Analyzing Berkshire Hathaway's (BRKa) earnings isn't always straightforward.
The year 1985 wasn't especially confusing compared to other years but serves as a useful example. The shareholder letter from that year shows that Berkshire's pre-tax earnings grew substantially year over year from $ 200.5 million to $ 613.4 million.
On the surface a great year but, unfortunately, that bottom line number doesn't reveal much about what Berkshire's true earnings power was at the time.
It was, in fact, a very good year but not nearly as good as the tripling would indicate.
The reason? Much of the increase came from the sale of marketable securities. Here's how the picture looked that year with gains from the sale of securities separated from the earnings (in millions) from Berkshire's operating businesses:*
1984 1985
Operating earnings $ 87.7 $125.4
Gain from Sale of Securities $104.7 $468.9
Other $ 8.1 $ 19.0
Total Earnings $200.5 $613.4
Here's how Warren Buffett explained the year over year performance in the 1985 shareholder letter:
"Our 1985 results include unusually large earnings from the sale of securities. This fact, in itself, does not mean that we had a particularly good year (though, of course, we did). Security profits in a given year bear similarities to a college
graduation ceremony in which the knowledge gained over four years is recognized on a day when nothing further is learned. We may
hold a stock for a decade or more, and during that period it may grow quite consistently in both business and market value. In
the year in which we finally sell it there may be no increase in value, or there may even be a decrease. But all growth in value
since purchase will be reflected in the accounting earnings of the year of sale. (If the stock owned is in our insurance subsidiaries, however, any gain or loss in market value will be reflected in net worth annually.) Thus, reported capital gains or
losses in any given year are meaningless as a measure of how well we have done in the current year."
The bulk of that gain from sale of securities was the result of selling General Foods.
Now, Berkshire had bought General Foods at what they viewed to be a substantial discount to per share business value back in 1980. Also, the business had fine underlying economics and, according to Buffett, a management that was focused on increasing that business value.
Shares bought cheap compared to 1980 value and, as a result of attractive underlying economics along with sound management, intrinsic value grew substantially over the five years or so.
None of the above led to a reported gain while the next thing that happened did. Philip Morris (now Altria: MO) came along and made a nice buyout offer for the shares of General Foods. More from the letter:
"We thus benefited from four factors: a bargain purchase price, a business with fine underlying economics, an able management concentrating on the interests of shareholders, and a buyer willing to pay full business value. While that last factor is the only one that produces reported earnings, we consider identification of the first three to be the key to building value for Berkshire shareholders. In selecting common stocks, we devote our attention to attractive purchases, not to the
possibility of attractive sales."
So value was enhanced over many years but the gains had to be recognized all at once as accounting earnings in that one year.
Adam
Long position in BRKb and MO established at less than recent market prices
* Earnings do not include the amortization of Goodwill. From the letter: "...amortization of Goodwill is not charged against the specific businesses but, for reasons outlined in the Appendix to my letter in the 1983 annual report, is aggregated as a separate item." The reason comes down to the difference between economic and accounting Goodwill. The Appendix in the 1983 letter does a nice job of explaining this.
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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, April 3, 2012
Monday, April 2, 2012
John Maynard Keynes, The Investor
An excerpt from chapter 12 of The General Theory of Employment, Interest, and Money by John Maynard Keynes:
The chapter is one of three that Warren Buffett has said investors should read.
"Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of "liquid" securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is "to beat the gun", as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves."
Later in the chapter Keynes equates this to games like Musical Chairs among others:
"These games can be played with zest and enjoyment, though...when the music stops some of the players will find themselves unseated."
In this Wall Street Journal article, Jason Zweig points out that Keynes was quite an investor. Well, at least he was once a change in investing styles occurred mid-career:
So an eight percent annual outperformance from 1924 to 1946.
Impressive, but clearly most of these exceptional results came after Keynes switched from the "macro" or "top-down" style to fundamental stock-picking.
In his earlier years, Keynes relied heavily upon monetary/economic signals to switch in and out of assets.
Using this earlier approach, Keynes went into the fall of 1929 with way too much stock exposure (83%) and paid for it.
Less than a few years after that experience, he switched from this "top down" approach to pure stock-picking focusing instead on the "bottom up" analysis of fundamentals.
Keynes also was known to concentrate his holdings (top five positions sometimes made up as much as 50% of the portfolio) and held shares for often more than five years.
Sound familiar? In Chapter 12 of The General Theory, Keynes said that the "spectacle of modern investment markets has sometimes moved me towards the conclusion" that they be set up in a way that will "force the investor to direct his mind to the long-term prospects and to those only."
Yet, Keynes also understood how difficult it was to get most market participants to act in this way.
The reason? There's a fundamental dilemma that impedes this from happening. More from Chapter 12:
"...the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is "liquid" (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk."
Finding the right balance is a problem persists to this day. I think it's safe to say we've gone too far in the direction of liquidity by a long shot but the same forces seem at work.
You don't have to agree with some of the economic theories of Keynes (on things like the need, at times, for government intervention in the economy) to learn from him when it comes to investing.
Adam
Keynes: One Mean Money Manager - Jason Zweig, Wall Street Journal
The General Theory of Employment, Interest, and Money - John Maynard Keynes
HT: Gaurang Sathaye
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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 are never a recommendation to buy or sell anything.
The chapter is one of three that Warren Buffett has said investors should read.
"Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of "liquid" securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is "to beat the gun", as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves."
Later in the chapter Keynes equates this to games like Musical Chairs among others:
"These games can be played with zest and enjoyment, though...when the music stops some of the players will find themselves unseated."
In this Wall Street Journal article, Jason Zweig points out that Keynes was quite an investor. Well, at least he was once a change in investing styles occurred mid-career:
Impressive, but clearly most of these exceptional results came after Keynes switched from the "macro" or "top-down" style to fundamental stock-picking.
In his earlier years, Keynes relied heavily upon monetary/economic signals to switch in and out of assets.
Using this earlier approach, Keynes went into the fall of 1929 with way too much stock exposure (83%) and paid for it.
Less than a few years after that experience, he switched from this "top down" approach to pure stock-picking focusing instead on the "bottom up" analysis of fundamentals.
Keynes also was known to concentrate his holdings (top five positions sometimes made up as much as 50% of the portfolio) and held shares for often more than five years.
Sound familiar? In Chapter 12 of The General Theory, Keynes said that the "spectacle of modern investment markets has sometimes moved me towards the conclusion" that they be set up in a way that will "force the investor to direct his mind to the long-term prospects and to those only."
Yet, Keynes also understood how difficult it was to get most market participants to act in this way.
The reason? There's a fundamental dilemma that impedes this from happening. More from Chapter 12:
"...the liquidity of investment markets often facilitates, though it sometimes impedes, the course of new investment. For the fact that each individual investor flatters himself that his commitment is "liquid" (though this cannot be true for all investors collectively) calms his nerves and makes him much more willing to run a risk."
Finding the right balance is a problem persists to this day. I think it's safe to say we've gone too far in the direction of liquidity by a long shot but the same forces seem at work.
You don't have to agree with some of the economic theories of Keynes (on things like the need, at times, for government intervention in the economy) to learn from him when it comes to investing.
Adam
Keynes: One Mean Money Manager - Jason Zweig, Wall Street Journal
The General Theory of Employment, Interest, and Money - John Maynard Keynes
HT: Gaurang Sathaye
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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 are never a recommendation to buy or sell anything.
Friday, March 30, 2012
Highest Paid Hedge Fund Managers
In 2010, John Paulson topped the list in hedge fund manager earnings with $ 4.9 billion.
The Advantage Plus Fund he manages returned 17% that year.
In 2011, he steered the same fund to a 51% loss.
Paulson Advantage Plus Fund Drops 51% in 'Aberrational Year'
So that means he didn't top the list in pay among hedge fund managers in 2011.
Here's who did.
The Rich List
1 Raymond Dalio (Bridgewater Associates): $ 3.9 billion
2 Carl Icahn (Icahn Capital Management): $ 2.5 billion
3 James Simons (Renaissance Technologies Corp.): $ 2.1 billion
4 Kenneth Griffin (Citadel): $ 700 million
5 Steven Cohen (SAC Capital advisors): $ 585 million
Pay For Top-Earning U.S. Hedge Fund Managers
The top 25 hedge fund managers in pay earned a combined $ 14.4 billion. So their average pay came in at $576 million per manager last year.
That's down from $883 million in 2010.
I guess that makes 2011, at least by comparison, quite a bargain.
What I'd like to focus on here is not the gains that come from the money these managers have invested in their funds (especially if those invested funds DID NOT come from accumulated fees charges in prior years) but, instead, on the money made from the hedge fund industry standard "2 and 20" compensation structure.
(This type of compensation structure includes a management fee that's 2% of assets under management. It also includes, when applicable, a performance fee for 20% of the profits -- sometimes above a certain threshold -- or some similar variation.)
A good chunk of the above earnings comes from fees though, of course, this varies greatly by fund.
There shouldn't be much ambiguity as to how I view these frictional costs based upon prior posts.
To me, the idea of paying someone even 1% to manage money seems expensive.
Frictional costs gone wild.
Adam
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.
The Advantage Plus Fund he manages returned 17% that year.
In 2011, he steered the same fund to a 51% loss.
Paulson Advantage Plus Fund Drops 51% in 'Aberrational Year'
So that means he didn't top the list in pay among hedge fund managers in 2011.
Here's who did.
The Rich List
1 Raymond Dalio (Bridgewater Associates): $ 3.9 billion
2 Carl Icahn (Icahn Capital Management): $ 2.5 billion
3 James Simons (Renaissance Technologies Corp.): $ 2.1 billion
4 Kenneth Griffin (Citadel): $ 700 million
5 Steven Cohen (SAC Capital advisors): $ 585 million
Pay For Top-Earning U.S. Hedge Fund Managers
The top 25 hedge fund managers in pay earned a combined $ 14.4 billion. So their average pay came in at $576 million per manager last year.
That's down from $883 million in 2010.
I guess that makes 2011, at least by comparison, quite a bargain.
What I'd like to focus on here is not the gains that come from the money these managers have invested in their funds (especially if those invested funds DID NOT come from accumulated fees charges in prior years) but, instead, on the money made from the hedge fund industry standard "2 and 20" compensation structure.
(This type of compensation structure includes a management fee that's 2% of assets under management. It also includes, when applicable, a performance fee for 20% of the profits -- sometimes above a certain threshold -- or some similar variation.)
A good chunk of the above earnings comes from fees though, of course, this varies greatly by fund.
There shouldn't be much ambiguity as to how I view these frictional costs based upon prior posts.
To me, the idea of paying someone even 1% to manage money seems expensive.
Frictional costs gone wild.
Adam
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, March 29, 2012
Benjamin Graham: Margin of Safety
From Chapter 20 of Ben Graham's book, The Intelligent Investor:
"...the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume that prosperity is synonymous with safety."
Graham, later in the same chapter, added the following:
"...it follows that most of the fair-weather investments, acquired at fair-weather prices, are destined to suffer disturbing price declines when the horizon clouds over—and often sooner than that. Nor can the investor count with confidence on an eventual recovery—although this does come about in some proportion of the cases—for he has never had a real safety margin to tide him through adversity."
Highly cyclical, capital intensive businesses that have what seems like manageable debt can be far riskier than they seem when a healthy economy turns south.
They'll seem cheap in the good times but those with highly variable revenues, lots of fixed costs (operating leverage), and debt (financial leverage) are sometimes deceptively expensive.
What seems like normalized earnings in an expanding economy (and especially a bubble) turn out to be far from robust in a less favorable economic environment. Lower quality businesses end up struggling to cover interest charges and often can't lower their fixed operating expenses fast enough if the recession is severe enough.
Even if current owners don't get wiped out, a business that requires capital when it's scarce and common equity prices are low isn't the best thing to own.
One benefit of the recent financial crisis for investors is that it is easy to study which businesses had the toughest time during that period of severely reduced business activity.
It may not have been anything close to the worst economic conditions that could occur but was still a pretty good test.
The bottom line is that under favorable economic conditions some lower quality businesses have a margin of safety in appearance only.
The fact that a premium to intrinsic value was actually paid may not become obvious until it's too late.
Adam
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.
"...the risk of paying too high a price for good-quality stocks—while a real one—is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to "earning power" and assume that prosperity is synonymous with safety."
Graham, later in the same chapter, added the following:
"...it follows that most of the fair-weather investments, acquired at fair-weather prices, are destined to suffer disturbing price declines when the horizon clouds over—and often sooner than that. Nor can the investor count with confidence on an eventual recovery—although this does come about in some proportion of the cases—for he has never had a real safety margin to tide him through adversity."
Highly cyclical, capital intensive businesses that have what seems like manageable debt can be far riskier than they seem when a healthy economy turns south.
They'll seem cheap in the good times but those with highly variable revenues, lots of fixed costs (operating leverage), and debt (financial leverage) are sometimes deceptively expensive.
What seems like normalized earnings in an expanding economy (and especially a bubble) turn out to be far from robust in a less favorable economic environment. Lower quality businesses end up struggling to cover interest charges and often can't lower their fixed operating expenses fast enough if the recession is severe enough.
Even if current owners don't get wiped out, a business that requires capital when it's scarce and common equity prices are low isn't the best thing to own.
One benefit of the recent financial crisis for investors is that it is easy to study which businesses had the toughest time during that period of severely reduced business activity.
It may not have been anything close to the worst economic conditions that could occur but was still a pretty good test.
The bottom line is that under favorable economic conditions some lower quality businesses have a margin of safety in appearance only.
The fact that a premium to intrinsic value was actually paid may not become obvious until it's too late.
Adam
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.
Wednesday, March 28, 2012
Seth Klarman: Margin of Safety
From the book Margin of Safety by Seth Klarman:
"The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make, and pay little attention to risk, how much they can lose.
Institutional investors, in particular, are usually evaluated—and therefore measure themselves— on the basis of relative performance compared to the market as a whole, to a relevant market sector, or to their peers.
Value investors, by contrast, have as a primary goal the preservation of their capital. It follows that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss."
When a money manager grabs a headline for spectacular returns achieved the question that follows should be:
At what risk of permanent loss of capital?
This is especially true if the returns were accomplished over a shorter time horizon. The problem is, of course, unlike returns it's not possible to precisely measure the risks that were taken to achieve returns.
It's easy to promote returns.
It's much harder to promote effective risk avoidance.
Consider two money managers:
Money Manager 1: Earns 14 percent per year for six years for investors then a bear market kicks in. The market value of the portfolio drops 30 percent in year seven.
Money Manager 2: Earns 10 percent per year for six years for investors then a bear market kicks in. The market value of the portfolio drops 10 percent in year seven.
Who had the better seven year returns?
Money Manager 2
Who's portfolio performed better on the downside during a bear market?
Money Manager 2
Who do you think attracted more investors in the first six years?
It's best to not get enamored with spectacular returns of others unless the risks taken to achieve those returns are well understood.
Downside risk is regulated by judging value well and having the discipline and patience to wait and buy only when there's a meaningful discount to that value (and selling, at times, under the opposite conditions).
Unfortunately, the evidence suggests that many do the opposite. The tendency of investors buying high when it feels safe (usually during a spectacular performance frenzy) then selling out of fear and/or disgust when it temporarily all goes south.
Those with any doubt should compare money flows into equity mutual funds in 1999 to the money flows of more recent years.
Successful value investors develop (or have) the ability to be less susceptible to this risky behavioral pattern.
This all too predictable pattern takes away the investors best possible method of reducing risk.
Price.
Paying a low price relative to value (and sound judgment of value) regulates the downside risk for an investor.
The chance to buy an investment you understand well with the largest possible margin of safety usually happens in brutal bear markets when nothing seems to be going right.
It rarely feels good at the time.
Adam
* No matter how much someone wants to believe it, academic or otherwise, there will never be a single variable that captures the risks of an investment. Beta may lend itself to neat calculations but it's worthless when it comes to gauging risk. Risk is always a bunch of mostly not quantifiable judgments.
Intro. 11-12
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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.
"The focus of most investors differs from that of value investors. Most investors are primarily oriented toward return, how much they can make, and pay little attention to risk, how much they can lose.
Institutional investors, in particular, are usually evaluated—and therefore measure themselves— on the basis of relative performance compared to the market as a whole, to a relevant market sector, or to their peers.
Value investors, by contrast, have as a primary goal the preservation of their capital. It follows that value investors seek a margin of safety, allowing room for imprecision, bad luck, or analytical error in order to avoid sizable losses over time. A margin of safety is necessary because valuation is an imprecise art, the future is unpredictable, and investors are human and do make mistakes. It is adherence to the concept of a margin of safety that best distinguishes value investors from all others, who are not as concerned about loss."
When a money manager grabs a headline for spectacular returns achieved the question that follows should be:
At what risk of permanent loss of capital?
This is especially true if the returns were accomplished over a shorter time horizon. The problem is, of course, unlike returns it's not possible to precisely measure the risks that were taken to achieve returns.
It's easy to promote returns.
It's much harder to promote effective risk avoidance.
Consider two money managers:
Money Manager 1: Earns 14 percent per year for six years for investors then a bear market kicks in. The market value of the portfolio drops 30 percent in year seven.
Money Manager 2: Earns 10 percent per year for six years for investors then a bear market kicks in. The market value of the portfolio drops 10 percent in year seven.
Who had the better seven year returns?
Money Manager 2
Who's portfolio performed better on the downside during a bear market?
Money Manager 2
Who do you think attracted more investors in the first six years?
It's best to not get enamored with spectacular returns of others unless the risks taken to achieve those returns are well understood.
Downside risk is regulated by judging value well and having the discipline and patience to wait and buy only when there's a meaningful discount to that value (and selling, at times, under the opposite conditions).
Unfortunately, the evidence suggests that many do the opposite. The tendency of investors buying high when it feels safe (usually during a spectacular performance frenzy) then selling out of fear and/or disgust when it temporarily all goes south.
Those with any doubt should compare money flows into equity mutual funds in 1999 to the money flows of more recent years.
Successful value investors develop (or have) the ability to be less susceptible to this risky behavioral pattern.
This all too predictable pattern takes away the investors best possible method of reducing risk.
Price.
Paying a low price relative to value (and sound judgment of value) regulates the downside risk for an investor.
The chance to buy an investment you understand well with the largest possible margin of safety usually happens in brutal bear markets when nothing seems to be going right.
It rarely feels good at the time.
Adam
* No matter how much someone wants to believe it, academic or otherwise, there will never be a single variable that captures the risks of an investment. Beta may lend itself to neat calculations but it's worthless when it comes to gauging risk. Risk is always a bunch of mostly not quantifiable judgments.
Intro. 11-12
---
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, March 27, 2012
Where The Growth Is In The Beer Industry
From this release by the Brewers Association yesterday:
Craft brewers saw volume2 rise 13 percent, with a 15 percent increase in retail sales from 2010 to 2011, representing a total barrel increase of 1.3 million.
In 2011, craft brewers represented 5.68 percent of volume of the U.S. beer market, up from 4.97 in 2010, with production reaching 11,468,152 barrels. Additionally, the BA estimates the actual dollar sales figure from craft brewers in 2011 was $8.7 billion, up from $7.6 billion in 2010.
This trend of small batch independent brewers taking market share has continued for a number of years. Consider that this is happening while the overall U.S. beer market actually saw a volumes decrease 1.32 percent in 2011.
One thing I noted in this previous post is how the beer brewing industry has evolved since prohibition:
The Beer Industries Bright Spot
Before prohibition the U.S. had 1,751 breweries.
By 1980 that number had fallen to less than 100 breweries.
Where's it at now?
It is now up to 1,989 according to this latest release by the Brewers Association.
Adam
Note: The numbers from the Brewers Association are preliminary. The Association will publish its full 2011 industry analysis in the May/June 2012 issue of The New Brewer.
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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.
Craft brewers saw volume2 rise 13 percent, with a 15 percent increase in retail sales from 2010 to 2011, representing a total barrel increase of 1.3 million.
In 2011, craft brewers represented 5.68 percent of volume of the U.S. beer market, up from 4.97 in 2010, with production reaching 11,468,152 barrels. Additionally, the BA estimates the actual dollar sales figure from craft brewers in 2011 was $8.7 billion, up from $7.6 billion in 2010.
This trend of small batch independent brewers taking market share has continued for a number of years. Consider that this is happening while the overall U.S. beer market actually saw a volumes decrease 1.32 percent in 2011.
One thing I noted in this previous post is how the beer brewing industry has evolved since prohibition:
The Beer Industries Bright Spot
Before prohibition the U.S. had 1,751 breweries.
By 1980 that number had fallen to less than 100 breweries.
Where's it at now?
It is now up to 1,989 according to this latest release by the Brewers Association.
Adam
Note: The numbers from the Brewers Association are preliminary. The Association will publish its full 2011 industry analysis in the May/June 2012 issue of The New Brewer.
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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, March 26, 2012
Bats IPO: A Gift to Critics of Modern Market Structure
From this Bloomberg article on the errors that forced Bats to withdraw its IPO and some of the implications of the failure:
The malfunctions will refocus scrutiny on market structure in the U.S., where two decades of government regulation have broken the grip of the biggest exchanges and left trading fragmented over as many as 50 venues. Bats, whose name stands for Better Alternative Trading System, expanded in tandem with the automated firms that now dominate the buying and selling of American equities.
The withdrawal also raises questions about the reliability of venues formed as competitors to the New York Stock Exchange and Nasdaq Stock Market since the 1990s.
Themis Trading LLC has been shedding light for some time on some of the things that led to changes in market structure. I've included excerpts from some of their prior posts and one of their white paper's:
Regulations That Contributed to Existing U.S. Market Structure
Beginning with REG ATS in the late 90′s, the SEC has had the stated goal of transparency, and equal access to pricing by all market participants. Unfortunately, with decimalization and Reg NMS, the velocity of trading has skyrocketed. While this spawned some innovative products, nevertheless it has fragmented the market place and hurt the price discovery process in an unintended way. - From Themis Trading Comments on SEC Dark Pool Proposal
Unintended Negative Consequences
To regain public trust and confidence in our equity market, the SEC must undertake major reform. Such change faces two major challenges, however. It means admitting that the past decade of regulations have had serious unintended negative consequences. And it means going up against the HFT community, which is likely to do everything in its power to slow or water down the reform process.
The HFT community will claim that if any serious reform is implemented, they will be driven out of the market, spreads will increase and liquidity will dry up. We agree that spreads will widen, but liquidity will not vanish; only HFT volume will. And if a slightly wider spread is the cost of getting our market back into the hands of the owners who are responsible for price discovery, then that is a cost that most investors will gladly pay, we believe. While explicit costs will go up, the implicit costs of reduced market confidence will plummet. - From a White Paper by Sal Arnuk and Joseph Saluzzi
Those implicit costs may be hard to measure but that doesn't make the costs of reduced market confidence any less real.
Threat to Market Stability?
The first step in fixing a problem is admitting that you have one and that is exactly what this committee did last week. The unintended consequences of Reg ATS, the Order Handling Rules, Decimalization and Reg NMS have emerged into a serious threat to the stability of our market and they need to be addressed immediately. - From Great Expectations and the Frankenstein Market
Beneficial to Capital Formation?
Were these regulations beneficial to the markets? Were they beneficial to capital formation? Which is larger today: the cash equity business (ownership in real economic corporations), or more profitable market for derivative instruments of those equities? Is today’s Frankenstein market a result of “unintended consequences”, or is this market exactly the intended plan of the insiders, given that the current market participants had literally years to tool up to prepare (and take advantage of) for that very Frankenstein market? - From The Revolving Door
What's at stake seems straightforward enough but the fix won't be easy.
Does the market structure that exists today facilitate anything near the most effective capital raising and formation capability possible?
Are participants who invest primarily with longer term economic effects in mind being pushed aside in favor of more short-term oriented insiders?
I'm pretty sure that answers aren't likely to come from those with entrenched interest in the status quo. Pressure from places with fewer conflicts obviously have the better chance of getting us closer to more a desirable outcome.
Adam
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 are never a recommendation to buy or sell anything.
The malfunctions will refocus scrutiny on market structure in the U.S., where two decades of government regulation have broken the grip of the biggest exchanges and left trading fragmented over as many as 50 venues. Bats, whose name stands for Better Alternative Trading System, expanded in tandem with the automated firms that now dominate the buying and selling of American equities.
The withdrawal also raises questions about the reliability of venues formed as competitors to the New York Stock Exchange and Nasdaq Stock Market since the 1990s.
Themis Trading LLC has been shedding light for some time on some of the things that led to changes in market structure. I've included excerpts from some of their prior posts and one of their white paper's:
Regulations That Contributed to Existing U.S. Market Structure
Beginning with REG ATS in the late 90′s, the SEC has had the stated goal of transparency, and equal access to pricing by all market participants. Unfortunately, with decimalization and Reg NMS, the velocity of trading has skyrocketed. While this spawned some innovative products, nevertheless it has fragmented the market place and hurt the price discovery process in an unintended way. - From Themis Trading Comments on SEC Dark Pool Proposal
Unintended Negative Consequences
To regain public trust and confidence in our equity market, the SEC must undertake major reform. Such change faces two major challenges, however. It means admitting that the past decade of regulations have had serious unintended negative consequences. And it means going up against the HFT community, which is likely to do everything in its power to slow or water down the reform process.
The HFT community will claim that if any serious reform is implemented, they will be driven out of the market, spreads will increase and liquidity will dry up. We agree that spreads will widen, but liquidity will not vanish; only HFT volume will. And if a slightly wider spread is the cost of getting our market back into the hands of the owners who are responsible for price discovery, then that is a cost that most investors will gladly pay, we believe. While explicit costs will go up, the implicit costs of reduced market confidence will plummet. - From a White Paper by Sal Arnuk and Joseph Saluzzi
Those implicit costs may be hard to measure but that doesn't make the costs of reduced market confidence any less real.
Threat to Market Stability?
The first step in fixing a problem is admitting that you have one and that is exactly what this committee did last week. The unintended consequences of Reg ATS, the Order Handling Rules, Decimalization and Reg NMS have emerged into a serious threat to the stability of our market and they need to be addressed immediately. - From Great Expectations and the Frankenstein Market
Beneficial to Capital Formation?
Were these regulations beneficial to the markets? Were they beneficial to capital formation? Which is larger today: the cash equity business (ownership in real economic corporations), or more profitable market for derivative instruments of those equities? Is today’s Frankenstein market a result of “unintended consequences”, or is this market exactly the intended plan of the insiders, given that the current market participants had literally years to tool up to prepare (and take advantage of) for that very Frankenstein market? - From The Revolving Door
What's at stake seems straightforward enough but the fix won't be easy.
Does the market structure that exists today facilitate anything near the most effective capital raising and formation capability possible?
Are participants who invest primarily with longer term economic effects in mind being pushed aside in favor of more short-term oriented insiders?
I'm pretty sure that answers aren't likely to come from those with entrenched interest in the status quo. Pressure from places with fewer conflicts obviously have the better chance of getting us closer to more a desirable outcome.
Adam
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 are never a recommendation to buy or sell anything.
Friday, March 23, 2012
North American Oil and Gas Revolution
From this CNBC article:
Increased production of energy from a number of sources including deepwater drilling, natural gas exploration and Canada's oil sands could make North America the next Middle East, according to a new report from Citigroup.
According to the report, supply will go up substantially a result of the substantial strides in natural resource extraction. In addition, demand for oil in the U.S. is down 2 million barrels per day (since the peak in 2005) and is expected to continue declining over the next decade. Some of this is the result of the 2008 recession but it is also partly a structural decline.
The article quotes Ed Morse, head of global commodities research at Citigroup. Mr. Morse says this supply and demand revolution has "potentially extraordinary" economic consequences.
The report also predicts that the U.S. could overtake both Russia and Saudi Arabia in oil production by 2020. Check out the chart in this article.
According to the article, Citigroup's analysts assert that some of the consequences for the U.S. in a "good case" scenario include:
- An increase in GDP of 2.0 to 3.3 percent
- Roughly 3.6 million new jobs by 2020
- Decreased geopolitical risks
- A decline in oil prices
In 2011, the U.S. became an exporter of refined oil for the first time since 1949 but will likely continue to be a net importer of crude oil for a very long time. The U.S. currently imports roughly 9 million barrels of crude oil per day so there's a long way to go.
There's still a ways to go but the Citigroup report suggests the U.S. could put a material dent in those 9 million barrels of daily imported crude oil in less than ten years.
From this article in The New York Times:
Across the country, the oil and gas industry is vastly increasing production, reversing two decades of decline. Using new technology and spurred by rising oil prices since the mid-2000s, the industry is extracting millions of barrels more a week, from the deepest waters of the Gulf of Mexico to the prairies of North Dakota.
We are also using significantly less gasoline. In part due to the recession and high prices but also from driving less with more fuel-efficient machines. While our reliance on imports continues to be substantial, I doubt many would have predicted that anything like this would happen in the U.S. as recently as five or so years ago.
The question is whether there's a smart way to invest in this.
That I haven't figured out yet.
Adam
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 are never a recommendation to buy or sell anything.
Increased production of energy from a number of sources including deepwater drilling, natural gas exploration and Canada's oil sands could make North America the next Middle East, according to a new report from Citigroup.
According to the report, supply will go up substantially a result of the substantial strides in natural resource extraction. In addition, demand for oil in the U.S. is down 2 million barrels per day (since the peak in 2005) and is expected to continue declining over the next decade. Some of this is the result of the 2008 recession but it is also partly a structural decline.
The article quotes Ed Morse, head of global commodities research at Citigroup. Mr. Morse says this supply and demand revolution has "potentially extraordinary" economic consequences.
The report also predicts that the U.S. could overtake both Russia and Saudi Arabia in oil production by 2020. Check out the chart in this article.
- An increase in GDP of 2.0 to 3.3 percent
- Roughly 3.6 million new jobs by 2020
- Decreased geopolitical risks
- A decline in oil prices
In 2011, the U.S. became an exporter of refined oil for the first time since 1949 but will likely continue to be a net importer of crude oil for a very long time. The U.S. currently imports roughly 9 million barrels of crude oil per day so there's a long way to go.
There's still a ways to go but the Citigroup report suggests the U.S. could put a material dent in those 9 million barrels of daily imported crude oil in less than ten years.
From this article in The New York Times:
Across the country, the oil and gas industry is vastly increasing production, reversing two decades of decline. Using new technology and spurred by rising oil prices since the mid-2000s, the industry is extracting millions of barrels more a week, from the deepest waters of the Gulf of Mexico to the prairies of North Dakota.
We are also using significantly less gasoline. In part due to the recession and high prices but also from driving less with more fuel-efficient machines. While our reliance on imports continues to be substantial, I doubt many would have predicted that anything like this would happen in the U.S. as recently as five or so years ago.
The question is whether there's a smart way to invest in this.
That I haven't figured out yet.
Adam
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 are never a recommendation to buy or sell anything.
Thursday, March 22, 2012
Buffett's Bet Against Hedge Funds, Part II
Yesterday's post about Buffett's bet that hedge funds (or actually funds of hedge funds selected by Protege Partners LLC) would not outperform the S&P 500 over ten years brought the following to mind:
Let's say a hypothetical hedge fund manages $ 5 billion.
That means just the annual 2 percent management fee* (the 2 percent of assets that a typical hedge fund charges investors each year) alone will cost its investors $ 100 million/year. The costs would be more, of course, since a hedge fund will also usually charge investors 20 percent of profits generated (performance fees). There would also be an additional 1.25 percent of assets and 7.5 percent of any gains charged if a fund of hedge funds is involved as noted in yesterday's post.
(As I write this I still find all these fees very hard to believe.)
Now, compare the above to Berkshire Hathaway (BRKa).**
Berkshire Hathaway's market value is $ 200 billion (it's not hard to argue the company is worth more but that's another topic).
So Berkshire is 40x bigger than the above hypothetical hedge fund but Buffett's pay has been and continues to be much more reasonable. For decades, Buffett's compensation has been the $ 100k/year he collects in salary. Buffett does also benefit from personal and home security that Berkshire pays for but otherwise no bonus, stock options, or other forms of compensation.
(Buffett's primary source of wealth has come from the shares he purchased decades ago.)
Quite a contrast and, well, quite a bargain.
What Buffett has been paid during the forty plus years as CEO added together is, in total, less than 5 percent of what the hypothetical hedge fund above would be paid in one year.
Now naturally some of the $ 100 million paid to the hedge fund goes to other operating expenses. So to be completely fair, at least some of the operating costs of Berkshire's headquarters (though much of those costs are presumably related to the operating businesses Berkshire owns outright), including the new investment managers, shouldn't be ignored. That's the only way to make this a true apples-to-apples comparison of frictional costs (though I know of no corporation Berkshire's size with such a small headquarters).
Let's not split hairs. This difference in costs, I think, speaks for itself. Precision not required. Berkshire is built to minimize frictional costs for investors like few other investment vehicles. Add the cost for Berkshire's headquarters (all 19 employees) and the total frictional costs compared to the value of the assets being managed is still lower than any fund in existence by a large margin.
(Consider I'm also ignoring the performance fees that hedge funds charge which are far from inconsequential.)
...frictional costs of all sorts may well amount to 20 percent of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80 percent or so of what they would earn if they just sat still and listened to no one.- From the How to Minimize Investment Returns section of the 2005 Berkshire Hathaway Shareholder Letter
What if Buffett had been charging '2 and 20' fees instead all these years?
Berkshire would be a shadow of itself and its long-term investors, of which it has many, a lot less rich.
We know with Buffett in charge Berkshire has produced ~20 percent returns per year for decades. Due to its sheer size, it will almost certainly not do that well in the future whether Buffett's at the helm or not.
Having said that, the company is made up of a pretty fine set of assets that are likely to compound nicely in value over time.
I'm guessing no matter who is running Berkshire over the coming decades, even if not the compensated at a bargain $ 100k per year rate, that the frictional costs as a percent of value will continue to be lower than just about any fund in existence.
Adam
Long position in BRKb established at less than recent market prices
Related posts:
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
* The article mentioned in yesterday's post noted that, in addition to the '2 and 20' fees hedge funds typically charge (investors are charged 2% of the assets each year in management fees plus 20% of profits generated in performance fees), the funds of funds add another layer of fees. According to the Bloomberg article, on average this is an additional 1.25 percent of assets and 7.5 percent of any profits.
** Berkshire's not a hedge fund, of course, but I think it's worthwhile to make the comparison. Much like a hedge fund, Berkshire is an investment vehicle that attempts to generate satisfactory returns and manage risks. The investor is just charged a lot less for the privilege.
---
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.
Let's say a hypothetical hedge fund manages $ 5 billion.
That means just the annual 2 percent management fee* (the 2 percent of assets that a typical hedge fund charges investors each year) alone will cost its investors $ 100 million/year. The costs would be more, of course, since a hedge fund will also usually charge investors 20 percent of profits generated (performance fees). There would also be an additional 1.25 percent of assets and 7.5 percent of any gains charged if a fund of hedge funds is involved as noted in yesterday's post.
(As I write this I still find all these fees very hard to believe.)
Now, compare the above to Berkshire Hathaway (BRKa).**
Berkshire Hathaway's market value is $ 200 billion (it's not hard to argue the company is worth more but that's another topic).
So Berkshire is 40x bigger than the above hypothetical hedge fund but Buffett's pay has been and continues to be much more reasonable. For decades, Buffett's compensation has been the $ 100k/year he collects in salary. Buffett does also benefit from personal and home security that Berkshire pays for but otherwise no bonus, stock options, or other forms of compensation.
(Buffett's primary source of wealth has come from the shares he purchased decades ago.)
Quite a contrast and, well, quite a bargain.
What Buffett has been paid during the forty plus years as CEO added together is, in total, less than 5 percent of what the hypothetical hedge fund above would be paid in one year.
Now naturally some of the $ 100 million paid to the hedge fund goes to other operating expenses. So to be completely fair, at least some of the operating costs of Berkshire's headquarters (though much of those costs are presumably related to the operating businesses Berkshire owns outright), including the new investment managers, shouldn't be ignored. That's the only way to make this a true apples-to-apples comparison of frictional costs (though I know of no corporation Berkshire's size with such a small headquarters).
Let's not split hairs. This difference in costs, I think, speaks for itself. Precision not required. Berkshire is built to minimize frictional costs for investors like few other investment vehicles. Add the cost for Berkshire's headquarters (all 19 employees) and the total frictional costs compared to the value of the assets being managed is still lower than any fund in existence by a large margin.
(Consider I'm also ignoring the performance fees that hedge funds charge which are far from inconsequential.)
...frictional costs of all sorts may well amount to 20 percent of the earnings of American business. In other words, the burden of paying Helpers may cause American equity investors, overall, to earn only 80 percent or so of what they would earn if they just sat still and listened to no one.- From the How to Minimize Investment Returns section of the 2005 Berkshire Hathaway Shareholder Letter
What if Buffett had been charging '2 and 20' fees instead all these years?
Berkshire would be a shadow of itself and its long-term investors, of which it has many, a lot less rich.
We know with Buffett in charge Berkshire has produced ~20 percent returns per year for decades. Due to its sheer size, it will almost certainly not do that well in the future whether Buffett's at the helm or not.
Having said that, the company is made up of a pretty fine set of assets that are likely to compound nicely in value over time.
I'm guessing no matter who is running Berkshire over the coming decades, even if not the compensated at a bargain $ 100k per year rate, that the frictional costs as a percent of value will continue to be lower than just about any fund in existence.
Adam
Long position in BRKb established at less than recent market prices
Related posts:
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
* The article mentioned in yesterday's post noted that, in addition to the '2 and 20' fees hedge funds typically charge (investors are charged 2% of the assets each year in management fees plus 20% of profits generated in performance fees), the funds of funds add another layer of fees. According to the Bloomberg article, on average this is an additional 1.25 percent of assets and 7.5 percent of any profits.
** Berkshire's not a hedge fund, of course, but I think it's worthwhile to make the comparison. Much like a hedge fund, Berkshire is an investment vehicle that attempts to generate satisfactory returns and manage risks. The investor is just charged a lot less for the privilege.
---
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.
Wednesday, March 21, 2012
Buffett's Bet Against Hedge Funds
A little over 4 years ago, Warren Buffett made a $ 1 million friendly wager with Protege Partners LLC, a New York fund of hedge funds.
The bet Buffett made with Protege was that "a portfolio of funds of hedge funds" of their choosing couldn't beat the S&P 500 over a ten year period.
The winner's charity of choice is to receive the $ 1 million.
For background, here's the wording of the specific wager that was made between Buffett and Protege:
"Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses."
So how are the funds chosen by Protege doing against a Vanguard mutual fund that tracks the S&P 500?
This article notes that the returns since the beginning of the bet have been as follows:
Vanguard S&P 500: Plus 2.2 percent return (low-cost Admiral shares)
Hedge funds: Minus 4.5 percent return
That's hardly definitive but, then again, not really surprising consider the difference in fees and other frictional costs.
Most hedge funds are compensated via the '2 and 20' fees. Investors in the fund are charged for 2 percent of the assets each year (management fees) plus 20 percent of profits generated (performance fees).
I happen to find the idea of paying that much baffling but, somewhat amazingly, the frictional costs involved go beyond those fees.
From the Bloomberg article:
In addition to the 2 percent management fee and 20 percent performance fee that hedge funds typically charge, the funds of funds add another layer of fees, on average 1.25 percent of assets and 7.5 percent of any gains, according to data compiled by Bloomberg.
To me, 1 percent seems like a lot.
Buffett and Protege present their arguments for the wager here*.
An excerpt from Buffett's argument:
...passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.
Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor's equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.
A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose...
An excerpt from Protege's argument:
Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional "relative-return" investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages. Funds of funds with the ability to sort the wheat from the chaff will earn returns that amply compensate for the extra layer of fees their clients pay.
According to the Bloomberg article, Buffett told Carol Loomis he thought his chance of winning was 60%. So for Buffett this is not exactly the high probability outcome he usually seems to like when putting capital at risk. I'm just guessing but this seems more about a way for Buffett to highlight the extremely high fees that are the norm in the industry.
It's certainly possible the funds that were chosen to compete with the S&P 500 by Protege may, in fact, do better over these ten years in this particular wager. To me, that would miss the primary point.
I think the more important thing to consider is that, with all those costs layered on, the probability of outperformance is not very high over the long haul. A large enough sample and enough time should reveal just that.
Certain funds will outperform, of course, but that a large percentage of funds (or funds of funds) could consistently overcome all those fees and expenses seems improbable at best.
Good luck to those trying to separate the few long-term winners from the rest.
Most investors, on average and over the long haul, will likely do better with a low-cost index fund.
Adam
Related posts:
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
* The site is longbets.org. Its stated purpose "is to improve long-term thinking" and is backed by the non-profit The Long Now Foundation.
---
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.
The bet Buffett made with Protege was that "a portfolio of funds of hedge funds" of their choosing couldn't beat the S&P 500 over a ten year period.
The winner's charity of choice is to receive the $ 1 million.
For background, here's the wording of the specific wager that was made between Buffett and Protege:
"Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses."
So how are the funds chosen by Protege doing against a Vanguard mutual fund that tracks the S&P 500?
This article notes that the returns since the beginning of the bet have been as follows:
Vanguard S&P 500: Plus 2.2 percent return (low-cost Admiral shares)
Hedge funds: Minus 4.5 percent return
That's hardly definitive but, then again, not really surprising consider the difference in fees and other frictional costs.
Most hedge funds are compensated via the '2 and 20' fees. Investors in the fund are charged for 2 percent of the assets each year (management fees) plus 20 percent of profits generated (performance fees).
I happen to find the idea of paying that much baffling but, somewhat amazingly, the frictional costs involved go beyond those fees.
From the Bloomberg article:
In addition to the 2 percent management fee and 20 percent performance fee that hedge funds typically charge, the funds of funds add another layer of fees, on average 1.25 percent of assets and 7.5 percent of any gains, according to data compiled by Bloomberg.
To me, 1 percent seems like a lot.
Buffett and Protege present their arguments for the wager here*.
An excerpt from Buffett's argument:
...passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.
Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor's equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.
A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose...
An excerpt from Protege's argument:
Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional "relative-return" investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.
There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages. Funds of funds with the ability to sort the wheat from the chaff will earn returns that amply compensate for the extra layer of fees their clients pay.
According to the Bloomberg article, Buffett told Carol Loomis he thought his chance of winning was 60%. So for Buffett this is not exactly the high probability outcome he usually seems to like when putting capital at risk. I'm just guessing but this seems more about a way for Buffett to highlight the extremely high fees that are the norm in the industry.
It's certainly possible the funds that were chosen to compete with the S&P 500 by Protege may, in fact, do better over these ten years in this particular wager. To me, that would miss the primary point.
I think the more important thing to consider is that, with all those costs layered on, the probability of outperformance is not very high over the long haul. A large enough sample and enough time should reveal just that.
Certain funds will outperform, of course, but that a large percentage of funds (or funds of funds) could consistently overcome all those fees and expenses seems improbable at best.
Good luck to those trying to separate the few long-term winners from the rest.
Most investors, on average and over the long haul, will likely do better with a low-cost index fund.
Adam
Related posts:
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
* The site is longbets.org. Its stated purpose "is to improve long-term thinking" and is backed by the non-profit The Long Now Foundation.
---
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.
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