he plopped it into his personal account. We assume he conducted the same in-depth analysis he does with candidates for BRK before pulling the trigger, so at minimum this exercise creates a time distraction. He assured the crowd that 99% of his investable wealth is in BRK, and that his personal account is just a mere 1%…that is still a decent size amount of capital given his net worth. We understand and agree that Seritage is not “Berkshire sized” as its market cap was under $2 billion when he bought it. However, it does beg the question of how well the securities that make up his “side account” have done when compared to BRK. How do we invest in that portfolio Warren?
We don’t want to leave you with the wrong impression. We love Warren and believe what he’s accomplished for his investors is virtually impossible to replicate. We admit that pointing out some of these discrepancies are conveniently self-serving, but we strongly believe that there’s a place for multiple schools of thought when investing for the long term. In the end, we found our time in Omaha invaluable and plan to attend next year.