Some things Charlie Munger had to say at the Daily Journal (DJCO) meeting earlier this year:
Now...we've done better than average. And now there's a question, why has that happened? Why has that happened? And the answer is pretty simple. We tried to do less. We never had the illusion we could just hire a bunch of bright young people and they would know more than anybody about canned soup and aerospace and utilities and so on and so on and so on. We never had that dream. We never thought we could get really useful information on all subjects like Jim Cramer pretends to have. (laughter) We always realized that if we worked very hard we can find a few things where we were right. And that a few things were enough.
and
...take the modern world where people are trying to teach you how to come in and trade actively in stocks. Well I regard that as roughly equivalent to trying to induce a bunch of young people to start off on heroin. It is really stupid...And then there are people on the TV, another wonderful place, and they say, "I have this book that will teach you how to make 300 percent a year. All you have to do is pay for shipping and I will mail it to you!" (laughter) How likely is it that a person who suddenly found a way to make 300 percent a year would be trying to sell books on the internet to you! (laughter) It's ridiculous.
Yet, somehow, apparently enough individuals will continue to behave as if they can get an edge by buying into what's being promoted -- whether in the form of a book, website, tv show or otherwise. If so, they're taking the promoter(s) advice -- someone who usually benefits one way or another by getting as many folks as possible to pay attention to that advice -- over that of Charlie Munger who's sound opinion is offered with no gain in mind.
And we're talking about Charlie Munger here.
The word wisdom shouldn't be thrown around carelessly though, in his case, it's the first word that comes to mind.
And that wisdom applies far beyond the relatively narrow world of investing.
More than a few capable investors exist in the world but, with Charlie Munger, we're not simply talking about a capable investor.
In other words, the much deserved praise and admiration that's come his way over the years still, to me, understates his broader significance.
Adam
No position in DJCO
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Showing posts with label Munger. Show all posts
Showing posts with label Munger. Show all posts
Tuesday, June 4, 2019
Wednesday, January 9, 2019
Quotes of 2018
Here's a collection of quotes said or written at some point during 2018.
Warren Buffett: When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
"...I would prefer to turn immediately to discussing Berkshire's operations. But...I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire's 'bottom-line' will be useless.
The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse)." - Warren Buffett
Jeff Bezos on High Standards
"High standards are contagious. Bring a new person onto a high standards team, and they'll quickly adapt. The opposite is also true. If low standards prevail, those too will quickly spread...I believe high standards are domain specific, and that you have to learn high standards separately in every arena of interest. When I started Amazon, I had high standards on inventing, on customer care, and (thankfully) on hiring. But I didn't have high standards on operational process: how to keep fixed problems fixed, how to eliminate defects at the root, how to inspect processes, and much more. I had to learn and develop high standards on all of that (my colleagues were my tutors).
Understanding this point is important because it keeps you humble. You can consider yourself a person of high standards in general and still have debilitating blind spots. There can be whole arenas of endeavor where you may not even know that your standards are low or non-existent, and certainly not world class. It's critical to be open to that likelihood." - Jeff Bezos
Berkshire 2018 Meeting Highlights - Part II
"...I have here a New York Times of March 12th, 1942. I'm a little behind on my reading. (Laughter)
And if you go back to that time, that — it was about, what? Just about three months since we got involved in a war which we were losing at that point.
The newspaper headlines were filled with bad news from the Pacific...I'd like you to imagine that at that time you had invested $10,000. And you put that money in an index fund — we didn't have index funds then — but you, in effect, bought the S&P 500...[or]...Let's say you'd taken that $10,000 and you'd listened to the prophets of doom and gloom around you, and you'll get that constantly throughout your life. And instead, you'd used the $10,000 to buy gold...And you could look at it...But it didn't produce anything. It was never going to produce anything...So if you decided to go with a nonproductive asset — gold — instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock — whatever it might be — you would now have over 100 times the value of what you would have had with a nonproductive asset.
In other words, for every dollar you had made in American business, you'd have less than a penny by — of gain — by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort." - Warren Buffett
"...the one thing we know is we think that long-term bonds are a terrible investment, and we — at current rates or anything close to current rates...it's almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you're an individual, then you pay tax on it. You're going to have some income taxes to pay.
And let's say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income...I think I would stick with productive businesses, or productive — certain other productive assets — by far.
But what the bond market does in the next year, you know — you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge. - Warren Buffett
"...it really wasn't fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.
But it clearly wasn't fair. And the conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time...And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people..." - Charlie Munger
Happy New Year,
Adam
Quotes of 2017
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Warren Buffett: When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
"...I would prefer to turn immediately to discussing Berkshire's operations. But...I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire's 'bottom-line' will be useless.
The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse)." - Warren Buffett
Jeff Bezos on High Standards
"High standards are contagious. Bring a new person onto a high standards team, and they'll quickly adapt. The opposite is also true. If low standards prevail, those too will quickly spread...I believe high standards are domain specific, and that you have to learn high standards separately in every arena of interest. When I started Amazon, I had high standards on inventing, on customer care, and (thankfully) on hiring. But I didn't have high standards on operational process: how to keep fixed problems fixed, how to eliminate defects at the root, how to inspect processes, and much more. I had to learn and develop high standards on all of that (my colleagues were my tutors).
Understanding this point is important because it keeps you humble. You can consider yourself a person of high standards in general and still have debilitating blind spots. There can be whole arenas of endeavor where you may not even know that your standards are low or non-existent, and certainly not world class. It's critical to be open to that likelihood." - Jeff Bezos
Berkshire 2018 Meeting Highlights - Part II
"...I have here a New York Times of March 12th, 1942. I'm a little behind on my reading. (Laughter)
And if you go back to that time, that — it was about, what? Just about three months since we got involved in a war which we were losing at that point.
The newspaper headlines were filled with bad news from the Pacific...I'd like you to imagine that at that time you had invested $10,000. And you put that money in an index fund — we didn't have index funds then — but you, in effect, bought the S&P 500...[or]...Let's say you'd taken that $10,000 and you'd listened to the prophets of doom and gloom around you, and you'll get that constantly throughout your life. And instead, you'd used the $10,000 to buy gold...And you could look at it...But it didn't produce anything. It was never going to produce anything...So if you decided to go with a nonproductive asset — gold — instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock — whatever it might be — you would now have over 100 times the value of what you would have had with a nonproductive asset.
In other words, for every dollar you had made in American business, you'd have less than a penny by — of gain — by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort." - Warren Buffett
"...the one thing we know is we think that long-term bonds are a terrible investment, and we — at current rates or anything close to current rates...it's almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you're an individual, then you pay tax on it. You're going to have some income taxes to pay.
And let's say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income...I think I would stick with productive businesses, or productive — certain other productive assets — by far.
But what the bond market does in the next year, you know — you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge. - Warren Buffett
"...it really wasn't fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.
But it clearly wasn't fair. And the conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time...And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people..." - Charlie Munger
Adam
Quotes of 2017
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, October 2, 2018
Berkshire 2018 Meeting Highlights - Part II
From the Berkshire Hathaway (BRKa) shareholder meeting earlier this year:
Warren Buffett: "...I have here a New York Times of March 12th, 1942. I'm a little behind on my reading. (Laughter)
And if you go back to that time, that — it was about, what? Just about three months since we got involved in a war which we were losing at that point.
The newspaper headlines were filled with bad news from the Pacific...I'd like you to imagine that at that time you had invested $10,000. And you put that money in an index fund — we didn't have index funds then — but you, in effect, bought the S&P 500...[or]...Let's say you'd taken that $10,000 and you'd listened to the prophets of doom and gloom around you, and you'll get that constantly throughout your life. And instead, you'd used the $10,000 to buy gold.
Now for your $10,000 you would have been able to buy about 300 ounces of gold. And while the businesses were reinvesting in more plants, and new inventions came along, you would go down every year in your — look in your safe deposit box — and you'd have your 300 ounces of gold.
And you could look at it, and you could fondle it, and you could — I mean, whatever you wanted to do with it. (Laughter)
But it didn't produce anything. It was never going to produce anything...So if you decided to go with a nonproductive asset — gold — instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock — whatever it might be — you would now have over 100 times the value of what you would have had with a nonproductive asset.
In other words, for every dollar you had made in American business, you'd have less than a penny by — of gain — by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort."
Later in the meeting, Warren Buffett and Charlie Munger had this to say about long-term bonds relative to productive assets:
Warren Buffett: "...the one thing we know is we think that long-term bonds are a terrible investment, and we — at current rates or anything close to current rates...it's almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you're an individual, then you pay tax on it. You're going to have some income taxes to pay.
And let's say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income...I think I would stick with productive businesses, or productive — certain other productive assets — by far.
But what the bond market does in the next year, you know — you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge.
Charlie?"
Charlie Munger: "Well, it really wasn't fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.
But it clearly wasn't fair. And the conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time.
And it was quite unfair to a lot of people. And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people — (laughter) — and I hope that we continue to be so."
(Laughter)
Some might have a difficult time internalizing the fact that owning a piece of a public company should be viewed as similar to the ownership of productive assets that generally aren't traded publicly (e.g. 100% private ownership of a restaurant, small factory, or farm). The second by second quotations during market hours, at least in part, have a tendency to distract the partial owner from the bigger picture.
It shouldn't but often does.
So they end up buying/selling too much.
What should be advantage -- the ability to conveniently deploy and free up capital -- becomes disadvantage.
Getting beyond this is just one small step -- but an important one.
There are practical differences and considerations, of course. Naturally, owning a very small part of a business means you can't much influence the direction of the company (whether excess capital should be distributed or allocated, new market opportunities, location considerations, competitive threats, technology shifts, etc.). So a quality board and management team will usually matter enormously.
Yet, otherwise, Buffett has on prior occasions made the point that a stock ownership of a publicly-traded company should be thought of the same way as the sole ownership of something like a rental property or a business.
How much cash (compared to understood alternatives) that a productive asset likely produces over the very long haul relative to the cash to be invested -- whether or not publicly traded, whether or not owned outright -- is what ultimately matters.
No such consideration is necessary for the nonproductive asset.
It produces nothing and never will.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett: Berkshire 2018 Meeting Highlights - Part I
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line:& The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Warren Buffett: "...I have here a New York Times of March 12th, 1942. I'm a little behind on my reading. (Laughter)
And if you go back to that time, that — it was about, what? Just about three months since we got involved in a war which we were losing at that point.
The newspaper headlines were filled with bad news from the Pacific...I'd like you to imagine that at that time you had invested $10,000. And you put that money in an index fund — we didn't have index funds then — but you, in effect, bought the S&P 500...[or]...Let's say you'd taken that $10,000 and you'd listened to the prophets of doom and gloom around you, and you'll get that constantly throughout your life. And instead, you'd used the $10,000 to buy gold.
Now for your $10,000 you would have been able to buy about 300 ounces of gold. And while the businesses were reinvesting in more plants, and new inventions came along, you would go down every year in your — look in your safe deposit box — and you'd have your 300 ounces of gold.
And you could look at it, and you could fondle it, and you could — I mean, whatever you wanted to do with it. (Laughter)
But it didn't produce anything. It was never going to produce anything...So if you decided to go with a nonproductive asset — gold — instead of a productive asset, which actually was earning more money and reinvesting and paying dividends and maybe purchasing stock — whatever it might be — you would now have over 100 times the value of what you would have had with a nonproductive asset.
In other words, for every dollar you had made in American business, you'd have less than a penny by — of gain — by buying in this store of value, which people tell you to run to every time you get scared by the headlines or something of the sort."
Later in the meeting, Warren Buffett and Charlie Munger had this to say about long-term bonds relative to productive assets:
Warren Buffett: "...the one thing we know is we think that long-term bonds are a terrible investment, and we — at current rates or anything close to current rates...it's almost ridiculous when you think about it. Because here the Federal Reserve Board is telling you we want 2 percent a year inflation. And the very long bond is not much more than 3 percent. And of course, if you're an individual, then you pay tax on it. You're going to have some income taxes to pay.
And let's say it brings your after-tax return down to 2 1/2 percent. So the Federal Reserve is telling you that they're going to do whatever's in their power to make sure that you don't get more than a half a percent a year of inflation-adjusted income...I think I would stick with productive businesses, or productive — certain other productive assets — by far.
But what the bond market does in the next year, you know — you’ve got trillions of dollars in the hands of people that are trying to guess which maturity would be the best to own and all that sort of thing. And we do not bring anything to that game that would allow us to think that we’ve got an edge.
Charlie?"
Charlie Munger: "Well, it really wasn't fair for our monetary authorities to reduce the savings rates, paid mostly to our old people with savings accounts, as much as they did. But they probably had to do it to fight the Great Recession, appropriately.
But it clearly wasn't fair. And the conditions were weird. In my whole lifetime, it's only happened once that interest rates went down so low and stayed low for a long time.
And it was quite unfair to a lot of people. And it benefited the people in this room enormously because it drove asset prices up, including the price of Berkshire Hathaway stock. So we're all a bunch of undeserving people — (laughter) — and I hope that we continue to be so."
(Laughter)
Some might have a difficult time internalizing the fact that owning a piece of a public company should be viewed as similar to the ownership of productive assets that generally aren't traded publicly (e.g. 100% private ownership of a restaurant, small factory, or farm). The second by second quotations during market hours, at least in part, have a tendency to distract the partial owner from the bigger picture.
It shouldn't but often does.
So they end up buying/selling too much.
What should be advantage -- the ability to conveniently deploy and free up capital -- becomes disadvantage.
Getting beyond this is just one small step -- but an important one.
There are practical differences and considerations, of course. Naturally, owning a very small part of a business means you can't much influence the direction of the company (whether excess capital should be distributed or allocated, new market opportunities, location considerations, competitive threats, technology shifts, etc.). So a quality board and management team will usually matter enormously.
Yet, otherwise, Buffett has on prior occasions made the point that a stock ownership of a publicly-traded company should be thought of the same way as the sole ownership of something like a rental property or a business.
How much cash (compared to understood alternatives) that a productive asset likely produces over the very long haul relative to the cash to be invested -- whether or not publicly traded, whether or not owned outright -- is what ultimately matters.
No such consideration is necessary for the nonproductive asset.
It produces nothing and never will.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett: Berkshire 2018 Meeting Highlights - Part I
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line:& The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, August 7, 2018
Berkshire 2018 Meeting Highlights - Part I
The following question was asked by Jack Ciesielski -- an accounting expert and Berkshire investor -- during Berkshire Hathaway's (BRKa) most recent shareholder meeting:
"Mr. Buffett, in this year's shareholder letter you have harsh words for the new accounting rule that requires companies to use market value accounting for their investment holdings.
'For analytical purposes,' you said, 'Berkshire’s bottom-line will be useless.'
I'd like to argue with you about that. Shouldn't a company’s earnings report cite everything that happened to, and within, a company during an accounting period?"
The response...
Warren Buffett: "Well...we've got $170 billion of partly-owned companies, which we intend to own for decades, and which we expect to become worth more money over time, and where we reflect the market value in our balance sheet, does it make sense to, every quarter, mark those up and down through the income account, when at the same time we own businesses that have become worth far more money...take GEICO...we bought half the company for $50 million, roughly — do we want to be marking that up every quarter to the value — and having it run through the income account?
That becomes an appraisal process. There's nothing wrong with doing that, in terms of evaluation. But in terms of — and you can call it gain in net asset value or loss in net asset value — that's what a closed-end investment fund, or an open-investment fund would do.
But to run that through an income account — if I looked at our 60 or 70 businesses...and every quarter we marked those to market, we would have, obviously, a great many, in certain cases, where over time we’d have them at 10 times what we paid, but how quarter-by-quarter we should mark those up and run it through the income account, where 99 percent of investors probably look at net income as being meaningful, in terms of what has been produced from operations during the year, I think would be — well, I can say it would be enormously deceptive.
I mean, in the first quarter of this year — you saw the figures earlier — where we had the best what I would call operating earnings in our history, and our securities went — were down six billion, or whatever it was, to keep running that through the income account every day you would say that we might have made on Friday, we probably made 2 1/2 billion dollars. Well, if you have investors and commentators and analysts and everybody else working off those net income numbers and trying to project earnings for quarters, and earnings for future years, to the penny, I think you're doing a great disservice by running those through the income account.
I think it's fine to have marketable securities on the balance sheet — the information available as to their market value — but we have businesses there — if we — we never would do it — but if we were to sell half, we’ll say, of the BNSF railroad, we would receive more than we carried — carried for them — we would turn — we could turn it into a marketable security and it would look like we made a ton of money overnight. Or if we were to appraise it, you know, appraise it every three months and write it up and down, A, it could lead to all kinds of manipulation, but B, and it would just lead to the average — to any investor— being totally confused.
I don't want to receive data in that manner and therefore I don't want to send it out in that manner.
Charlie?"
CHARLIE MUNGER: "Well, to me it's obvious that the change in valuation should be noted, and it is and always has been — it goes right into the net worth figures.
So the questioner doesn't understand his own profession. (Laughter and applause)
I’m not supposed to talk that way but it slips out once in a while." (Laughter)
Here's a prior post covering what Buffett had to say in the shareholder letter about the consequences of this new accounting rule.
As a direct result of the rule Berkshire's most recent earnings, as one might expect, produced headlines like:
- Berkshire Hathaway posts surge in profits
- Warren Buffett’s Berkshire Hathaway profit soars in second quarter
These articles do attempt to explain what's behind such a substantial increase in quarterly earnings. Still, the new rule has real potential for misunderstanding.
To invest well one needs to understand accounting and the rules do necessarily change over time.
Yet that doesn't mean changes -- even if well-intended -- should make it more difficult for the investor to draw meaningful conclusions. That doesn't mean those who otherwise are rather familiar with Generally Accepted Accounting Principles (GAAP) should need to keep up with changes that don't seem to add much value or, worse yet, create confusion.
The investing process is already difficult enough without such confusion.
Berkshire's operating earnings did indeed improve but much of it comes down to the new accounting rule -- a rule that's just as certain the produce future headlines like "massive decline in profits" the next time, inevitably, the market (or a specific stock in the portfolio) happens to drop dramatically.
Buffett explained the latest results this way:
"In 2018, due to a change in Generally Accepted Accounting Principles (“GAAP”), we are now required to include the changes in unrealized gains/losses of our equity security investments as a component of investment gains/losses in our earnings statements. In the table above, investment gains/losses in 2018 include a gain of approximately $4.5 billion in the second quarter and a loss of approximately $1.7 billion in the first six months of 2018 due to changes during the second quarter of 2018 and changes during the first six months of 2018 in the unrealized gains/losses of equity security investments held at June 30, 2018. In 2017 and in prior years, while changes in unrealized gains/losses were reflected in our shareholders’ equity, they were not included in our earnings statements. Accordingly, the following statement which has been included in each of Berkshire’s earnings releases for many years along with some additional comments (additional comments underlined) is even more important when analyzing Berkshire’s periodic results. The amount of investment gains/losses in any given quarter is usually meaningless and delivers figures for net earnings per share that can be misleading to investors who have little or no knowledge of accounting rules."
Note that Buffett is clarifying the numbers -- primarily by isolating short-term fluctuations "in unrealized gains/losses of our equity security investments" from the operating earnings -- so investors understand that the headline net earnings, due to the new rule, are far greater than what he considers the more meaningful but much lower Berkshire operating earnings. In other words, if in a future quarter he emphasizes that operating earnings are actually higher than the net earnings number it won't be because -- and unfortunately, this is too often the case -- he's trying to paint a rosier than reality picture.
History more than suggests that such behavior would be, to say the very least, unusual for Berkshire.
The goal here simply seems to be trying to communicate a number that's as meaningful as possible for investors.
Accounting is very useful but has its limits.
"...you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization...But you have to know enough about it to understand its limitations—because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations." - Charlie Munger at USC Business School in 1994
Confusion, at best, seems the most likely outcome that this new rule is going to produce.
Some of the limitations of accounting are inherent.
Others are not.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett: When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line:& The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"Mr. Buffett, in this year's shareholder letter you have harsh words for the new accounting rule that requires companies to use market value accounting for their investment holdings.
'For analytical purposes,' you said, 'Berkshire’s bottom-line will be useless.'
I'd like to argue with you about that. Shouldn't a company’s earnings report cite everything that happened to, and within, a company during an accounting period?"
The response...
Warren Buffett: "Well...we've got $170 billion of partly-owned companies, which we intend to own for decades, and which we expect to become worth more money over time, and where we reflect the market value in our balance sheet, does it make sense to, every quarter, mark those up and down through the income account, when at the same time we own businesses that have become worth far more money...take GEICO...we bought half the company for $50 million, roughly — do we want to be marking that up every quarter to the value — and having it run through the income account?
That becomes an appraisal process. There's nothing wrong with doing that, in terms of evaluation. But in terms of — and you can call it gain in net asset value or loss in net asset value — that's what a closed-end investment fund, or an open-investment fund would do.
But to run that through an income account — if I looked at our 60 or 70 businesses...and every quarter we marked those to market, we would have, obviously, a great many, in certain cases, where over time we’d have them at 10 times what we paid, but how quarter-by-quarter we should mark those up and run it through the income account, where 99 percent of investors probably look at net income as being meaningful, in terms of what has been produced from operations during the year, I think would be — well, I can say it would be enormously deceptive.
I mean, in the first quarter of this year — you saw the figures earlier — where we had the best what I would call operating earnings in our history, and our securities went — were down six billion, or whatever it was, to keep running that through the income account every day you would say that we might have made on Friday, we probably made 2 1/2 billion dollars. Well, if you have investors and commentators and analysts and everybody else working off those net income numbers and trying to project earnings for quarters, and earnings for future years, to the penny, I think you're doing a great disservice by running those through the income account.
I think it's fine to have marketable securities on the balance sheet — the information available as to their market value — but we have businesses there — if we — we never would do it — but if we were to sell half, we’ll say, of the BNSF railroad, we would receive more than we carried — carried for them — we would turn — we could turn it into a marketable security and it would look like we made a ton of money overnight. Or if we were to appraise it, you know, appraise it every three months and write it up and down, A, it could lead to all kinds of manipulation, but B, and it would just lead to the average — to any investor— being totally confused.
I don't want to receive data in that manner and therefore I don't want to send it out in that manner.
Charlie?"
CHARLIE MUNGER: "Well, to me it's obvious that the change in valuation should be noted, and it is and always has been — it goes right into the net worth figures.
So the questioner doesn't understand his own profession. (Laughter and applause)
I’m not supposed to talk that way but it slips out once in a while." (Laughter)
Here's a prior post covering what Buffett had to say in the shareholder letter about the consequences of this new accounting rule.
As a direct result of the rule Berkshire's most recent earnings, as one might expect, produced headlines like:
- Berkshire Hathaway posts surge in profits
- Warren Buffett’s Berkshire Hathaway profit soars in second quarter
These articles do attempt to explain what's behind such a substantial increase in quarterly earnings. Still, the new rule has real potential for misunderstanding.
To invest well one needs to understand accounting and the rules do necessarily change over time.
Yet that doesn't mean changes -- even if well-intended -- should make it more difficult for the investor to draw meaningful conclusions. That doesn't mean those who otherwise are rather familiar with Generally Accepted Accounting Principles (GAAP) should need to keep up with changes that don't seem to add much value or, worse yet, create confusion.
The investing process is already difficult enough without such confusion.
Berkshire's operating earnings did indeed improve but much of it comes down to the new accounting rule -- a rule that's just as certain the produce future headlines like "massive decline in profits" the next time, inevitably, the market (or a specific stock in the portfolio) happens to drop dramatically.
Buffett explained the latest results this way:
"In 2018, due to a change in Generally Accepted Accounting Principles (“GAAP”), we are now required to include the changes in unrealized gains/losses of our equity security investments as a component of investment gains/losses in our earnings statements. In the table above, investment gains/losses in 2018 include a gain of approximately $4.5 billion in the second quarter and a loss of approximately $1.7 billion in the first six months of 2018 due to changes during the second quarter of 2018 and changes during the first six months of 2018 in the unrealized gains/losses of equity security investments held at June 30, 2018. In 2017 and in prior years, while changes in unrealized gains/losses were reflected in our shareholders’ equity, they were not included in our earnings statements. Accordingly, the following statement which has been included in each of Berkshire’s earnings releases for many years along with some additional comments (additional comments underlined) is even more important when analyzing Berkshire’s periodic results. The amount of investment gains/losses in any given quarter is usually meaningless and delivers figures for net earnings per share that can be misleading to investors who have little or no knowledge of accounting rules."
Note that Buffett is clarifying the numbers -- primarily by isolating short-term fluctuations "in unrealized gains/losses of our equity security investments" from the operating earnings -- so investors understand that the headline net earnings, due to the new rule, are far greater than what he considers the more meaningful but much lower Berkshire operating earnings. In other words, if in a future quarter he emphasizes that operating earnings are actually higher than the net earnings number it won't be because -- and unfortunately, this is too often the case -- he's trying to paint a rosier than reality picture.
History more than suggests that such behavior would be, to say the very least, unusual for Berkshire.
The goal here simply seems to be trying to communicate a number that's as meaningful as possible for investors.
Accounting is very useful but has its limits.
"...you have to know accounting. It's the language of practical business life. It was a very useful thing to deliver to civilization...But you have to know enough about it to understand its limitations—because although accounting is the starting place, it's only a crude approximation. And it's not very hard to understand its limitations." - Charlie Munger at USC Business School in 1994
Confusion, at best, seems the most likely outcome that this new rule is going to produce.
Some of the limitations of accounting are inherent.
Others are not.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett: When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line:& The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, April 23, 2018
When a Non-Random Rule & Random Fluctuations "Swamp the Truly Important"
From Warren Buffett's latest Berkshire Hathaway (BRKa) shareholder letter:
"...I would prefer to turn immediately to discussing Berkshire's operations. But...I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire's 'bottom-line' will be useless.
The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse)."
Upon reading this it immediately reminded me of something Charlie Munger once said at a Wesco shareholder meeting:
"Anyone with an engineering frame of mind will look at [accounting standards] and want to throw up in the aisle. And go ahead if you want to. It will be a memorable moment for all of us."
Charlie's been pretty tough on the accounting profession in the past.
Here's a few additional examples.
Adam
Long position in BRKb established at much lower than recently prevailing market prices. No position in KHC.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"...I would prefer to turn immediately to discussing Berkshire's operations. But...I must first tell you about a new accounting rule – a generally accepted accounting principle (GAAP) – that in future quarterly and annual reports will severely distort Berkshire's net income figures and very often mislead commentators and investors.
The new rule says that the net change in unrealized investment gains and losses in stocks we hold must be included in all net income figures we report to you. That requirement will produce some truly wild and capricious swings in our GAAP bottom-line. Berkshire owns $170 billion of marketable stocks (not including our shares of Kraft Heinz), and the value of these holdings can easily swing by $10 billion or more within a quarterly reporting period. Including gyrations of that magnitude in reported net income will swamp the truly important numbers that describe our operating performance. For analytical purposes, Berkshire's 'bottom-line' will be useless.
The new rule compounds the communication problems we have long had in dealing with the realized gains (or losses) that accounting rules compel us to include in our net income. In past quarterly and annual press releases, we have regularly warned you not to pay attention to these realized gains, because they – just like our unrealized gains – fluctuate randomly.
That's largely because we sell securities when that seems the intelligent thing to do, not because we are trying to influence earnings in any way. As a result, we sometimes have reported substantial realized gains for a period when our portfolio, overall, performed poorly (or the converse)."
Upon reading this it immediately reminded me of something Charlie Munger once said at a Wesco shareholder meeting:
"Anyone with an engineering frame of mind will look at [accounting standards] and want to throw up in the aisle. And go ahead if you want to. It will be a memorable moment for all of us."
Charlie's been pretty tough on the accounting profession in the past.
Here's a few additional examples.
Adam
Long position in BRKb established at much lower than recently prevailing market prices. No position in KHC.
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, January 11, 2018
Quotes of 2017
Here's a collection of quotes said or written at some point during 2017.
Innovators, Imitators, & the Swarming Incompetents
"...the great majority of [investment] managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane...said it well: 'In investment management, the progression is from the innovators to the imitators to the swarming incompetents.'
Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods. If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him." - Warren Buffett
Buffett on Bogle
"If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.
In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me." - Warren Buffett
Buffett on American Business
"American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.
Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: 'We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.'
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well." - Warren Buffett
Destroying Bad Ideas - Part II
"...I've done so many dumb things that I'm very busy destroying bad ideas because I keep having them. So it's hard for me to just single out one from such a multitude. But I actually like it when I destroy a bad idea because...I think it's my duty to destroy old ideas. I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better. That is the absolute standard outcome in life. There's an old German folk saying...'We're too soon old and we're too late smart.' That's everybody's problem. And the reason we're too late smart is that the stupid ideas we...already have, we can't get rid of!...in most fields you want to get rid of your old ideas. And it's a good habit, and it gives you a big advantage in the competitive game of life since other people are so very bad at it. What happens is, as you spout ideas out, what you're doing is you're pounding them in. And so you get these ideas and then you start agitating and saying them and so forth. And of course, the person you're really convincing is you who already had the ideas. You're just pounding them in harder and harder. One of the reasons I don't spend much time telling the world what I think about how the federal reserve system should behave and so forth is I know that I'm just pounding the ideas into my own head when I think I'm telling the other people how to run things. So I think you have to have mental habits that -- I don't like it when young people get violently convinced on every damn cause or something. They think they know everything. Some 17 year old who wants to tell the whole world what should be done about abortion or foreign policy...or something. All he's doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you're just starting and have a lot to learn.
So it's very important that habit of getting rid of the dumb ideas. One of things I do is pat myself on the back every time I get rid of a dumb idea. You could say, 'could you really reinforce your own good behavior?' Yeah, you can. When other people won't praise you, you can praise yourself. I have a big system of patting myself on the back. Every time I get rid of a much beloved idea I pat myself on the back. Sometime several times. And I recommend the same mental habit to all of you. The price we pay for [not] being able to accept a new idea is just awesomely large." - Charlie Munger
Happy New Year,
Adam
Quotes of 2016
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Innovators, Imitators, & the Swarming Incompetents
"...the great majority of [investment] managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well. Bill Ruane...said it well: 'In investment management, the progression is from the innovators to the imitators to the swarming incompetents.'
Further complicating the search for the rare high-fee manager who is worth his or her pay is the fact that some investment professionals, just as some amateurs, will be lucky over short periods. If 1,000 managers make a market prediction at the beginning of a year, it's very likely that the calls of at least one will be correct for nine consecutive years. Of course, 1,000 monkeys would be just as likely to produce a seemingly all-wise prophet. But there would remain a difference: The lucky monkey would not find people standing in line to invest with him." - Warren Buffett
Buffett on Bogle
"If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle. For decades, Jack has urged investors to invest in ultra-low-cost index funds. In his crusade, he amassed only a tiny percentage of the wealth that has typically flowed to managers who have promised their investors large rewards while delivering them nothing – or, as in our bet, less than nothing – of added value.
In his early years, Jack was frequently mocked by the investment-management industry. Today, however, he has the satisfaction of knowing that he helped millions of investors realize far better returns on their savings than they otherwise would have earned. He is a hero to them and to me." - Warren Buffett
Buffett on American Business
"American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.
Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: 'We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.'
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well." - Warren Buffett
Destroying Bad Ideas - Part II
"...I've done so many dumb things that I'm very busy destroying bad ideas because I keep having them. So it's hard for me to just single out one from such a multitude. But I actually like it when I destroy a bad idea because...I think it's my duty to destroy old ideas. I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better. That is the absolute standard outcome in life. There's an old German folk saying...'We're too soon old and we're too late smart.' That's everybody's problem. And the reason we're too late smart is that the stupid ideas we...already have, we can't get rid of!...in most fields you want to get rid of your old ideas. And it's a good habit, and it gives you a big advantage in the competitive game of life since other people are so very bad at it. What happens is, as you spout ideas out, what you're doing is you're pounding them in. And so you get these ideas and then you start agitating and saying them and so forth. And of course, the person you're really convincing is you who already had the ideas. You're just pounding them in harder and harder. One of the reasons I don't spend much time telling the world what I think about how the federal reserve system should behave and so forth is I know that I'm just pounding the ideas into my own head when I think I'm telling the other people how to run things. So I think you have to have mental habits that -- I don't like it when young people get violently convinced on every damn cause or something. They think they know everything. Some 17 year old who wants to tell the whole world what should be done about abortion or foreign policy...or something. All he's doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you're just starting and have a lot to learn.
So it's very important that habit of getting rid of the dumb ideas. One of things I do is pat myself on the back every time I get rid of a dumb idea. You could say, 'could you really reinforce your own good behavior?' Yeah, you can. When other people won't praise you, you can praise yourself. I have a big system of patting myself on the back. Every time I get rid of a much beloved idea I pat myself on the back. Sometime several times. And I recommend the same mental habit to all of you. The price we pay for [not] being able to accept a new idea is just awesomely large." - Charlie Munger
Happy New Year,
Adam
Quotes of 2016
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, December 26, 2017
Destroying Bad Ideas - Part II
Charlie Munger has talked about the importance of routinely ridding oneself of the ideas -- often inferior yet, due to various biases and misjudgments, still favored -- that inevitably accumulate over time.
Destroying Bad Ideas - Part I
The problem is it's all too easy to do just the opposite -- to seek information that confirms what one already believes to be correct. In other words, after becoming enamored with a particular worldview, most don't enjoy later admitting that the 'story' they've long believed -- especially when previously embraced with enthusiasm and vigorously defended -- was far from perfect!
"The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things." - Charlie Munger at the 2006 Wesco Annual Meeting
So, instead, way too much energy is spent defending the flawed outlook while, at the same time, continuing to seek 'proof' of being 'right all along'.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Preferred views of reality have a more than decent chance of being riddled with defects. It's expecting that as the norm then attempting to be just a bit less wrong over time. This makes necessary an "ability to destroy your ideas rapidly" which is, well, more than challenging enough.
Developing, as a reliable mental habit, the capacity to get rid of subpar ideas depends on humility more so than brilliance.
With the above in mind consider what Charlie Munger said at the Daily Journal (DJCO) meeting earlier this year.
Munger, at the meeting, was asked which one of his ideas he found to be most difficult to destroy.
His answer:
"Well I've done so many dumb things that I'm very busy destroying bad ideas because I keep having them. So it's hard for me to just single out one from such a multitude. But I actually like it when I destroy a bad idea because...I think it's my duty to destroy old ideas. I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better. That is the absolute standard outcome in life. There's an old German folk saying...'We're too soon old and we're too late smart.' That's everybody's problem. And the reason we're too late smart is that the stupid ideas we...already have, we can't get rid of!...in most fields you want to get rid of your old ideas. And it's a good habit, and it gives you a big advantage in the competitive game of life since other people are so very bad at it. What happens is, as you spout ideas out, what you're doing is you're pounding them in. And so you get these ideas and then you start agitating and saying them and so forth. And of course, the person you're really convincing is you who already had the ideas. You're just pounding them in harder and harder. One of the reasons I don't spend much time telling the world what I think about how the federal reserve system should behave and so forth is I know that I'm just pounding the ideas into my own head when I think I'm telling the other people how to run things. So I think you have to have mental habits that -- I don't like it when young people get violently convinced on every damn cause or something. They think they know everything. Some 17 year old who wants to tell the whole world what should be done about abortion or foreign policy...or something. All he's doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you're just starting and have a lot to learn.
So it's very important that habit of getting rid of the dumb ideas. One of things I do is pat myself on the back every time I get rid of a dumb idea. You could say, 'could you really reinforce your own good behavior?' Yeah, you can. When other people won't praise you, you can praise yourself. I have a big system of patting myself on the back. Every time I get rid of a much beloved idea I pat myself on the back. Sometime several times. And I recommend the same mental habit to all of you. The price we pay for [not] being able to accept a new idea is just awesomely large. Indeed a lot of people die because they can't get new ideas through their head."
Charlie Munger's known for saying: "I have nothing to add."
Well, it seems best to behave the same way when something as wise as the above is said.
Adam
No position in DJCO
Related posts:
Destorying Bad Ideas - Part I
Investing Blunders
Buffett's $ 200 Billion Blunder
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Destroying Bad Ideas - Part I
The problem is it's all too easy to do just the opposite -- to seek information that confirms what one already believes to be correct. In other words, after becoming enamored with a particular worldview, most don't enjoy later admitting that the 'story' they've long believed -- especially when previously embraced with enthusiasm and vigorously defended -- was far from perfect!
"The ability to destroy your ideas rapidly instead of slowly when the occasion is right is one of the most valuable things." - Charlie Munger at the 2006 Wesco Annual Meeting
So, instead, way too much energy is spent defending the flawed outlook while, at the same time, continuing to seek 'proof' of being 'right all along'.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Preferred views of reality have a more than decent chance of being riddled with defects. It's expecting that as the norm then attempting to be just a bit less wrong over time. This makes necessary an "ability to destroy your ideas rapidly" which is, well, more than challenging enough.
Developing, as a reliable mental habit, the capacity to get rid of subpar ideas depends on humility more so than brilliance.
With the above in mind consider what Charlie Munger said at the Daily Journal (DJCO) meeting earlier this year.
Munger, at the meeting, was asked which one of his ideas he found to be most difficult to destroy.
His answer:
"Well I've done so many dumb things that I'm very busy destroying bad ideas because I keep having them. So it's hard for me to just single out one from such a multitude. But I actually like it when I destroy a bad idea because...I think it's my duty to destroy old ideas. I know so many people whose main problem of life, is that the old ideas displace the entry of new ideas that are better. That is the absolute standard outcome in life. There's an old German folk saying...'We're too soon old and we're too late smart.' That's everybody's problem. And the reason we're too late smart is that the stupid ideas we...already have, we can't get rid of!...in most fields you want to get rid of your old ideas. And it's a good habit, and it gives you a big advantage in the competitive game of life since other people are so very bad at it. What happens is, as you spout ideas out, what you're doing is you're pounding them in. And so you get these ideas and then you start agitating and saying them and so forth. And of course, the person you're really convincing is you who already had the ideas. You're just pounding them in harder and harder. One of the reasons I don't spend much time telling the world what I think about how the federal reserve system should behave and so forth is I know that I'm just pounding the ideas into my own head when I think I'm telling the other people how to run things. So I think you have to have mental habits that -- I don't like it when young people get violently convinced on every damn cause or something. They think they know everything. Some 17 year old who wants to tell the whole world what should be done about abortion or foreign policy...or something. All he's doing when he or she spouts about what he deeply believes is pounding the ideas he already has in, which is a very dumb idea when you're just starting and have a lot to learn.
So it's very important that habit of getting rid of the dumb ideas. One of things I do is pat myself on the back every time I get rid of a dumb idea. You could say, 'could you really reinforce your own good behavior?' Yeah, you can. When other people won't praise you, you can praise yourself. I have a big system of patting myself on the back. Every time I get rid of a much beloved idea I pat myself on the back. Sometime several times. And I recommend the same mental habit to all of you. The price we pay for [not] being able to accept a new idea is just awesomely large. Indeed a lot of people die because they can't get new ideas through their head."
Charlie Munger's known for saying: "I have nothing to add."
Well, it seems best to behave the same way when something as wise as the above is said.
Adam
No position in DJCO
Related posts:
Destorying Bad Ideas - Part I
Investing Blunders
Buffett's $ 200 Billion Blunder
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Monday, July 31, 2017
Investing Blunders
Warren Buffett once said the following about his decision to purchase Berkshire Hathaway (BRKa) back in 1964:
"I had now committed a major amount of money to a terrible business. And Berkshire Hathaway became the base for everything pretty much that I've done since. So in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway. I really should— should have bought it for a new entity.
Because Berkshire Hathaway was carrying this anchor, all these textile assets. So initially, it was all textile assets that weren't any good. And then, gradually, we built more things on to it. But always, we were carrying this anchor. And for 20 years, I fought the textile business before I gave up. As instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now...This is $200 billion. You can— you can figure that... Because the genius here thought he could run a textile business."
Buffett's $ 200 Billion Blunder
Berkshire's textile operations were shut down in 1985.
The above is from an interview with Becky Quick of CNBC that happened back in 2010. This past May she sat down for an interview with Warren Buffett, Charlie Munger, and Bill Gates. During the latter part of this interview she asked what they thought were the "worst trades" they've made in the past. Buffett, understandably considering the scale of the error, brought up Berkshire again.
QUICK: "...Warren has talked about his worst trades in the past. And Warren, I believe you said it was Berkshire Hathaway itself that was your worst trade."
BUFFETT: "Yeah, but I have plenty of other competitors...there are three companies [that] came together for Berkshire, actually. Diversified Retailing and Blue Chip Stamps were two others. And the base companies of both of the other two totally failed, disappeared. So we're three for three in terms of our building blocks. And we thought they were okay at the time, didn't we, Charlie?"
MUNGER: "Well, we bought them so cheaply, that we could return more money than we paid. And then we took the money and bought these other companies. So it wasn't as though we lost big chunks of money. It's just that it was such a dumb way to do business. Scrambling around with those unfashionable dying businesses, Textile Mills in New England. The power costs in the south...were 60% lower than they were in New England... What kind of an idiot would go into textiles in New England?"
BUFFETT: "The guy on your right."
MUNGER: "Yeah."
Later Charlie Munger said the following when asked a similar question:
MUNGER: "I made a tech company investment. And we damn near went broke and we hovered on the edge of a precipice for about three or four years. And it was agony. And it was a lot of money to me at the time. Now, we scrambled out of it with a pretty good profit. But it wasn't the world's smartest investment. And it took a lot of intelligent scrambling to rectify the situation. And I'm not looking to repeat the dumb decisions that got me there."
BUFFETT: "We'll find new ones."
QUICK: "Yeah."
MUNGER: "Yeah, we will."
I'd quibble with the terminology "worst trades" since neither Buffett or Munger really engage in trading activities or, at least, have not done so for a very long time.
Those who invest know -- or, one way or another, likely will come to know -- that mistakes are nearly inevitable. The question is how costly they are allowed to become and whether what's learned along the way is effectively put to use.
Some expend an awful lot of energy trying to prove to the world, and convincing themselves, that they're right. The process (of convincing) itself can serve to reinforce and solidify ideas -- whether flawed or otherwise -- possibly leading to a calcified world view that's increasingly less willing consider alternatives.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Sometimes -- or, possibly, often -- it'd have been better redirecting that effort towards the exploration of whether a particularly favored idea deserves such a status.
"To kill an error is as good a service as, and sometimes even better than, the establishing of a new truth or fact." - Charles Darwin
Ideas, even those most favored (especially those most favored?), should be viewed more skeptically and challenged relentlessly. Easier said.
"If others examined themselves attentively, as I do, they would find themselves, as I do, full of inanity and nonsense. Get rid of it I cannot without getting rid of myself. We are all steeped in it, one as much as another; but those who are aware of it are a little better off -- though I don't know." - Michel de Montaigne
Some healthy doubt can be a very useful thing.
An attitude that, to me, has a good chance of being applicable beyond the world of investing.
Though I don't know.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett's $ 200 Billion Blunder
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"I had now committed a major amount of money to a terrible business. And Berkshire Hathaway became the base for everything pretty much that I've done since. So in 1967, when a good insurance company came along, I bought it for Berkshire Hathaway. I really should— should have bought it for a new entity.
Because Berkshire Hathaway was carrying this anchor, all these textile assets. So initially, it was all textile assets that weren't any good. And then, gradually, we built more things on to it. But always, we were carrying this anchor. And for 20 years, I fought the textile business before I gave up. As instead of putting that money into the textile business originally, we just started out with the insurance company, Berkshire would be worth twice as much as it is now...This is $200 billion. You can— you can figure that... Because the genius here thought he could run a textile business."
Buffett's $ 200 Billion Blunder
Berkshire's textile operations were shut down in 1985.
The above is from an interview with Becky Quick of CNBC that happened back in 2010. This past May she sat down for an interview with Warren Buffett, Charlie Munger, and Bill Gates. During the latter part of this interview she asked what they thought were the "worst trades" they've made in the past. Buffett, understandably considering the scale of the error, brought up Berkshire again.
QUICK: "...Warren has talked about his worst trades in the past. And Warren, I believe you said it was Berkshire Hathaway itself that was your worst trade."
BUFFETT: "Yeah, but I have plenty of other competitors...there are three companies [that] came together for Berkshire, actually. Diversified Retailing and Blue Chip Stamps were two others. And the base companies of both of the other two totally failed, disappeared. So we're three for three in terms of our building blocks. And we thought they were okay at the time, didn't we, Charlie?"
MUNGER: "Well, we bought them so cheaply, that we could return more money than we paid. And then we took the money and bought these other companies. So it wasn't as though we lost big chunks of money. It's just that it was such a dumb way to do business. Scrambling around with those unfashionable dying businesses, Textile Mills in New England. The power costs in the south...were 60% lower than they were in New England... What kind of an idiot would go into textiles in New England?"
BUFFETT: "The guy on your right."
MUNGER: "Yeah."
Later Charlie Munger said the following when asked a similar question:
MUNGER: "I made a tech company investment. And we damn near went broke and we hovered on the edge of a precipice for about three or four years. And it was agony. And it was a lot of money to me at the time. Now, we scrambled out of it with a pretty good profit. But it wasn't the world's smartest investment. And it took a lot of intelligent scrambling to rectify the situation. And I'm not looking to repeat the dumb decisions that got me there."
BUFFETT: "We'll find new ones."
QUICK: "Yeah."
MUNGER: "Yeah, we will."
I'd quibble with the terminology "worst trades" since neither Buffett or Munger really engage in trading activities or, at least, have not done so for a very long time.
Those who invest know -- or, one way or another, likely will come to know -- that mistakes are nearly inevitable. The question is how costly they are allowed to become and whether what's learned along the way is effectively put to use.
Some expend an awful lot of energy trying to prove to the world, and convincing themselves, that they're right. The process (of convincing) itself can serve to reinforce and solidify ideas -- whether flawed or otherwise -- possibly leading to a calcified world view that's increasingly less willing consider alternatives.
"The first principle is that you must not fool yourself -- and you are the easiest person to fool." - Richard Feynman
Sometimes -- or, possibly, often -- it'd have been better redirecting that effort towards the exploration of whether a particularly favored idea deserves such a status.
"To kill an error is as good a service as, and sometimes even better than, the establishing of a new truth or fact." - Charles Darwin
Ideas, even those most favored (especially those most favored?), should be viewed more skeptically and challenged relentlessly. Easier said.
"If others examined themselves attentively, as I do, they would find themselves, as I do, full of inanity and nonsense. Get rid of it I cannot without getting rid of myself. We are all steeped in it, one as much as another; but those who are aware of it are a little better off -- though I don't know." - Michel de Montaigne
Some healthy doubt can be a very useful thing.
An attitude that, to me, has a good chance of being applicable beyond the world of investing.
Though I don't know.
Adam
Long position in BRKb established at much lower than recent market prices
Related post:
Buffett's $ 200 Billion Blunder
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Tuesday, January 10, 2017
Quotes of 2016
Here's a collection of quotes said or written at some point during 2016.
Buffett on Stock-Based Compensation
"...it has become common for managers to tell their owners to ignore certain expense items that are all too real. 'Stock-based compensation' is the most egregious example. The very name says it all: 'compensation.' If compensation isn't an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?
Wall Street analysts often play their part in this charade, too, parroting the phony, compensation-ignoring 'earnings' figures fed them by managements. Maybe the offending analysts don’t know any better. Or maybe they fear losing 'access' to management. Or maybe they are cynical, telling themselves that since everyone else is playing the game, why shouldn’t they go along with it. Whatever their reasoning, these analysts are guilty of propagating misleading numbers that can deceive investors." - Warren Buffett
Bezos: The "Inseparable Twins" of Failure and Invention
"...corporate cultures...are enduring, stable, hard to change. They can be a source of advantage or disadvantage. You can write down your corporate culture, but when you do so, you're discovering it, uncovering it – not creating it. It is created slowly over time by the people and by events – by the stories of past success and failure that become a deep part of the company lore. If it's a distinctive culture, it will fit certain people like a custom-made glove. The reason cultures are so stable in time is because people self-select. Someone energized by competitive zeal may select and be happy in one culture, while someone who loves to pioneer and invent may choose another. The world, thankfully, is full of many high-performing, highly distinctive corporate cultures. We never claim that our approach is the right one – just that it's ours – and over the last two decades, we’ve collected a large group of like-minded people. Folks who find our approach energizing and meaningful.
One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment. Most large organizations embrace the idea of invention, but are not willing to suffer the string of failed experiments necessary to get there." - Jeff Bezos
Buffett: The "Double-Barrel Effect"
"The ideal business is one that takes no capital but yet grows...if you have a business that grows, and gives you a lot of money every year, and...it [capital] isn't required in its growth, you get a double-barrel effect: from the earnings growth that occurs internally without the use of capital, and then you get the capital it produces to go and buy other businesses.
And See's Candy was a good example of that." - Warren Buffett
Berkshire 2016 Meeting: Charlie Munger Highlights - Part I
"...looking back, I don't regret that I didn't make more money or become better known, or any of those things. I do regret that I didn't wise up as fast as I could have — but there's a blessing in that, too. Now that I'm 92, I still have a lot of ignorance left to work on." - Charlie Munger
"...every person has to have about eight or ten glasses of water every day to stay alive...and it improves life to add a little extra flavor to your water -- a little stimulation, and a few calories if you want to eat that way. There are huge benefits to humanity in that and it's worth having some disadvantages. We ought to almost have a law...where these people shouldn't be allowed to cite the defect without also citing the advantage. It's immature and stupid."
"Well, there could hardly be anything more important [than microeconomics]....Business and microeconomics are sort of the same term. Microeconomics is what we do and macroeconomics is what we put up with." - Charlie Munger
Berkshire 2016 Meeting: Charlie Munger Highlights - Part II
"We try to avoid the worst anchoring effect, which is always your previous conclusion. We really try and destroy our previous ideas." - Charlie Munger
"What you've got to do is be aversive to the standard stupidities. If you just keep those out, you don't have to be smart." - Charlie Munger
"...sometimes when you reduce volume it is very intelligent because you're losing money on the volume you're discarding. It's quite common for a business not only to have more employees than it needs, but it sometimes has two or three customers that could be better off without. So it's hard to judge from outside whether things are good or bad just because volume is going up or down a little." - Charlie Munger
"I don't think anybody really knows much about negative interest rates...None of the great economists who studied this stuff and taught it to our children understand it either...our advantage is that we know we don't understand it." - Charlie Munger
Buffett on Active Investing
"Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you 'just buy an S&P index fund and sit for the next 50 years.' You don't get to be a consultant that way. And you certainly don't get an annual fee that way. So the consultant has every motivation in the world to tell you, 'this year I think we should concentrate more on international stocks,' or 'this manager is particularly good on the short side,' and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which... cumulatively eat up capital like crazy." - Warren Buffett
Bogle & Buffett on Frictional Costs
"We have two [investment] managers at Berkshire. They each manage $9 billion for us. They both ran hedge funds before. If they had a 2/20 arrangement with Berkshire, which is not uncommon in the hedge fund world, they would be getting $180 million annually each merely for breathing. It's a compensation scheme that is unbelievable to me..." - Warren Buffett
Happy New Year,
Adam
Quotes of 2015
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Buffett on Stock-Based Compensation
"...it has become common for managers to tell their owners to ignore certain expense items that are all too real. 'Stock-based compensation' is the most egregious example. The very name says it all: 'compensation.' If compensation isn't an expense, what is it? And, if real and recurring expenses don’t belong in the calculation of earnings, where in the world do they belong?
Wall Street analysts often play their part in this charade, too, parroting the phony, compensation-ignoring 'earnings' figures fed them by managements. Maybe the offending analysts don’t know any better. Or maybe they fear losing 'access' to management. Or maybe they are cynical, telling themselves that since everyone else is playing the game, why shouldn’t they go along with it. Whatever their reasoning, these analysts are guilty of propagating misleading numbers that can deceive investors." - Warren Buffett
Bezos: The "Inseparable Twins" of Failure and Invention
"...corporate cultures...are enduring, stable, hard to change. They can be a source of advantage or disadvantage. You can write down your corporate culture, but when you do so, you're discovering it, uncovering it – not creating it. It is created slowly over time by the people and by events – by the stories of past success and failure that become a deep part of the company lore. If it's a distinctive culture, it will fit certain people like a custom-made glove. The reason cultures are so stable in time is because people self-select. Someone energized by competitive zeal may select and be happy in one culture, while someone who loves to pioneer and invent may choose another. The world, thankfully, is full of many high-performing, highly distinctive corporate cultures. We never claim that our approach is the right one – just that it's ours – and over the last two decades, we’ve collected a large group of like-minded people. Folks who find our approach energizing and meaningful.
One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment. Most large organizations embrace the idea of invention, but are not willing to suffer the string of failed experiments necessary to get there." - Jeff Bezos
Buffett: The "Double-Barrel Effect"
"The ideal business is one that takes no capital but yet grows...if you have a business that grows, and gives you a lot of money every year, and...it [capital] isn't required in its growth, you get a double-barrel effect: from the earnings growth that occurs internally without the use of capital, and then you get the capital it produces to go and buy other businesses.
And See's Candy was a good example of that." - Warren Buffett
Berkshire 2016 Meeting: Charlie Munger Highlights - Part I
"...looking back, I don't regret that I didn't make more money or become better known, or any of those things. I do regret that I didn't wise up as fast as I could have — but there's a blessing in that, too. Now that I'm 92, I still have a lot of ignorance left to work on." - Charlie Munger
"Well, there could hardly be anything more important [than microeconomics]....Business and microeconomics are sort of the same term. Microeconomics is what we do and macroeconomics is what we put up with." - Charlie Munger
Berkshire 2016 Meeting: Charlie Munger Highlights - Part II
"We try to avoid the worst anchoring effect, which is always your previous conclusion. We really try and destroy our previous ideas." - Charlie Munger
"What you've got to do is be aversive to the standard stupidities. If you just keep those out, you don't have to be smart." - Charlie Munger
"...sometimes when you reduce volume it is very intelligent because you're losing money on the volume you're discarding. It's quite common for a business not only to have more employees than it needs, but it sometimes has two or three customers that could be better off without. So it's hard to judge from outside whether things are good or bad just because volume is going up or down a little." - Charlie Munger
"I don't think anybody really knows much about negative interest rates...None of the great economists who studied this stuff and taught it to our children understand it either...our advantage is that we know we don't understand it." - Charlie Munger
Buffett on Active Investing
"Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you 'just buy an S&P index fund and sit for the next 50 years.' You don't get to be a consultant that way. And you certainly don't get an annual fee that way. So the consultant has every motivation in the world to tell you, 'this year I think we should concentrate more on international stocks,' or 'this manager is particularly good on the short side,' and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which... cumulatively eat up capital like crazy." - Warren Buffett
Bogle & Buffett on Frictional Costs
"We have two [investment] managers at Berkshire. They each manage $9 billion for us. They both ran hedge funds before. If they had a 2/20 arrangement with Berkshire, which is not uncommon in the hedge fund world, they would be getting $180 million annually each merely for breathing. It's a compensation scheme that is unbelievable to me..." - Warren Buffett
Happy New Year,
Adam
Quotes of 2015
---
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
Thursday, October 13, 2016
Bogle & Buffett on Frictional Costs
John Bogle had the following to say in a speech earlier this year:
"Hedge funds (so-called; actually concentrated investment accounts which offer a wide variety of strategies) manage about $2.8 trillion of assets, at a cost equal to at least 3% of assets per year (300 basis points, an informed guess), generating some $84 billion in annual fees."
Vanguard manages roughly $3 trillion with roughly two thirds being index funds. Similar size but naturally much lower costs:
"The costs of supervising these index portfolios come to about $400 million annually, or 0.02% per year (two basis points)—less than 1% of the hedge fund rate. Administering the index funds and handling the accounts of some 15 million index shareholders costs another $1.2 billion, adding 0.06% (six basis points) to bring the aggregate expense ratio to eight basis points."
The ~ 300 basis point "informed guess" is primarily driven by the 2 and 20 compensation structure that is common to hedge funds. The above comments are not unlike those made by Warren Buffett -- in reference to his bet that a low-cost S&P 500 index fund would outperform a basket of hedge funds chosen by experts -- at the Berkshire Hathaway (BRKa) shareholder meeting earlier this year:
"The result is that after eight years and several hundred hedge fund managers being involved, the totally unmanaged fund by Vanguard with very minimal costs is now 40-something [percentage] points ahead of the group of hedge funds. It may sound like a terrible result for the hedge funds, but it's not a terrible result for the hedge fund managers."
Buffett also pointed out...
"We have two [investment] managers at Berkshire. They each manage $9 billion for us. They both ran hedge funds before. If they had a 2/20 arrangement with Berkshire, which is not uncommon in the hedge fund world, they would be getting $180 million annually each merely for breathing."
And then added:
"It's a compensation scheme that is unbelievable to me and that's one reason I made this bet."
So it comes down to this big difference in frictional costs to explain the results (so far) of Buffett's bet.
Investors in these high-cost funds are betting that, over many years, a capable manager can reliably outrun such a frictional cost headwind and that somehow those investors will be able to correctly pick beforehand who that manager is going to be. As Charlie Munger said at the same Berkshire meeting:
"There have been a few of these managers who've actually succeeded...But it's a tiny group of people...like looking for a needle in a haystack."
The likelihood that a manager will do well ends up much higher than the likelihood those who actually put their capital at risk will do well.
It seems rather obvious that the system would be vastly improved if the opposite were true.
Tortured logic is required to explain why those who are putting their capital at risk shouldn't first be compensated sufficiently before vast sums are drained from their balance sheet.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
Buffett on Active Investing
John Bogle: Arithmetic Quants vs Algorithmic Quants
Hedge Funds: Balancing Risk & Reward?
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
"Hedge funds (so-called; actually concentrated investment accounts which offer a wide variety of strategies) manage about $2.8 trillion of assets, at a cost equal to at least 3% of assets per year (300 basis points, an informed guess), generating some $84 billion in annual fees."
Vanguard manages roughly $3 trillion with roughly two thirds being index funds. Similar size but naturally much lower costs:
"The costs of supervising these index portfolios come to about $400 million annually, or 0.02% per year (two basis points)—less than 1% of the hedge fund rate. Administering the index funds and handling the accounts of some 15 million index shareholders costs another $1.2 billion, adding 0.06% (six basis points) to bring the aggregate expense ratio to eight basis points."
The ~ 300 basis point "informed guess" is primarily driven by the 2 and 20 compensation structure that is common to hedge funds. The above comments are not unlike those made by Warren Buffett -- in reference to his bet that a low-cost S&P 500 index fund would outperform a basket of hedge funds chosen by experts -- at the Berkshire Hathaway (BRKa) shareholder meeting earlier this year:
"The result is that after eight years and several hundred hedge fund managers being involved, the totally unmanaged fund by Vanguard with very minimal costs is now 40-something [percentage] points ahead of the group of hedge funds. It may sound like a terrible result for the hedge funds, but it's not a terrible result for the hedge fund managers."
Buffett also pointed out...
"We have two [investment] managers at Berkshire. They each manage $9 billion for us. They both ran hedge funds before. If they had a 2/20 arrangement with Berkshire, which is not uncommon in the hedge fund world, they would be getting $180 million annually each merely for breathing."
And then added:
"It's a compensation scheme that is unbelievable to me and that's one reason I made this bet."
So it comes down to this big difference in frictional costs to explain the results (so far) of Buffett's bet.
Investors in these high-cost funds are betting that, over many years, a capable manager can reliably outrun such a frictional cost headwind and that somehow those investors will be able to correctly pick beforehand who that manager is going to be. As Charlie Munger said at the same Berkshire meeting:
"There have been a few of these managers who've actually succeeded...But it's a tiny group of people...like looking for a needle in a haystack."
The likelihood that a manager will do well ends up much higher than the likelihood those who actually put their capital at risk will do well.
It seems rather obvious that the system would be vastly improved if the opposite were true.
Tortured logic is required to explain why those who are putting their capital at risk shouldn't first be compensated sufficiently before vast sums are drained from their balance sheet.
Adam
Long position in BRKb established at much lower than recent market prices
Related posts:
Buffett on Active Investing
John Bogle: Arithmetic Quants vs Algorithmic Quants
Hedge Funds: Balancing Risk & Reward?
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic", Part II
Index Fund Investing Revisited
Charlie Munger on Complexity, Hedge Funds, and Pension Funds
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
Buffett's Bet Against Hedge Funds, Part II
Buffett's Bet Against Hedge Funds
The Illusion of Control
Buffett, Bogle, and the "Invisible Foot" Revisited
If Buffett Were Paid Like a Hedge Fund Manager - Part II
If Buffett Were Paid Like a Hedge Fund Manager
Buffett, Bogle, and the Invisible Foot
Charlie Munger on LTCM & Overconfidence
"Nothing But Costs"
Bogle: History and the Classics
When Genius Failed...Again
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