The Investor's Consigliere

Charlie Munger Slate Essay

Charles Munger of Berkshire Hathway writes a sobering parable.  This may be the main disagreement between him and Warren Buffett.

Disclosure: Long Berkshire Hathaway.

Time Horizon Matters: New York's Real Estate Families

I liked this article. 

Burlington Northern (BNSF) / Buffett Interview Transcript

Matthew Rose, CEO of Burlington Northern Santa Fe Corporation, which is about to be bought by Berkshire Hathaway, conducted an in-house interview with Warren Buffett about the pending acquisition.  BNSF filed the transcript of the interview as a 425.  This excerpt in particular planted a little seed in my head:

MKR:  Okay, next question.  In 10 years, how will you evaluate the acquisition of BNSF, whether or not it's been successful?

WB:  Well, I -- I'll measure it against my own standard, which is that I have made a bet on the country doing well.  And if I'm wrong on that, that's my fault and not anybody at BNSF's fault.  But i will look at how it does compared to other railroads.  I'll look at how railroads are doing versus trucking and all of that.  But in the end, I don't really worry about that very much.  I, I've seen what's been done here.  I think I know how the country is going to develop.  I think the west is going to do well.  I'd rather be in the west than in the east.  So I really don't have much of a worry about that.

That last little part caught my attention as I stared out my window towards the east side of Manhattan.  Why does he think the west will do better than the east?  It's a multi-decade grand thematic kind of question, not the business-specific kind Buffett usually addresses.  And I'm not sure how easy it is to predict these kinds of things.  I doubt many in 1979 were predicting that New York, then near-bankrupt, would soon re-emerge as the capital of the universe.  On the other hand, as early as the late 1960s political scientists were forecasting a population shift towards the Sun Belt, and that turned out to be true.  Maybe Buffett's prediction is a continuation of that prediction.  Maybe it's a prediction about the continued rise of China, or it has something to do with being long commodities.  I don't know.

I come from a people who like to wander.  Sometimes we've chosen to wander and sometimes others have chosen for us, if you know what I mean.  I was born in a different country (Australia) than my sister (South Africa), and we were both born in different countries than our parents (Israel and France), who were themselves born in different countries than their own parents (Lithuania, Translyvania, South Africa and South Africa again).  But we arrived in the Unites States when I was about three and except for thousands of trips across the Hudson River and back, we've more or less stayed put ever since.  Until recently it never occurred to me to live anywhere else.

But if you come from a family like mine, and you're interested in how to preserve and grow wealth over long periods of time, then you know that neither money nor people can count on staying put forever. 

Disclosure: Long Berkshire Hathaway

The Mythical Mittelstand and American Family Offices

The FT reports on how the Mittelstand, the hard-to-define group of small to medium-sized businesses that all English-speaking media are required to describe as the "backbone" of the German economy, is coping with the economic downturn.  Here is the money quote for me:

Many family-owned companies say they can ride out the economic storm thanks to conservative management in the boom years. Mr Klingelnberg says his company has almost no debt, a €50m credit line with its banks, and €20m in cash.

As a result, the engineering company wants to make use of lowly asset valuations to buy rivals and broaden its product pipeline, a counter-cyclical investment pattern typical of many a German family company - and one that highly indebted, private equity owned groups can now only dream of.

The financial conservatism of the Mittelstand is legendary.  That doesn't mean it's true, but if it is I wonder why.  Some hypotheses, starting with my least favorite:

1)  Financial conservatism is inherent in the German character.  I discount this--much of the underwater real estate in Miami Beach is owned by Germans.  Plus it's always a mistake to attribute too much to "national character."  Ten years ago Iceland had one national character, one year ago it had another, and today it has still another.

2)  The Mittelstand doesn't need high debt because it can earn returns on capital comparable to companies outside Germany without it.  I also discount this, unless there is some magic to being a car-parts supplier in Germany that automatically makes it a great business.

3)  Some regulatory or tax difference that I don't know about.

4)  Survivorship bias plus lessons learned.  German business had a pretty rough 20th century: two World Wars, hyperinflation, the partition of the country.  Those that survived tended to be financially conservative, and learned to think in terms of being able to survive calamity. 

5)  The tendency of Mittelstand companies to be family-owned, often in their second or third generation, creates a tendency to think long-term and to avoid catastrophe risk.  Conversely, ownership by outside shareholders creates a tendency to think shorter term.  The longer your time horizon, the more you have to think about catastrophe risk because its cumulative probability gets surprisingly high.  If you finance your company such that it only has a 1% of going bankrupt in any one year, the likeihood you make it five years without going bust is 95.1%.  Most hedge fund managers would take those odds over that time horizon.  But if you have to make it 50 years, your likelihood of doing so with the same financing structure falls to less than 40%.

To the extent these last two hypotheses are valid, there are two lessons for investors, especially American family offices.  The first is that nations rise and fall.  The second is that you must take care that the money managers with whom you invest have the same time horizon and approach to catastrophe risk as you do. 

Family Foresight Hall of Fame: The Wallenberg Family

Amazingly, per this Economist article the Wallenberg family is in its fifth generation and remains on top of Sweden Inc.--and in a socialist country no less.  Investor AB, the Wallenberg's investment holding company, is in its way one of the most successful family offices, with actively managed interests in listed companies, private equity, and hedge funds. 

And if you'll permit me to get personal, the family gets much extra credit for producing this man.

By the way, although the Swedish stock market is down 58.1% in dollar terms since Dec 31, 2007, it is the unlikely holder of the highest real return record of all the major stock markets in the 1900-2000 period, at 8.2% annualized.

Book Review: "The Decline and Fall of the British Aristocracy"

I continue to brood over the great difficulty of growing wealth over decades, especially for families that have moved from being in business to being portfolio investors in charge of an "endowment."  The task of any endowment, which must not only provide current liquid income for the present generation but must also be invested for the future, is forbidding.  And I confess that, notwithstanding yesterday's great events, I also continue to brood over the near-inevitable decline of the United States as the world's top power, and what that means for those who hold most of their wealth here.

David Cannadine's "The Decline and Fall of the British Aristocracy" is an epic study of the political, social, and economic decline of what, as late as the 1870s, was still the richest group in the richest empire in the world.  Your consigliere, as is his weakness, cared mostly about the money stuff.  Specifically, I asked myself the following questions:  How could people who were so rich and powerful lose so much of both in such a short period?  Were there any exceptions to the rule of general decline, survivors and even thrivers worthy of study?  And, most broodingly, are there any lessons for today's financial "aristocrats," who form the wealthy elite of today's wealthiest world power?  Some impressions:

• It's remarkable just how much the wealth of the British aristocracy, and the power and prestige that followed from it, rested on just a few foundations which, once shaken, brought the whole thing down.  The main foundation of the class was wealth in the form of land, and the main foundation of land as a form of wealth was the profitability of agriculture.  Shielded from foreign competition and favorably taxed, British agriculture was very profitable from the 1840s all the way to the 1870s (about as long, I would point out, as Wall Street's long expansion, which most date from 1982).  Landowners of the time could have been forgiven for supposing such a state would continue indefinitely, and many (and their willing lenders) conducted their affairs as if it would.  Most landed estates were mortgaged or otherwise encumbered by leverage.

• Of course, the good times did not last.  An agricultural downturn began in the 1880s and did not abate for another 70 years.  Estates that could once support their mortgages (and their owners' lifestyles) fell into ruin.  The P/E ratio of land purchases collapsed and financing dried up.  Sound familiar?

• At the margin, taxes made a big difference.  Accompanying the agricultural depression in Britain were a range of new taxes on the landed aristocracy, both on income and on capital.  I'm forced to wonder how much of today's American finance aristocracy, particularly professional money management in the L.P. form (hedge funds, PE Funds, VC Funds) was helped along by favorable tax laws, and how much of that would go away if the laws were changed.

• Yes there were survivors, and even some aristocrats who managed to thrive in the new order.  Amazingly to me, in the 2008 Sunday Times Rich List you can still find a few names that once appeared on Cannadine's list of the greatest British landowners circa 1880.  And I don't think they were all simply lucky (although it helps to have started with a lot of money), so it is useful to study them.  As usual, capital allocation (really re-allocation) was key*.  As early as 1879 one lord advised his brethren to sell part of their landholdings, pay off their debt, and invest whatever proceeds remained in equities, often foreign equities.  Many did and ended up better off.  Others shifted horizontally into industries in which they already had some expertise, such as agribusiness or land development or, in the case of those who best combined good luck and skill, London real estate development (see here and here, and note that the estate of the Duke of Westminster was, during the crucial period of general aristocratic decline, unencumbered by leverage, which no doubt gave him room to maneuver).  Others could not or would not adapt.  I suspect that many held onto their land not because they truly believed "things will come back soon," but because of the tradition and prestige associated with that particular asset.  They learned a lesson that today's contemporary art collectors may be about to: when the profitability of an asset departs, its prestige departs soon afterwards.

It would be wrong to take this book as a perfect guide of things to come for the American wealthy.  But a poverty of imagination--the inability to conceive of a future different from the present--is so inherent in the human mind that it can only be overcome through conscious effort.  This particular disease seems to strike wealthy investors most strongly, those to whom good times have been the most good.  For me therefore, the study of history is a form of mental calisthenics, a way of exercising the "times will surely change and I will have to change along with them" muscle that would otherwise decay into uselessness.

* Now that I think about it, the best modern parallel to the decline of the British aristocracy may be the decline of the great 20th century media dynasties.  Like their spiritual ancestors, the current generation of media owners inherited assets (chiefly monopoly newspapers) that conferred on them both great profits and great prestige.  But the world changed around them, and what used to be widely considered the most solid form of wealth was no longer so.  Some saw it coming and managed to reallocate capital to other things (the Grahams, the Thomsons, the Murdochs) while others could not or would not for reasons of prestige, or were too busy living well to notice.

Family Foresight Hall of Fame: the Fuggerei

Yves Smith offers insights on a WSJ article about the Fuggerei, a German housing settlement funded by a trust that has managed to sustain itself for nearly 500 years.  Here is the excerpt addressing its investment strategy:

The charitable trust, however, has been careful in its investments. Most revenue for the upkeep of the Fuggerei comes from old forestry holdings, which became a staple investment for the Fuggers in the late 17th century after they got burned on higher-yielding but riskier financing ventures.

Over the past 200 years, the trust's annual returns after inflation have ranged from 2% in a good year to 0.5% in a bad year, estimates Wolf-Dietrich Graf von Hundt, the administrator. The trust also has a few local real-estate holdings but no exposure to U.S. subprime mortgages, Icelandic savings accounts or New York investment funds that have undone other charities.

Renovations are slow. Some apartments still don't have central heating or showers. But there was enough money to repair the Fuggerei after marauding Swedish troops and their horses took up temporary residence in the 17th century, and after Allied bombing raids damaged most of the buildings in World War II.

The lesson isn't lost on Alexander Fugger-Babenhausen, a descendant of Jakob the Rich. He expects soon to replace his father -- Prince Hubertus Fugger-Babenhausen -- on the Fuggerei trust's board. The 27-year-old Harvard graduate recently returned to Augsburg after stints in London with Morgan Stanley and private-equity firm TPG. He says he lost a small bundle on Washington Mutual shares along the way.

The recent financial meltdown has been "a good reality check," says the younger Mr. Fugger-Babenhausen, over buttered pretzels at his family's hilltop castle, itself burned and pillaged over the centuries. "I'm not thinking I can reinvent the wheel."

Forbes Billionaire Blowups of 2008

Leverage is a pattern.

Family Foresight Hall of Fame: Ambassador Joseph P. Kennedy

Leaving politics aside, it is most impressive that a man born in 1888 without a fortune, none of whose nine children ever pursued lucrative careers, nonetheless has a granddaughter who, despite never having earned a significant income herself, has the means to pursue one of the most expensive positions in public service.

Capital Allocation is King--Newspapers Edition

"Someone's sitting in the shade today because someone planted a tree a long time ago." 

-Warren Buffett

In 1975 David Halberstam published The Powers that Be, his study of the great American media dynasties.  It depicted the Washington Post Company as a kind of plucky little brother to its northern neighbor, the New York Times Company:

"The New York Times.  There was, Bradlee [Ben Bradlee was managing editor of the Post] often thought, the Times and then there was everyone else.  Only the Times had the money, the resources, the prestige, the tradition to do great things, an institution that seemed the very equal of any government institution, a power unto itself.  The Times was the Times, and the others weres simply newspapers.  Only the Times had the money and the power and the prestige to stand up to the government, to hire the lawyers, to stand equal to the Solicitor General of the United States, to fight if necessary not just City Hall but 1600 Pennslylvannia Avenue."

Today the Times is still considered the paper of record, and dwarfs the Post in terms of daily circulation (1,038,000 to 635,000).  Both have suffered greatly from the decline of the newspaper business.  Look closer at the financials of their parent coompanies, however, and a different picture emerges:

• The New York Times Company has a market capitalization of $1.08 billion.  The family that controls it, the Ochs-Sulzbergers, owns about 19% of the equity, about $206 million.

• The Washington Post Company has a market capitalization of $3.7 billion.  The controlling Graham family's interest amount to at least $1.8 billion.

How could the Grahams have caught up to and overtaken the Sulzbergers when the latter's flagship product continues to be larger, and both flagships are suffering?  The answer, in the main, is superior capital allocation over a period of decades.

The following two articles tell the story:

FT article about the Washington Post Company

New York Magazine article about the New York Times Company

Of the two companies, guess which had Buffett on the board of directors?

May 11 2009 Update: a New York Post article about the Sulzberger's finances.