Warren Buffett
A tribute on his 93rd Birthday.
Warren Buffett celebrated his 93rd birthday last week. There has been a lot of coverage of it in newspapers, magazines, the financial TV channels and on social media. I have decided to write my own tribute to Mr Buffett. This task should be a easy !! Buffett has achieved so much over eight decade, the thing should practically write itself!
I have decided to focus on two elements.
The first is his philosophy in business and investment management, in particular, the emphasis on stewardship and partnership.
The second is an exploration of his sincere and profound acknowledgment of the role luck in his life.
I will start with a few words on his investment investment record
There are a only few people who have compounded returns at 20% of more over a few years.
There are very few (if any) professional investors whose active investing life has spanned 70 years.
Warren Buffett is probably the only investor to have achieved both. He has compounded at an average CAGR of ~19%-21% for over 7 decades. If we do the arithmetic ( (1.19)^71) , we can say a theoretical (and probably non-existent) investor who investment $1000 in the Buffet Partnerships in the early 1950s and stayed invested throughout by rolling their capital into Berkshire Hathaway when the Buffet Partnerships folded, would be worth ~$ 231mn today.
In fact, these numbers probably understate the wealth generated as the Buffet Partnerships in the early years probably compounded at a much higher rate than 19%.
Buffet’s investment record over such a long period (he made his first investment in 1941) is remarkable. He has made a lot of mistakes (which he often cheerfully admits) but his overall performance is unlikely to be matched.
I want focus on his philosophy with respect to business and investment management, particularly on the related notions of stewardship and partnership.
Definition: Stewardship involves the responsible care or management of some good, together with some kind of answerability.
Buffett has always been in the business of stewardship of other people’s valuable capital. He has felt deeply the responsibility and obligation that managing other peoples’ money entails. In the early days, the first investors in the Buffett partnerships were Omaha natives, relatives and neighbours and colleagues of his father in law. They were people he saw everyday and felt a deep obligation to look after their capital well. This required avoiding excessive risk, avoiding long-term permanent losses and generating above average returns.
This leads us to the related ideas of fiduciary and partnership.
A fiduciary is someone who manages money or property for someone else. When you're named a fiduciary and accept the role, you must – by law – manage the person's money and property for their benefit, not yours.
“Although our form is corporate, our attitude is partnership. Charlie Munger and I think of our shareholders as owners-partners, and ourselves as managing partners. . . . We do not view the company itself as the owner of our business assets but instead view the company as a conduit through which our shareholders own the assets. CEOs must embrace stewardship as a way of life and treat their owners as partners not patsies. It's time for CEOs to walk the walk.”
Once we understand this, we see why Warren Buffett has only ever paid himself a salary of $100,000 as CEO, and has never been given (or taken) stock options or bonuses for performance.
Buffett acquired his 30% stake in Berkshire Hathaway in the open market in the mid-1960s and has never sold a share though he has given away a lot to charity. Anybody at the time could have bought at the same price in the market at that time. Buffett did not acquire shares through under-priced stock options, stock grants for performance or other means not available to other investors.
Based on his track record or his position as Chairman, CEO and major shareholder, Buffett could easily have awarded himself millions of dollars in salary and much more in the form of stock options and other remuneration. He did not do so because this would be a violation of the partnership principle. This attitude and behaviour is extremely rare in corporate America. Management routinely get multi-million dollar salaries and stock options and other perks, often irrespective of actual performance.
The world of business and investment management is full of examples where these fundamental principles of partnership and stewardship have been breached. Buffett has often spoken out against these. He has never done it in anger and usually made his points with humour and with a deep appeal to rationality.
Consider the issue of expensing stock options. Many companies in 1990s and beyond, especially in the tech sector, have awarded generous stock options and stock grants to managers and employees.Under the accounting rules of the time, these were not recorded in the financial statements except as a footnote.
The Accounting authorities sought to change to mandate inclusion in the financial statements. Companies, particularly in the tech sector, mounted a campaign against the proposals.
Buffet thought they were wrong and stated his case in a characteristically pithy way.
“What are these options if not compensation?” he asked. If they are compensation, then what are they if not expenses? And if they are expenses, they have to be shown in the profit and loss account?
Buffett's common sense prevailed and stock remuneration is now expensed in the financial statements. The battle was won but Buffet’s war went on, and goes on.
Another example comes from Buffett's involvement with Salomon Brothers. Investment banking is an industry where principles of partnership or stewardship did not hold sway, once firms had stopped being partnerships and became listed companies.
Investment banks are involved in cyclical markets and in times of boom, most of the spoils went to the employees and in times of downturns, the losses accrue to the shareholders. The brightest and the best were attracted to the business because of this “Heads I win tails, you lose dynamic”. There was no partnership. Buffett had made an arguably ill-judged investment in Salomon brothers and fought the good fight. He tried to bring cultural and behavioural change in the organisation. However, the forces of greed and self-entitlement were much stronger than he'd realised. In the end, he was happy to exit this very unhappy encounter with his reputation and his capital intact.
Hedge funds have been a major force in the investment management industry in the last four decades. The managers have sought outside capital with the promise that they could achieve high and positive risk -adjusted returns, irrespective of market conditions. For this promise they demanded and received the fabled 2 and 20 -that is a 2% management fee and 20% of the profits if any. Any losses were fully borne by the investors. It was another heads I win, tails you lose situation. Warren Buffett characteristically said hedge funds were not an investment scheme but a compensation scheme. Of course the compensation in question was for the managers, the hired gunslingers and not the owners of the risk capital.
For over seven decades, Warren Buffett has consistently diligently and successfully been a fair and just partner for investors. He has both walked the walk and talked the talk.
The second aspect I would like to focus on is gratitude and luck. I believe Mr Buffett is extremely grateful for all the opportunities given to him by his family, his city and his country. He has taken full advantage of them and achieved spectacular results. I believe that he would be the first to acknowledge the role of luck and good fortune in his life.
He illustrated this by a theoretical wager which he calls the ovarian lottery.
In this scenario a genie appears 24 hours before you are born. A genie gives you the chance to determine the economic and social system into which you are going to emerge. There is a catch though as you do not have any control over where you would be born. If you play the lottery, you do not know whether you’re going to be male or female, or rich or poor and be born in Bangladesh or Boston.
According to Buffett, if you took the wager, “…you would rationally choose a system that is going to produce an abundant amount of goods which would increase at a rapid rate so that the future generations would have a better life. The system should incentivize the people who won the lottery but at the same time should ensure that the others who didn’t win the lottery have a decent life.”
To be born male in a middle class privileged white family in America in 1930 was in Buffett's view to have one the ovarian lottery.
“The womb from which you emerge determines your fate to an enormous degree for most of the seven billion people in the world,”
Buffett acknowledges the role of luck in his success.
“When I was a kid, I got all kinds of good things. I had the advantage of a home where people talked about interesting things, and I had intelligent parents and I went to decent schools. I don’t think I could have been raised with a better pair of parents. That was enormously important. I didn’t get money from my parents, and I really didn’t want it. But I was born at the right time and place. I won the ‘Ovarian Lottery”
Successful people usually attribute their success to their effort, hard work and application, and not to luck or the ovarian lottery.
People often argue something along the lines “... Surely if I who started with so little have achieved so much, those who have “failed” must be stupid, or feckless or morally deficient or somehow deserving of their ill-luck.”
Mr Buffett is an extraordinary individual, who through focused application, talent and effort has achieved much. However, any objective consideration of his life has to acknowledge the role of luck. Mr Buffett frequently does so.
Buffett was born in 1930, just after the great crash of 1929 when stock markets collapsed, fortunes were wiped out and the global economy was plunged into a terrible depression which did not end till the advent of war in the 1940s.
When Warren Buffett started investing seriously in the early 1950s, the folk memory of the 1929 crash and its aftermath was deeply ingrained in the psychology of the people.
The prevailing belief was the stock market was a risky place, a gambling den where those foolish enough to venture would be ruined financially. They say opinions make markets. The prevailing negativity in the 1950s and 1960s meant stocks were cheap and there were lots of bargains around. There was great scope to find Ben Graham net-nets which were essentially dirt cheap stocks with a huge margin of safety. These low prices prevailed for the best part of 14 or 15 years and Buffett took full advantage of this by investing successfully, growing his clients capital and becoming seriously rich in the process. A New York Times article noted the following:
Over the following thirteen years (to 1966/ 1967), Buffett achieved a compounded annual return of 29.5 percent, and the total fund, including some investments from new partners, grew from $105,000 to $105 million. Buffett's own wealth rose to $25 million.
As time goes on, opinions change, new ideas come to the fore and old ideas die. Memories fade as people who had experienced historical traumas like the crash, slowly disappear.
By the mid 1960s, the fear of stocks had been replaced by speculative enthusiasm. Buffett realised something fundamental had changed and the way he had made money in the previous 15 years was unlikely to be successful in the next 15.
“However, I do believe certain conditions that now exist are likely to make activity in markets more difficult for us for the intermediate future. The above may simply be "old-fogeyism" (after all, I am 37). When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were - not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing large and apparently easy, profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital.”
He implicitly acknowledges the luck of 14 years of favourable market conditions. However, he no longer understood the way the markets and was fearful that he could not adopt the new way of investing without much greater risk of higher losses.
This is a rare attitude amongst investment managers. Most managers attribute success to their own efforts or genius or skill and do not attribute it to favourable market conditions. On the other hand most failures are attributed to unfavourable market conditions.
As one reads about Buffett's extraordinary life story one is struck by luck and “What Ifs”
What if Buffett had not found Benjamin Graham's book in the Omaha Public Library in 1948? He would not have realised that Graham was still teaching a course at Columbia University in New York. He would not have been his star student and his employee.
What if Warren Buffett had not met Charlie Munger in 1959 and cultivated a friendship which has been amicable and productive ever since? Buffett would still have been a great investor but his performance surely would have been much diminished had Munger’s slow influence not shifted Buffett's investment philosophy from Benjamin Graham’s statistically cheap “cigar-butt” stocks to Philip Fisher’s focus on quality stocks at fair prices.
What if a recruitment consultant had not found a IBM manager called Ajit Jain who knew nothing about insurance, but convinced Buffett he had the intellect and strength to turn around his reinsurance business.
We are all products of our time, products of luck and ill-luck, favourable and unfavourable circumstances and anything we must acknowledge the role of luck and the contribution of those who have enabled us to achieve.
For seven decades, Warren Buffett has been an exemplar as a practitioner of stewardship and partnership by dealing fairly with the providers of capital. He has built up a reputation for unimpeachable integrity and trustworthiness.
Despite his great success, he remains a very modest man who will readily discount his own considerable effort and skill. He has often noted the role of luck and good fortune in his life.
For his example in just these two ways, I celebrate the life of Warren Buffett and wish him a happy birthday and many more years of active engagement with the business and investing world.