Book: Warren Buffett’s Ground Rules
Author: Jeremy C. Miller
This is a very interesting book that focuses on Buffett’s pre-Berkshire Hathaway days, when he used to operate more akin to a hedge-fund manager vs. owner-operator + captive insurance as capital supplier model he used after.
Buffett charged 25% performance fee above 6% threshold because he figured the market was going up 5-7% a year on average. He also had a high watermark which means the cumulative return had to be above 6% before he’d start taking his fee.
Additions and redemptions could be made only once a year (forcing investors to look at their performance from a LT perspective. Those who needed, could borrow as much as 20% of their capital at 6% interest.
Buffett’s first partnership was started with people he cared about deeply, which undoubtedly influenced how he structured the fees. He also charged a lower fee when the partners were willing to take on more risk [interest thought here is how is risk defined and how he and his partners agreed on its definition].
While it’s easy to pigeonhole Graham purely as a deep-value investor, Graham paid up for quality when he bought GEICO–and he made more money from GEICO than all his other activities (not just investments) combined.
It’s also important to remember that Graham was a child of the Great Depression and his investing framework perhaps reflected some of that experience.
The really big money tends to be made by investors who are right on qualitative decisions, but the more sure money tends to be made on the obvious quantitative decisions.
Buffett told his partners at BPL that they should expect his investments to tilt toward Generals when market was falling and toward Workouts (M&A, liquidations, re-orgs, spin-offs etc.) when the market was rising.
As for using leverage, he thought that some borrowed money is warranted against a portfolio of Workouts but very dangerous against Generals.
As for diversification, Buffett thought that if one could identify six wonderful businesses, that is all the diversification you need.
“The course of the stock market will determine, to a great degree, when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we should concentrate on what should happen, not when it should happen.”
“Who would think of buying/selling a private business based on someone’s guess on the stock market? The availability of a quote should be an asset to be utilized, if so desired.”
The lack of performance exceeding, or even matching an unmanaged index is no way a reflection of either intellectual capacity or integrity. I think it’s much more of a product of:
- group decisions
- desire to conform to policies and portfolio of other large well-regarded institutions
- institutional framework whereby personal rewards for independent action are in no way commensurate with general risk attached to such an action (average is “safe”)
- adherence to diversification practices that are irrational
- inertia (when twenty years of investment experience = one year’s experience–twenty times)
While I much prefer a five-year test, I feel three years is the absolute minimum for judging performance… with exception being the three years covering a speculative explosion in a bull market.