Warren Buffett has the reputation of "the world's greatest investor" and his pronouncements have Delphic qualities that are analysed at great length. Investors in his company, Berkshire Hathaway, have in many cases become millionaires. His approach to managing money is often argued to carry profound insights for the small investor.
Last weekend's annual meeting of Berkshire Hathaway investors has deservedly attracted even more attention than usual: the increase in the per-share book value of Berkshire in 2003 was only slightly shy of its long term average of 22.2 per cent, compounded since 1965. Over the same period US equities, measured by the S&P, have had an annual total compound return of 10.4 per cent. What is his secret?
Buffett has a reputation for being unfailingly polite, which is a touch surprising when we read some of his comments about the professional investment management industry and matters of corporate governance. He generally eschews "macro forecasting", observing that the "cemetery for seers has a huge section set aside for macro forecasters".
Like that other great American investor, Peter Lynch, Buffett has little time for economists. Most recently, the "Sage of Omaha" has described his distaste for derivatives and has slated hedge funds as a mere "fad". So much for polite discourse.
Buffett's attitudes towards the fund management industry are best illustrated by an anecdote he recounted some time ago. When asked about the successes of other money managers he suggested that the questioner imagine a game that involved giving the entire US population a coin which they have to toss and call heads or tails.
The law of averages being what it is, around 150 million people would get it right. Then they are asked to toss again: roughly 75 million would call correctly. And so on until you are left with a band of successful tossers of, say, less than 100 who had guessed right on multiple occasions.
At this point our lucky tossers would start appearing on chat shows and their faces would grace the front of magazine covers. They would be asked the secret of their success, whether they tossed in the morning or afternoon, whether they tossed with their right or left hand. But their apparent success would, of course, be down to pure statistical chance: some people are destined to get lucky.
This apparently, is how Buffett views many of the other successful money managers in the US who also have developed long track records. Of course, whether or not Buffett himself falls into this category is a question left hanging in the air.
Buffett's approach to investing can be described very simply: "search out bargain stocks or whole companies and hold them forever". He is a value investor steeped in the traditions of Graham and Dodd, two money managers from half a century ago who wrote the bible on this style of investing. Berkshire's track record speaks for itself and it is a brave critic who suggests that Buffett is anything other than a superb, perhaps the best ever, manager of other people's money.
Buffett's advice right now to the personal equity investor is, essentially, either to buy shares in Berkshire (but he is always careful to promise less stellar returns going forward) or to invest in an index fund. For anyone following the first piece of advice it is instructive to look at what they end up owning.
Berkshire owns a lot of insurance businesses outright. Generally, these have provided fabulous returns, although not without one or two large bumps along the way. Another typical holding is seen with the recent outright purchase of a Wal-Mart subsidiary called McLane. This company distributes groceries and non-food items to convenience stores, drug stores, fast food restaurants and others. It operates with wafer-thin margins (roughly 1 per cent) and has sales of around $23 billion. As Buffett says of the company, "it's made to order [for Berkshire\]".
A simple, transparent and unexciting business with a superb management team that generates loads of cash: that, in a nutshell, is the Buffett ethos.
Berkshire has large (defined as greater than $500 million) holdings in 10 companies. The list is a familiar one and contains little that can be described as exotic, with the possible exception of a chunk of PetroChina. Buffett obviously believes in part of the China story.
His "buy and hold" strategy is seen by the fact that his holding in Coca-Cola hasn't been touched in a decade, American Express has been held since 1998, Gillette since 1989; Moody's is the relative newcomer, entering the portfolio in 2000. The 18.1 per cent holding of the Washington Post is 31 years old.
Buffett's criticisms of derivatives have been misreported. He can hardly be anti-derivative since the insurance business is both an extensive user of such instruments and, in essence, is a derivative business.
Rather, Buffett believes that the way derivative exposures are reported by all sorts of companies is hopeless. Even someone as well-versed in derivatives as Buffett (and he is an expert) knows that financial statements of companies that make extensive use of exotic financial instruments are always dreadfully opaque.
The negative comments about hedge funds are most interesting and also need qualifying. Buffett clearly believes that the hedge fund industry is flaky, but that has not prevented him from putting $604 million in an outfit called Value Capital, a firm that specialises in highly hedged fixed income opportunities. Looks like a hedge fund to me.
With only one negative year out of the last 39 and the style of investing that he adopts, Buffett himself might be described as the ultimate hedge fund manager.
Warren Buffett is undoubtedly very good at what he does. But he does have one key success factor not granted to any other fund manager: his investors give him time. That, more than anything else, is the underlying driver of his results and it is the number one lesson for any investor, big or small. Value investing has been shown many times to be the only long-term winning strategy for stock markets: but only if you give it enough time to work.
