The Investor's Consigliere

Warren Buffett New York Times Op-Ed

The last one urged people to "buy American" stocks.  This one is a warning about the side effects to be expected from the extraordinary fiscal and monetary measures that have been taken to turn around the economy.

A little background:  Buffett's father Howard was kind of a psychopath about inflation--he thought FDR would turn the US into the Weimar Republic.  His son was never as bad, but throughout his career the specter of inflation has always guided his investment decisions.  In 1977 he wrote an essay for Fortune called "How Inflation Swindles the Equity Investor" which is the best analysis of the effect of inflation on corporations I've ever read.

Buffett almost guarantees that one day the United States will face higher inflation as a result of the actions being taken.  Yet here we sit with the 10-Year Treasury yielding 3.53%.

P.S.  Some might argue that this op-ed conflicts with the last op-ed he wrote, in which he urged Americans to buy equities.  If we're in for inflation, stocks will do poorly, like they did in the 1970s.  But read the first op-ed closely and you'll see that Buffett recommended only that Americans buy equities as an alternative to cash, which is perfectly consistent with his thinking in the second op-ed.  In fact, if you fear inflation your money may be best off in equities (public or private, in the sense of being a business owner), even more so than gold.

Disclosure: Long Berkshire Hathaway

P.P.S.  If you're a member of SumZero, you can see my write-up of a stock I think will do well in an inflationary environment.

James Boswell Obituary

Continuing on my theme of getting investing "back to business":  In my opinion, young value investors like me spend too much time studying investors and and investing and not enough time studying businessmen and businesses. 

Here is a businessman and a business worth studying: James G. Boswell II, a California cotton baron who recently died.  Here is his obituary in the New York Times, and here is a book about him.  I can't think of a more terrible business than "American cotton farming" and yet Boswell made a great success of it.  If he'd housed it all in a limited partnership with outside investors, charged 2 and 20 and called it "Boswell Capital Management," it might have been one of the most successful hedge funds ever.

Update: Another obituary from the LA Times.

Berkshire Hathaway Letter to Shareholders

is here!  Raise your hand if you sat there clicking "reload current page" until the 2008 letter showed up. I'll have a longer commentary later, but here are some initial thoughts:

1)  Your consigliere is on record saying that value investors who venture into macroeconomics do so at their peril.  I was afraid, I'll confess, that Buffett would do just that in his letter.  But he didn't.

2)  Buffett is well-known for preaching against diversification, but states that one of goals is for Berkshire to maintain "dozens of sources of earnings and cash" and that another is to find "new and VARIED streams of earnings."  In fact, Berkshire is probably the most diversified company in the world.

3)  Kremlinology alert--I'm about to read too much into Buffett's wording:  On page 4 Buffett very precisely writes that the three large PIPE deals he made were "In our insurance portfolios."  Meaning they were funded in large part by cheap/free float.  So a 10% coupon on one of these deals is less than the return on equity to a Berkshire shareholder from doing the deal. 

4)  Berkshire's large equity put portfolio can be understood as partly a bet on future inflation, as they were written on indices that reflect nominal currency values.  There is a chart on page 206 of Barton Bigg's Wealth, War and Wisdom that I'm too stupid to know how to reproduce.   It shows that from 1932 through mid-1957, a period that included both the Great Depression and World War II, the Italian stock market enjoyed near-uninterrupted growth.  But it's a nominal index--in real terms the market fell.  But if you'd written a long-term put on that index on similar terms as the ones Buffett made, you would not have had to pay anything.  Of course Buffett must also navigate inflation when trying to invest the premium he's received on those puts.

5)  Berkshire Hathaway the stock declined 32% in 2008.  Berkshire Hathaway the company declined only 9.6%, as measured by book value.  Keep in mind that the company is now largely in the business at "borrowing" money from policyholder at very low/free/negative rates in order to invest in regulated utilities.  Those two parts of the business did very well.

More later. 

Billionaire Liu Family of China

Nice NYT article about the Liu family, one of China's richest.

I've created a new category for this post, called "Investor-Owner-Operators."  Great investors exist along a continuum, call it the "investor/businessman" continuum.  At one end are completely passive investors, who are not really businessmen at all.  Most hedge fund managers fall into this category.  One small step over are so-called activist investors, who try to have some managerial influence over their investments.  Then come private equity and venture capital funds, who not only allocate capital to businesses but take an active role in their management via board seats and selecting the operating executives.  All the way at the other end of the spectrum are the pure businessmen whom nobody really thinks of as investors at all but in fact are, because capital allocation is part of their job.  I've written before that Sam Walton was one of the greatest investors of all time, even though no one calls him that.  The point of thinking about it in terms of a continuum is not to say one way is better than another.  It's simply to recognize that great investment records--sustained success in allocating and reallocating capital at high returns--are found in various places, and the student of investing unnecessarily limits his universe by defining the term "investor" too narrowly.  It's also to underscore the importance of "looking through" in investing.  Too often institutional investors forget just how many layers of capital allocation exist (each taking their cut out of the ultimate return) in one investment.  An endowment that invests in a hedge fund of funds is really allocating capital to someone (the FoF manager) who in turn is allocating capital to someone (the underlying hedge fund manager) who in turn is allocating capital to someone (company management) who in turn is allocating capital.  That's why even the most institutional of institutional investors, in order to succeed, must know something about evaluating businesses.

I place the Liu family into a category in the middle of the continuum, which I call the "investor-owner-operator."  I think of this category as the ideal, the perfect melding of all the various functions of a capitalist.  Buffett goes in this category, as does Phil Ruffin, whom I recently wrote about.  If I were an institutional investor who, like Yale's endowment, allocated capital to external money managers, I would consider investor-owner-operators to be almost a separate asset class.  Why pay 2 and 20 to a hedge fund manager to allocate your capital for you when someone like Warren Buffett or Leucadia or Li Ka-shing does exactly the same thing for much less, and often does it much better?