Reviewing Warren Buffett’s Nine Great Points, Including Why You Should Eat Your Own Cooking
18 January 2011 | People and Companies | News | Cannon Asset Managers
Dr Adrian Saville, CIO of Cannon Asset Managers, reviews some wisdom distilled from Berkshire Hathaway’s annual letter to shareholders written by Warren Buffett
As we start 2011, I believe that it is worthwhile reviewing some of Warren Buffet’s wisdom gleaned from his annual letters to shareholders which are always filled with gems. For me, nine such nuggets stand out in terms of the way sensible investment thinking is fashioned and great businesses are run.
- Buffett makes an important connection between fund size and performance. He notes: “The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue.” Whilst Buffett is making the argument in relation to a few hundred billion dollars, the point is valid throughout the investment management industry. Size counts, because investment performance and size are inversely correlated. The bigger you are, the fewer the opportunities available.
- A characteristic of many so-called “active” investment managers is that they tend towards being closet trackers. Their portfolios are heavily weighted to holding index positions and to holding what others in the industry hold. Consequently, a sadly large proportion of active managers deliver market-like performance yet charge active management fees, thereby delivering worse than market results. In considering Berkshire Hathaway’s relative performance, Buffett notes: “Selecting the S&P 500 as our bogey was an easy choice because our shareholders, at virtually no cost, can match its performance by holding an index fund. Why should they pay us for merely duplicating that result?”
- Successful investment management is as much about what you don’t own as it is about what you own. In this regard, Buffett’s long-time partner, Charlie Munger, quips: “All I want to know is where I’m going to die, so I’ll never go there.”
- Hype is an investment killer. Equally, hype sets the foundation for unhappy clients as expectations become sentiment charged and unrealistic: “We make no attempt to woo Wall Street. Investors who buy and sell based upon media or analyst commentary are not for us. Instead we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur.”
- Despite our industry’s slavish obsession, forecasting is futile. In this regard, Buffett noted colourfully in his 2008 letter to shareholders: “We are certain, for example, that the economy will be in shambles [next year] – and probably well beyond – but that conclusion does not tell us whether the market will rise or fall.” This underscores the point that whilst economic forecasting has a reasonable chance of producing sensible results, trying to forecast market movements tends to be a wasted effort. This is because market direction is sentiment fuelled and herd driven; sentiment and herd behaviour are fickle and vulnerable to what are often trivial events.
- Great businesses involve the contribution of people who love what they do, and consider their work to be a passion and a privilege. Buffett notes: “We both feel lucky to work at a business we love.”
- A true test of a person’s conviction is whether they are willing to eat their own cooking. Buffett notes with regard to Berkshire Hathaway’s investment in the aviation business, NetJets: “... we eat our own cooking ... no other testimonial means more.”
- On the subject of leadership, Buffett is unequivocal: “Charlie and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books, with the exception of operations-related contracts at a few of our subsidiaries ... If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.” This stance differs sharply from the common business practice of “the buck stops there”.
- Finally, great businesses can feed great businesses. This makes a rare example of the business school principle of “synergy”. Thus, Buffett signs off his letter imploring the shareholders to come to the annual meeting in Omaha by rail: “P.S. Come by rail”, he writes. Two years ago Berkshire Hathaway made a substantial investment in the rail industry by buying Burlington Northern Sante Fe.
Drawn together, these points underscore many of the attributes of successful businesses as well as successful asset management. More specifically, they highlight attributes that investors will only find at great investment firms who know that size is the enemy of investment performance; the only way to beat the market is to be different from it (although this is not always easy) – herding may be fashionable but it is lethal to long-run success; and when risk management goes out the door, investment returns go out the window.
