Taking note of Warren’s wise words
The Berkshire Hathaway’s annual shareholder letter has always been a special event for this writer as I continue to be a devout follower of Warren Buffett.
Warren is not shy to admit his mistakes, offer timeless wisdom on investing and remind us all of the positive and beneficial nature of markets. No summary can really do justice to his insights and witty writing, so I would urge you to take some time and read the originals, if you have not done so already. The letters can be found here in their entirety:
Below are some of Warren’s highlighted thoughts that I found particularly entertaining and interesting with some of my own commentary.
“From the standpoint of existing shareholders, repurchases are always a plus. Though the day-to-day impact of these purchases is usually minuscule, it’s always better for a seller to have an additional buyer in the market …. Ergo, the question of whether a repurchase action is value-enhancing or value-destroying for continuing shareholders is entirely purchase-price dependent … It is important to remember that there are two occasions in which repurchases should not take place, even if the company’s shares are underpriced.
“One is when a business both needs all its available money to protect or expand its own operations and is also uncomfortable adding further debt. Here, the internal need for funds should take priority … The second exception, less common, materialises when a business acquisition (or some other investment opportunity) offers far greater value than do the undervalued shares of the potential repurchaser.”
For a number of local companies in Bermuda, given their extremely depressed values, the almost unarguable best thing they could do would be to repurchase shares and do so extremely aggressively. One of the most important roles the CEO and board has as stewards of a company is the efficient and effective allocation of capital. Arguably nothing adds more to the value per share of companies than the effective execution of capital allocation.
Fear and Courage
“Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do … 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 … We like to make hay while the sun sets, knowing that it will surely rise again.”
When it comes to investing behavioural impediments involving the paralysis of fear and uncertainty hold many investors back and rob them of excellent sources of future gains. It is rare if not impossible to get great prices with great news.
“Competitive dynamics almost guarantee that the insurance industry, despite the float income all its companies enjoy, will continue its dismal record of earning subnormal returns on tangible net worth as compared to other American businesses … This outcome is made more certain by the dramatically lower interest rates that now exist throughout the world. The investment portfolios of almost all P/C companies — though not those of Berkshire — are heavily concentrated in bonds. As these high-yielding legacy investments mature and are replaced by bonds yielding a pittance, earnings from float will steadily fall. For that reason, and others as well, it’s a good bet that industry results over the next ten years will fall short of those recorded in the past decade, particularly in the case of companies that specialise in reinsurance.”
Warren rarely gives future prognostications but this one seems rather sombre for Bermuda’s largest industry. It is increasingly likely that insurance and reinsurance is not going to be a significant future driver of growth in the world economy nor a huge source of jobs in the developed world. It could be suggested that this is a mature industry now being subject to increasing competitive conditions and technological disruption. Time will tell but at least Warren would appear less enthused by prospects of the insurance industry.
Hedge Funds and Fees
“ … the huge fixed fees charged by all of the funds and funds-of-funds involved — fees that were totally unwarranted by performance — were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”… I estimate that over the nine-year period roughly 60 per cent — gulp! — of all gains achieved by the five funds-of-funds were diverted to the two levels of managers … In my opinion, the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future … 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-neutralising, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.”
The excessive layering of fees in the finance industry continues to be a problem.
Many hedge funds with their high annual and performance fees coupled with another overlapping structure involved with funds of funds seems like highway robbery to me. Even traditional managers who buy funds and then charge another high fee above this only adds to the chances for dismal performance for the investor.
Returns come and go but fees will be persistent. Most active managers underperform for many reasons, chiefly because they really aren’t “active” (more on this in a future article). As Warren also notes, a portion of the blame for the pension crisis we now face is the direct result of the compounding in excessive fees.
Nathan Kowalski CPA, CA, CFA, CIM is the Chief Financial Officer of Anchor Investment Management Ltd. and the views expressed are his own.
Disclaimer: This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their financial advisers prior to any investment decision. Index performance is shown for illustrative purposes only. You cannot invest directly in an index.
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