Friday, September 29, 2017

Buffett on American Business

From the Berkshire Hathaway (BRKashareholder letter released earlier this year:

"Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America's economic dynamism. One word sums up our country's achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.

You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776."

And later Warren Buffett writes that...

"American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.

Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: 'We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.'

During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well."

So, essentially, those with a long investing horizon who view favorably the equity markets hitting new highs have it backwards.

Buying stocks when they sell near their full intrinsic per-share value -- or, worse yet, above a conservative estimate of that value -- simply increase their risk of loss and reduce forward returns.

"We hear it all the time: 'Riskier investments produce higher returns' and 'If you want to make more money, take more risk.'

Both of these formulations are terrible. In brief, if riskier investments could be counted on to produce higher returns, they wouldn't be riskier." - Howard Marks in his memo: Risk Revisited

"If you buy a dollar bill for 60 cents, it's riskier than if you buy a dollar bill for 40 cents, but the expectation of reward is greater in the latter case. The greater the potential for reward in the value portfolio, the less risk there is." - Warren Buffett in The Superinvestors of Graham-and-Doddsville

Prevailing wisdom may suggest otherwise but, at least for investors, risk and reward need not be positively correlated.

Frequently misunderstood and underutilized.

American businesses, in the long run, will likely do just fine and their long-term owners have a relatively uncomplicated way to tilt the relation between risk and reward in their favor.

Those who, by and large, are investing with eye toward many years down the road should be hoping that stocks get cheap again.

Adam

Long position in BRKb established at much lower than recent market prices

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, August 15, 2017

Berkshire Hathaway 2nd Quarter 2017 13F-HR

The Berkshire Hathaway (BRKa2nd Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 1st Quarter 13F-HR.)

There was both some buying and selling during the quarter. Here's a quick summary of the changes:*

Added to Existing Positions
Apple (AAPL): 835 thous. shares bought (<1% incr.); stake = $ 18.8 bil.
Bank of New York (BK): 17.2 mil. shares (52% incr.); stake = $ 2.6 bil.
General Motors (GM): 10.0 mil. shares (20% incr.); stake = $ 2.1 bil.
Lib. SiriusXM (LSXMK): 8.8 mil. shares (39% incr.); stake = $ 1.3 bil.

I generally include above only those positions that were worth at least $ 1 billion at the end of the 2nd quarter. In a portfolio this size -- ~$ 307 billion (equities, fixed income, cash, and other investments including Kraft Heinz: KHC at fair value) according to the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.

Liberty SiriusXM (LSXMA) is the only positions added to worth less than $ 1 billion.

New Positions
STORE Capital (STOR): 18.6 mil. shares; stake = $ 418 mil.
Synchrony Financial (SYF): 17.5 mil. shares; stake = $ 521 mil.

Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Reduced Positions
Wells Fargo (WFC): 11.7 mil. shares sold (2% decr.); stake = $ 25.9 bil.
IBM (IBM): 10.5 mil. shares (16% decr.); stake = $ 8.3 bil.
Delta Airlines (DAL): 1.9 mil. shares (3% decr.); stake = $ 2.9 bil.
American Airlines (AAL): 2.3 mil. shares (4% decr.); stake = $ 2.4 bil.
United Airlines (UAL): 740 thous. shares (2% decr.); stake = $ 2.1 bil.

Warren Buffett previously said that Berkshire had been selling its IBM shares during the 1st and 2nd quarter.

Berkshire also previously announced why they will need to sell some of their Wells Fargo shares to keep the ownership stake below 10%.

No other positions valued at more than $ 1 billion were partially sold off during the quarter. Reduced position worth less than $ 1 billion included Sirius XM (SIRI) and WABCO Holdings (WBC),

Sold Positions
General Electric (GE)

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and technology stocks (primarily IBM and Apple).

1. Kraft Heinz (KHC) = $ 27.9 bil.
2. Wells Fargo (WFC) = $ 25.9 bil.
3. Apple (AAPL) = $ 18.8 bil.
4. Coca-Cola (KO) = $ 17.9 bil.
5. American Express (AXP) = $ 12.8 bil.

As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire also owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.

The portfolio excludes all the operating businesses that Berkshire owns outright with ~ 367,000 employees (25 being at headquarters) according to the latest available annual report.

Here are some examples of Berkshire's non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Berkshire Hathaway Automotive, Oriental Trading Company, Precision Castparts, and Duracell.
(Among others.)

In addition to the above businesses and investment portfolio, Berkshire's large insurance operation (BH Reinsurance, General Re, GEICO etc.) has historically been rather profitable while providing plenty of "float" for their investments.

See page 116 of the annual report for a more complete listing of Berkshire's businesses.

Adam

Long positions in BRKb, KO, WFC, and AXP established at much lower than recent market prices. Also, long position in IBM established somewhat above recent market prices. (In each case compared to average cost basis.)

* All values shown are based upon the last trading day of the 2nd quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F. What is not included are shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F is if Berkshire buys the ADR. Investments in things like preferred shares (and valuable warrants, where applicable, as explained in the recent letters) are also not included in the 13F.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, July 31, 2017

Investing Blunders

Warren Buffett once said the following about his decision to purchase Berkshire Hathaway (BRKa) back in 1964:

"I had now committed a major amount of money to a terrible business. And Berkshire Hathaway became the base for everything pretty much that I've done since. So in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway. I really should— should have bought it for a new entity.

Because Berkshire Hathaway was carrying this anchor, all these textile assets. So initially, it was all textile assets that weren't any good. And then, gradually, we built more things on to it. But always, we were carrying this anchor. And for 20 years, I fought the textile business before I gave up. As instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now...This is $200 billion. You can— you can figure that... Because the genius here thought he could run a textile business."

Buffett's $ 200 Billion Blunder

Berkshire's textile operations were shut down in 1985.

The above is from an interview with Becky Quick of CNBC that happened back in 2010. This past May she sat down for an interview with Warren Buffett, Charlie Munger, and Bill Gates. During the latter part of this interview she asked what they thought were the "worst trades" they've made in the past. Buffett, understandably considering the scale of the error, brought up Berkshire again.

QUICK: "...Warren has talked about his worst trades in the past. And Warren, I believe you said it was Berkshire Hathaway itself that was your worst trade."

BUFFETT: "Yeah, but I have plenty of other competitors...there are three companies [that] came together for Berkshire, actually. Diversified Retailing and Blue Chip Stamps were two others. And the base companies of both of the other two totally failed, disappeared. So we're three for three in terms of our building blocks. And we thought they were okay at the time, didn't we, Charlie?"

MUNGER: "Well, we bought them so cheaply, that we could return more money than we paid. And then we took the money and bought these other companies. So it wasn't as though we lost big chunks of money. It's just that it was such a dumb way to do business. Scrambling around with those unfashionable dying businesses, Textile Mills in New England. The power costs in the south...were 60% lower than they were in New England... What kind of an idiot would go into textiles in New England?"

BUFFETT: "The guy on your right."

MUNGER: "Yeah."

Later Charlie Munger said the following when asked a similar question:

MUNGER: "I made a tech company investment. And we damn near went broke and we hovered on the edge of a precipice for about three or four years. And it was agony. And it was a lot of money to me at the time. Now, we scrambled out of it with a pretty good profit. But it wasn't the world's smartest investment. And it took a lot of intelligent scrambling to rectify the situation. And I'm not looking to repeat the dumb decisions that got me there."

BUFFETT: "We'll find new ones."

QUICK: "Yeah."

MUNGER: "Yeah, we will."

I'd quibble with the terminology "worst trades" since neither Buffett or Munger really engage in trading activities or, at least, have not done so for a very long time.

Those who invest know -- or, one way or another, likely will come to know -- that mistakes are nearly inevitable. The question is how costly they are allowed to become and whether what's learned along the way is effectively put to use.

Some expend an awful lot of energy trying to prove to the world, and convincing themselves, that they're right. The process (of convincing) itself can serve to reinforce and solidify ideas -- whether flawed or otherwise -- possibly leading to a calcified world view that's increasingly less willing consider alternatives.

"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman

Sometimes -- or, possibly, often -- it'd have been better redirecting that effort towards the exploration of whether a particularly favored idea deserves such a status.

"To kill an error is as good a service as, and sometimes even better than, the establishing of a new truth or fact." - Charles Darwin

Ideas, even those most favored (especially those most favored?), should be viewed more skeptically and challenged relentlessly. Easier said.

"If others examined themselves attentively, as I do, they would find themselves, as I do, full of inanity and nonsense. Get rid of it I cannot without getting rid of myself. We are all steeped in it, one as much as another; but those who are aware of it are a little better off -- though I don't know." - Michel de Montaigne

Some healthy doubt can be a very useful thing.

An attitude that, to me, has a good chance of being applicable beyond the world of investing.

Though I don't know.

Adam

Long position in BRKb established at much lower than recent market prices

Related post:
Buffett's $ 200 Billion Blunder

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, June 30, 2017

Compound Returns, Compound Costs...

"Hedge funds (so-called; actually concentrated investment accounts which offer a wide variety of strategies) manage about $2.8 trillion of assets, at a cost equal to at least 3% of assets per year (300 basis points, an informed guess), generating some $84 billion in annual fees." - John Bogle in a speech last year

Bogle's "informed guess" is, of course, primarily driven by the 2 and 20 compensation structure common to hedge funds.

In a prior post, I wrote what "if Buffett charged investors something like the 3% in annual fees to manage Berkshire Hathaway's (BRKa) current portfolio...?"

Well, 3 percent of Berkshire's now roughly $ 300 billion of cash and investments would increase Berkshire Hathaway (BRKa) expenses by ~ $ 9 billion which would naturally hurt shareholders by reducing intrinsic value -- materially so if this were to become an ongoing annual expense.* For many reasons such a fee structure would never exist at Berkshire, of course, but it's worth considering carefully how much less valuable Berkshire would be today if 1) Buffett had been draining those kind of fees out of the company all these years and 2) how much it would hurt investors going forward. If those kind of fees were charged in the past, Berkshire would in fact be a rather much smaller company and it's capacity to invest (not just in common stocks but also things like the capital intensive businesses Berkshire owns outright) would be a fraction of its current capability. Going forrward, if for some reason Berkshire started paying the $ 9 billion in fees -- fees likely to increase over time as the portfolio grows -- the impact would be substantial. Consider that Berkshire's invested roughly $ 13 billion in property, plant and equipment last year. Much of it to build and maintain things like the railroad, utilities, and energy infrastructure. Useful stuff. Well, that $ 9 billion in hypothetical fees would sure chew up a substantial chunk of Berkshire's $ 13 billion capital expenditure budget.

It's compounding returns pitted against what Bogle calls "the tyranny of compounding costs".

These annual Berkshire capital expenditures -- assuming they're intelligently implemented -- aren't just a likely future benefit Berkshire's continuing shareholders, they're potentially of substantial benefit more generally. In 2015, Buffett wrote that 86 percent of their property, plant and equipment budget was "deployed in the United States."

If this kind of high fee structure is detrimental to Berkshire shareholders -- never mind the possible adverse societal impact caused by high fees draining capital that could have been used to upgrade infrastructure --  why wouldn't this similarly apply to anyone managing lots of capital and charging high fees?

That question, at least for me, answers itself. The justification is usually that the money manager is so exceptional that the fees are fully justified. So that means, apparently, there's a large army of money managers so talented that they deserve compensation orders of magnitude greater than Mr. Buffett.

The money doesn't completely disappear, of course. The high fees being charged naturally get invested and spent somewhere but effective investment needs for good ideas to get backed by sufficient financial scale and real patience. Yet, at least relative to the Berkshire model, what could have been concentrated long-term investment seems, instead, destined to become rather diffuse and impatient while producing fewer things of lasting value.

"We have two [investment] managers at Berkshire. They each manage $9 billion for us. They both ran hedge funds before. If they had a 2/20 arrangement with Berkshire, which is not uncommon in the hedge fund world, they would be getting $180 million annually each merely for breathing." - Warren Buffett at last year's Berkshire Annual Meeting

Buffett, in any case, based on long-term track record is easily among the best -- if not the best -- at investing exceptionally well yet charging others little for it. I wouldn't expect his extraordinarily low compensation (considering the size of the job and the performance) to become the norm but it would seem a more reasonable equilibrium could exist between the two extremes.

"The way to wealth, it turns out, is to avoid the high-cost, high-turnover, opportunistic marketing modalities that characterize today's financial service system and rely on the magic of compounding returns. While the interests of the business are served by the aphorism 'Don't just stand there. Do something!' the interests of investors are served by an approach that is its diametrical opposite: 'Don't do something. Just stand there!'" - John Bogle in a commentary on CNBC

When high fees are tolerated "the magic of compounding returns" becomes something much less magical via "the tyranny of compounding costs".

Adam

Long position in BRKb eastablished at much lower than recent market prices

Related posts:
Buffett on Bogle
Buffett: Innovators, Imitators, & the Swarming Incompetents
Bogle & Buffett on Frictional Costs
Buffett on Active Investing
John Bogle: Arithmetic Quants vs Algorithmic Quants
Hedge Funds: Balancing Risk & Reward?
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Howard Marks on Risk
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again

* For Berkshire, even as large as it is, ~ $ 9 billion of additional costs would be a real hit to the company's earning power. If those fees were to actually become an ongoing cost it'd basically be a wealth transfer to Buffett but the intrinsic value of Berkshire -- of which Buffett is the largest shareholder -- would be materially reduced. In many ways it'd be like moving his wealth from one pocket to another while hurting all the other shareholders (and, somewhat weirdly, even himself). Buffett's wealth has come about alongside his investors instead of from his investors. For too many that's just not the case. Best case it's usually a bit of both.

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, May 16, 2017

Berkshire Hathaway 1st Quarter 2017 13F-HR

The Berkshire Hathaway (BRKa1st Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 4th Quarter 13F-HR.)

There was both some buying and selling during the quarter. Here's a quick summary of the changes:*

Added to Existing Positions
Apple (AAPL): 72 mil. shares (125% incr.); stake = $ 18.6 bil.
Southwest (LUV): 4.5 mil. shares (10%); stake = $ 2.6 bil.
American Airlines (AAL): 3.7 mil. shares (8%); stake = $ 2.1 bil.
Bank of New York (BK): 11.3 mil. shares (52%); stake = $ 1.6 bil.

I generally include above only those positions that were worth at least $ 1 billion at the end of the 1st quarter. In a portfolio this size -- more than $ 301 billion (equities, fixed income, cash, and other investments including Kraft Heinz: KHC at fair value) according to the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.

Positions that were added to worth less than $ 1 billion include Sirius XM (SIRI) and Liberty SiriusXM Group (LSXMALSXMK).

New Positions
There were no entirely new positions added during the quarter.

Warren Buffett previously mentioned that Berkshire had purchased shares of Southwest Airlines during the 4th quarter.

Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Reduced Positions
IBM (IBM): 16.7 mil. shares (20% decr.); stake = $ 11.2 bil.
Delta Airlines (DAL): 5.0 mil. shares (8% decr.); stake = $ 2.5 bil.

That 20% decrease in IBM shares naturally only reflects what was sold in the 1st quarter. Warren Buffett previously mentioned that Berkshire had, in total, sold roughly a third of its shares in IBM during the 1st and 2nd quarter.

No other positions valued at more than $ 1 billion were partially sold off during the quarter. The only reduced position worth less than $ 1 billion was WABCO Holdings (WBC),

Sold Positions
Twenty-First Century Fox (FOXA)

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and technology stocks (primarily IBM and Apple).

1. Kraft Heinz (KHC) = $ 29.6 bil.
2. Wells Fargo (WFC) = $ 26.7 bil.
3. Apple (AAPL) = $ 18.6 bil.
4. Coca-Cola (KO) = $ 17.0 bil.
5. American Express (AXP) = $ 12.0 bil.

As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire also owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.

The portfolio excludes all the operating businesses that Berkshire owns outright with ~ 367,000 employees (25 being at headquarters) according to the latest available annual report.

Here are some examples of Berkshire's non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Berkshire Hathaway Automotive, Oriental Trading Company, Precision Castparts, and Duracell.
(Among others.)

In addition to the above businesses and investment portfolio, Berkshire's large insurance operation (BH Reinsurance, General Re, GEICO etc.) has historically been rather profitable while providing plenty of "float" for their investments.

See page 116 of the annual report for a more complete listing of Berkshire's businesses.

Adam

Long positions in BRKb, KO, WFC, and AXP established at much lower than recent market prices. Also, long position in IBM established somewhat above recent market prices. (In each case compared to average cost basis.)

* All values shown are based upon the last trading day of the 1st quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F. What is not included are shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F is if Berkshire buys the ADR. Investments in things like preferred shares (and valuable warrants, where applicable, as explained in the recent letters) are also not included in the 13F.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Friday, April 28, 2017

Buffett on Bogle

"If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.

In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me." - From Warren Buffett's latest letter

John Bogle, in a speech last year, noted that:

- Hedge funds, in total, managed at the time something like $2.8 trillion in assets
- Investors in such funds pay out to their managers ~ 3 percent per annum -- what he calls an "informed guess" -- or roughly like $ 84 billion (yes...billion) in fees per year
- Vanguard manages ~$3 trillion in assets -- nearly the same amount as all hedge funds combined -- with two thirds being index funds.
- The cost of managing the ~ $2 trillion of index fund assets = .08 percent of assets per annum = ~ $ 1.6 billion

Quite a difference in costs even after normalizing the $ 2.8 trillion to the size of the index fund asset base. The compounded impact of these extra costs for investors over the long haul is hardly small.

In fact, even a traditional actively managed mutual fund that charges something like "only" 1 percent per annum is an order of magnitude more costly than the typical index fund. Imagine two investors. Both have $ 100k to invest and a 35 year investment horizon. Each have portfolios excluding fees that produce a 6 percent annual return over those 35 years. The only difference is one of the investors is paying 1 percent in annual fees while the other has .08 percent in annual fees.

So how much more wealth would the low fee paying investor have at the end of the 35 year investment horizon?

~ $ 200k

What's worth noting is that here we have someone who's accomplished great success through active investing (Buffett) with high respect and admiration for the person (Bogle) who has been encouraging investors to avoid such an approach for decades.

To understand why this seemingly inherent conflict might exist just consider the frictional costs -- or lack thereof -- inherent to Buffett's approach. Now, imagine if Buffett charged investors something like the 3% in annual fees to manage Berkshire Hathaway's (BRKa) current portfolio -- ~ $ 276 billion of cash and investments at the end of 2016 -- instead of the $ 100,000 salary plus security costs?*

Berkshire would instantly become a very different and very much less valuable investment -- more than $ 8 billion in additional costs tends to do that -- but that'll have to be a subject for another day.

High fees or not, it's just not easy to figure out who'll be able to produce -- over many years/decades and many investing environments -- satisfactory or better results.

Add in the high fees and an already difficult task becomes even tougher.

When it comes to investing -- and often well beyond the world of investing -- it's tough to beat the wisdom of Bogle and Buffett.

Adam

Long position in BRKb eastablished at much lower than recent market prices

Related posts:
Buffett: Innovators, Imitators, & the Swarming Incompetents
Bogle & Buffett on Frictional Costs
Buffett on Active Investing
John Bogle: Arithmetic Quants vs Algorithmic Quants
Hedge Funds: Balancing Risk & Reward?
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Howard Marks on Risk
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again

* Otherwise, Buffett generally receives no stock options, stock grants or bonuses. Keep in mind that Buffett's $ 100,000 salary covers not only his investment portfolio responsibilities, but also finding and buying new businesses outright, and making sure the many businesses Berkshire already owns outright (which combined have 367,000 employees according to the latest annual report) are run effectively by honest and capable people (among other things).

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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Wednesday, March 22, 2017

Buffett: Innovators, Imitators, & the Swarming Incompetents

From Warren Buffett's most recent Berkshire Hathaway (BRKa) shareholder letter:

"...the great majority of [investment] managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane – a truly wonderful human being and a man whom I identified 60 years ago as almost certain to deliver superior investment returns over the long haul – said it well: 'In investment management, the progression is from the innovators to the imitators to the swarming incompetents.'

Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods. If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him."

Buffett later adds:

"When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients."

What's an investor to do? According to Buffett, the vast majority of investors, large or small, would be better off owning index funds with reasonably low expenses.
(A view he's advocated previously including in the 2013 letter.)

Buffett, late last month on CNBC, further elaborated on his thinking on the high expenses investors often end up paying:

"The amount of money people wasted getting investment advice is just ridiculous in this country."

He then goes on to say:

"...it borders on obscene...I've known 10 or so people with modest amounts of money, I would bet a lot of money that they would do better than average. And I say that there are hundreds, maybe even thousands. But there's thousands, and thousands, and thousands and thousands of hedge fund managers charging two and twenty...And you don't get better because you charge a lot. I mean, that does not make you a better judge of securities or anything like that. And so the good salespeople, overwhelmingly, are the ones that attract the money, rather than the very few who are extraordinary at managing money."

Charlie Munger is, not surprisingly, included in that list of 10. Buffett says the people who he thought likely to do well in the investing business were not "the smartest guys necessarily in the world," but then added "although maybe Charlie is."

I find it very tough to argue with that.

Paying something like 1.5% per annum in incremental frictional costs -- or, incredibly, in some cases even more -- may not intuitively seem like a big deal but, on a compounded basis, the difference in long range outcomes is hardly insignificant.

Let's say a basket of investments increase in value -- before any fees -- at an annual rate of 5.0% for 25 years. Well, subtract those 1.5% in annual fees from the returns* over 25 years and you'll find that the gain takes a material haircut. In fact, after 25 years the investor ends up with only 60 cents on the dollar. So instead, for example, of having $ 100k in gains the investor instead keeps roughly $ 60k.**

It's the investor who puts capital at risk for many years yet a good chunk of the gains end up elsewhere.

What if the actual gains over 25 years end up being more modest?

Something like 1.5% annually before fees?

In that case, the gains to the investor would of course have to be zero since the 1.5% in fees exactly offset the returns. So, amazingly, the investment manager ends up with a positive, albeit reduced compared to the 5.0% scenario, result but the investor ends up breaking even.

Win-win...at least for the manager.

Once again, remember who actually put the capital at risk here.

Now, what if returns before fees end up being less than 1.5% over 25 years? Well, it will produce a net loss for the investor. Those fees still have to be covered somehow and if gains aren't sufficient the costs must be subtracted from the funds initially invested. This creates a scenario where, once again, the manager gets a positive, though admittedly more muted, result while the investor necessarily incurs a loss.

So 1.5% per year in fees sounds kind of harmless until considered in dollar terms over a proper long-term investing horizon.

What if during -- or, especially, toward the end of -- the 25 year period there's a big decline in market prices? Well, if the money is not needed by the investor (and emotions don't take over) during such an event this need not be the end of the world. Prices may normalize if whatever precipitated the decline mostly comes to an end. Yet it is the investor who has to ride it out or otherwise take the hit. In other words, the manager keeps all those fees paid out in prior years no matter what happens. Add a couple of zeros or more to the numbers above and it's not difficult to see why, as Buffett said in the letter, usually it's "the managers who reap outsized profits, not the clients."

Some managers, of course, suggest they have the capability to produce even greater returns than the examples I've used above and, well, a small number might even achieve such a result (without taking crazy risks). Yet picking a manager beforehand who will actually end up being worth something like 1.5% per annum in fees is easier said than done. During bull markets, when returns seem like they'll indefinitely be high, the high fees being charged will also seem like not terribly important background noise. Unfortunately, it's likely that with a long enough investment time horizon -- multiple market environments that inevitably include the good, the bad, and the ugly -- the importance of those fees will, ultimately, more or less become foreground noise.

Big declines in capital markets from time to time are unavoidable.

When it will happen and to what degree is neither knowable nor controllable.

Keeping expenses low is.

Seems straightforward enough but far too many investors still find it difficult to keep what are mostly avoidable costs at reasonable levels.

The result? A quiet, meaningful, but largely unnecessary wealth transfer.

Dumb ideas emerge from time to time in investing; keeping a close eye on the frictional costs likely won't prove to be one of them.

If expenses are kept in check the bulk of the gains mostly benefit whoever has actually put capital at risk. If not, much of the value that should compound and accumulate over time will, instead, end up in someone else's pocket.

Naturally, as equity prices rise to premium levels -- compared to per share intrinsic business values -- future returns eventually become anywhere from diminished to entirely insufficient while, at the same time, the possibility of permanent capital loss increases.
(Especially when the investment horizon is too short.)

As always, the price paid is paramount. Otherwise terrific asset(s) can be turned into lousy investment(s) if the price paid is too high.

Inadequate margin of safety.

Reduced potential reward.

Greater risk of loss.

Despite the popular view reward and risk need not always be positively correlated.

It's impossible to ignore where equity valuations are now compared to not all that long ago.

Adam

Long position in BRKb established at much lower than recent market prices

Related posts:
Bogle & Buffett on Frictional Costs
Buffett on Active Investing
John Bogle: Arithmetic Quants vs Algorithmic Quants
Hedge Funds: Balancing Risk & Reward?
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Howard Marks on Risk
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Risk and Reward Revisited
Newton's Fourth Law
Investor Overconfidence
Buffett on Risk and Reward
Margin of Safety & Mr. Market's Mood
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again

* Excluding tax considerations.
** If 4 times as much capital were invested but otherwise nothing changes in terms of performance, then the outcome over 25 years would of course be proportional (as far as returns and fees). At first this might seem fair enough. More money to manage...more fees, right? Yet, since we're still talking about the same 5% annualized return, those extra fees were generated simply because more assets were under management. Now, more assets no doubt will have some additional cost associated with them, but is 4 times more in fees really justified? Purchasing 4 times as many shares of a particular stock, for example, hardly increases the cost structure by four-fold. Does it really take 4 times the effort and skill to produce such a materially higher amount of fees? I think the question answers itself.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
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Wednesday, February 15, 2017

Berkshire Hathaway 4th Quarter 2016 13F-HR

The Berkshire Hathaway (BRKa4th Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 3rd Quarter 13F-HR.)

There was both some buying and selling during the quarter. Here's a quick summary of the changes:*

Added to Existing Positions
Apple (AAPL): 42.1 mil. shares (276% incr.); stake = $ 6.6 bil.
Delta Air Lines (DAL): 53.7 mil. shares (847%); stake = $ 3.0 bil.
American Airlines (AAL): 23.8 mil. shares (109%); stake = $ 2.1 bil.
United Continental (UAL): 24.4 mil. shares (538%); stake = $ 2.1 bil.
Bank of New York (BK): 535 thous. shares (2%); stake = $ 1.0 bil.

I generally include above only those positions that were worth at least $ 1 billion at the end of the 4th quarter. In a portfolio this size -- roughly $ 257 billion (equities, fixed income, cash, and other investments including Kraft Heinz: KHC at fair value) according to the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much. No positions worth less than $ 1 billion were added during the quarter.

New Positions
Southwest Airlines (LUV): 43.2 mil. shares; stake = $ 2.2 bil.
Monsanto (MON): 8.04 mil. shares; stake = $ 846 mil.
Sirius XM Holdings (SIRI): 167 mil. shares; stake = $ 742 mil.

Warren Buffett previously mentioned that Berkshire had purchased shares of Southwest Airlines during the 4th quarter.

Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Reduced Positions
No positions still valued at more than $ 1 billion were partially sold off during the quarter. Positions that were sold in part but worth less than $ 1 billion include Wal-Mart (WMT) and Verizon (VZ),

Sold Positions
Deere & Company (DE)
Kinder Morgan (KMI)
Liberty Media/Formula One Group (FWONK) - Formerly LMCK
Liberty Media/Formula One Group (FWONA) - Formerly LMCA
Now, Inc. (DNOW)
Lee Enterprises (LEE)

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and technology stocks (primarily IBM and Apple).

1. Kraft Heinz (KHC) = $ 28.4 bil.
2. Wells Fargo (WFC) = $ 26.4 bil.
3. Coca-Cola (KO) = $ 16.6 bil.
4. IBM (IBM) = $ 13.5 bil.
5. American Express (AXP) = $ 11.2 bil.

As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.

The portfolio excludes all the operating businesses that Berkshire owns outright with ~ 361,000 employees (25 being at headquarters) according to the latest available letter. Numbers like these -- along with many other things of interest especially for Berkshire shareholders -- should be updated in the next annual report and letter.

Here are some examples of Berkshire's non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Berkshire Hathaway Automotive, Oriental Trading Company, Precision Castparts, and Duracell.
(Among others.)

In addition to the above businesses and investment portfolio, Berkshire's large insurance operation (BH Reinsurance, General Re, GEICO etc.) has historically been rather profitable while providing plenty of "float" for their investments.

See page 115 of the annual report for a more complete listing of Berkshire's businesses.

Adam

Long positions in BRKb, KO, WFC, and AXP established at much lower than recent market prices. Also, long positions in WMT and IBM established somewhat below recent market prices. (In each case compared to average cost basis.)

* All values shown are based upon the last trading day of the 4th quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F. What is not included are shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F is if Berkshire buys the ADR. Investments in things like preferred shares (and valuable warrants, where applicable, as explained in the recent letters) are also not included in the 13F.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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