The Investor's Consigliere

Dan Duncan Obituary

In the Houston Chronicle. One of the country's greatest businessmen, he was almost unknown here in New York.

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

Southwestern Energy: Value Investing in Real Life

One of my ongoing interests is how great value investors can be found allocating capital within companies, not just in companies' securities.  In other words, you don't have to be a money manager per se to be a value investor and many of the best value investors work in "real" companies.  If you are in the business of scouting for and identifying great value investors, you widen your universe greatly by looking at these real companies in addition to hedge funds, mutual funds, etc.

One case in point: Southwestern Energy and its leader Howard Korell, recently profiled in the FT.  Once upon a time, oil and gas exploration companies were nearly equivalent to what hedge funds are today:  a man got together a group of investors in a limited partnership, the LPs were charged an incentive fee, and the man took the investors' money and invested it in a portfolio of oil wells he thought would yield profits.  Substitute the word "securities" for "oil wells" and you have a hedge fund.

Today most oil and gas exploration is housed in corporate form, and the incentive fee compensation comes in the form of stock options and bonuses, but the idea is the same: passive equity partners (shareholders) entrust their capital to managers who use it to invest in a portfolio of exploration projects.  And wherever you have investing, you can find value investing.

The FT article indicates that Southwestern under Korell excelled at two of the basic tenets value investors hold dear:

1)  The Charlie Munger idea of virtuous (from the Latin word for "manly," a word Munger may be the last on earth to say without irony) investing being about waiting and waiting, no matter what criticism you have to endure, for a situation in which the odds greatly favor you, and then betting big once you find one, again no matter what criticism you have to endure.  That's how Munger ran his partnership, and while this approach produced great volatility and some grief, he endured it stoically.  Southwestern made a huge and lonely bet over two long years, buying up drilling rights in the Fayetteville shale.

2)  Buy things cheap.  Oil and gas leases don't trade publicly, but they do trade frequently and with pretty good liquidity.  Like stocks, they represent claims on future cash flows which are uncertain.  And like stocks, they can be overpriced or underpriced.  A good lease at a too-high price is a bad investment, no matter how much oil or gas everyone knows it produces.  Southwestern Energy under Korell pursued only those leases that promised the best returns for the price paid. 

The result was an annual return for Southwestern shareholders of 4,374% in the past decade.  If that were a hedge fund, it would be the subject of many a Manhattan cocktail party.  But since it's an oil and gas outfit in Houston, most people in finance have probably never heard of it.  Fortunately for Southwestern's long-term shareholders, the money spends exactly the same no matter what you call it.

Disclosure: No position.

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?