Tuesday, February 21, 2012

Walter Schloss, "Superinvestor" Praised by Buffett, Dies at 95

Walter Schloss, one of the original disciples of Benjamin Graham, died over the weekend at the age of 95.

Warren Buffett, in a know well-known 1984 speech at Columbia Business School, described Schloss as one of the "superinvestors".

From 1955 to 2002, Schloss earned 16% per year after fees.

The S&P 500 returned 10% over the same period of time.

That kind of outperformance over 47 years turns $ 10 thousand into $ 10 million.

From this Omaho World-Herald article published today:

"Walter Schloss was a very close friend for 61 years," Buffett said Monday from his office in Omaha. "He had an extraordinary investment record, but even more important, he set an example for integrity in investment management. Walter never made a dime off of his investors unless they themselves made significant money. 

He charged no fixed fee at all and merely shared in their profits. His fiduciary sense was every bit the equal of his investment skills."

In this article, based upon the aforementioned 1984 speech, The Superinvestors of Graham-and-Doddsville, Buffett said the following about Walter Schloss:

Walter has diversified enormously, owning well over 100 stocks currently. He knows how to identify securities that sell at considerably less than their value to a private owner. And that's all he does...He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over and over again. He owns many more stocks than I do -- and is far less interested in the underlying nature of the business; I don't seem to have very much influence on Walter. That's one of his strengths; no one has much influence on him.

More recently, in 2006 Berkshire Hathaway Shareholder Letter, Warren Buffett also added this about Schloss:

Walter managed a remarkably successful investment partnership, from which he took not a dime unless his investors made money. My admiration for Walter, it should be noted, is not based on hindsight. A full fifty years ago, Walter was my sole recommendation to a St. Louis family who wanted an honest and able investment manager.

Walter did not go to business school, or for that matter, college. His office contained one file cabinet in 1956; the number mushroomed to four by 2002.

Buffett later continued with the following...

Following a strategy that involved no real risk – defined as permanent loss of capital – Walter produced results over his 47 partnership years that dramatically surpassed those of the S&P 500...There is simply no possibility that what Walter achieved over 47 years was due to chance.

I first publicly discussed Walter's remarkable record in 1984. At that time "efficient market theory" (EMT) was the centerpiece of investment instruction at most major business schools. This theory, as then most commonly taught, held that the price of any stock at any moment is not demonstrably mispriced, which means that no investor can be expected to overperform the stock market averages using only publicly-available information (though some will do so by luck). When I talked about Walter 23 years ago, his record forcefully contradicted this dogma.

And what did members of the academic community do when they were exposed to this new and important evidence? Unfortunately, they reacted in all-too-human fashion: Rather than opening their minds, they closed their eyes. To my knowledge no business school teaching EMT made any attempt to study Walter's performance and what it meant for the school's cherished theory.

Instead, the faculties of the schools went merrily on their way presenting EMT as having the certainty of scripture. Typically, a finance instructor who had the nerve to question EMT had about as much chance of major promotion as Galileo had of being named Pope.

Tens of thousands of students were therefore sent out into life believing that on every day the price of every stock was "right" (or, more accurately, not demonstrably wrong) and that attempts to evaluate businesses – that is, stocks – were useless. Walter meanwhile went on overperforming, his job made easier by the misguided instructions that had been given to those young minds. After all, if you are in the shipping business, it's helpful to have all of your potential competitors be taught that the earth is flat.

Maybe it was a good thing for his investors that Walter didn't go to college.

There are now quite a few examples of investors, each applying variations of Graham and Dodd, with excellent long-term performance.

What they have in common is not just superior long-term returns. It's also about how risk is defined and measured.

To them, risk cannot be measured by beta.

Risk is measured, rather imprecisely I might add, by the likelihood of a permanent loss of capital. It's about two variables, price versus value, and correctly judging what's an appropriate margin of safety for a specific investment.

The imprecision, when combined with one's own unique limits, means necessarily that no margin of safety (discount to conservatively calculated value) for some investment opportunities will be large enough.

"The essence of portfolio management is the management of risks, not the management of returns." - Benjamin Graham

So invest within your limits, be wary of false precision (roughly right is better than precisely wrong), and buy when a plain discount to intrinsic value exists. Sounds easy, right?

Spectacular returns can't be looked at in a vacuum though they'll generally get the headlines (try to write a good headline on the exceptional management of risk). I'll take the portfolio manager who routinely employs a substantial margin of safety and outperforms over another who tends to push the limits and outperforms.

A long track record of outperformance is at least an indication that the manager can handle all kinds of investing environments.

Of course, it's not possible to find many with a track record as long as Walter Schloss.

I just tend to be skeptical of headline grabbing returns in any given year (or actually even much longer for that matter. Better to judge returns in the context of risk (permanent capital loss) and length of track record.

The best managers know that returns will follow if permanent capital loss is avoided. Unfortunately, the inferior management of risk often only becomes obvious after the next unforeseen crisis.

Adam

Related posts:
Graham-and-Doddsville
Superinvestors: Gallileo vs The Flat Earth
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