Investing lessons from Buffett and Munger

The shareholder meetings of Berkshire Hathaway have turned into an annual pilgrimage for stock investors, attracting fund managers and high-net-worth folks in droves. But this year, the jamboree and the open house Q&A session with Warren Buffett and Charlie Munger threw up many pearls of wisdom for mutual fund investors, too. Here are some we distilled for our readers.

Not a good alternative
Every bull market brings with it a new fad for high net-worth investors (HNI). In India, the current HNI fad is AIFs or alternative investment funds. In the last few years, quite a few whiz-kid fund managers have quit the mutual fund industry to start or manage new AIFs that dabble in long-short, long-only and derivative strategies.

But if you've been ruing that you don't have `1 crore to invest in an AIF, you can take heart from this.

Brent Muio from Winnipeg, who worked for a pension fund, asked for Buffett's take on alternative investments. Buffett's straight response was that he was not excited by alternatives. He cited three reasons.

One, when you leverage to invest in equities, you can make extraordinary returns when the going is good, but you can also make some very damaging mistakes. Those mistakes are not really related to how smart the fund manager is. Buffett says, "We saw people with really extraordinarily high IQ destroyed by leverage. In Long Term Capital Management (a hedge fund which failed in America), you had people who could do maths in their sleep that I couldn't do during the day. But it all turned into pumpkins and mice in 1998."

Two, return calculations on alternatives are 'not honest'. Alternative funds, being closed-end often don't realistically mark down their holdings if there's market panic.

Three, the fee structures of alternative funds, which typically involve a fixed fee or a 'two-and-twenty' structure offer a very one-sided deal to the investor, who is locked in for many years (a two-and-twenty structure is where the fund manager gets 2 per cent of assets plus 20 per cent of profits). Buffett remembers asking an alternatives manager once, "How in the world can you ask for two and twenty when you really don't have any evidence that you are going to do better than the index?" To which the fund manager replied, "Because we can't get three-and-thirty!"

In short, Buffett thinks alternative funds are to be avoided for their use of leverage, their high fees, their lock-ins and lack of transparency.

Don't worry about style
When asked about their investing style, most fund managers in India like to describe themselves as bhakts of value investing. Equity funds like to hold forth on how they swear by value, growth, or 'growth at a reasonable price' styles of investing. But Buffett, in this meeting, rubbished the notion that the value and growth investing are two different things.
An investor asked Buffett if Berkshire was turning away from its value-investing principles by buying the Amazon stock in a heady bull market.

Buffett struck back saying that people buying Amazon were as much value investors as Buffett himself was in his early years. The common perception that value investing is all about buying stocks that are at a discount to their book value or trading at a low price-earnings ratio is all wrong.

All investing, he says, is about putting some money in now to get more later on. It's the same calculation you do, whether you're buying a bank at 70 percent of its book value or Amazon at a high P/E. Taking a diversion to Aesop's fables, he explained that all investing is based on estimating whether a bird in hand was going to be worth two, three, four or 10 in the bush.

Munger also chipped in to admit that Berkshire 'screwed up' by not identifying Google as a blockbuster stock in its early days. In fact, Buffett emphasised that the quality of the business comes first in his reply to another question about Kraft-Heinz, too. Though Buffett started out in his career by swooping in on 'cigar butt' stocks (cheap stocks that may or may not have an excellent underlying business) that is no longer his preferred style. "You can turn any investment into a bad deal by paying too much for it. But you can't turn any investment into a good deal by paying too little for it."

What fund investors can take away from this is to not to pay too much attention to whether the funds they own are value or growth style. Simply look for funds that have been consistently good at identifying businesses with profit growth that justifies their buying price.

When less disclosure is more
How much should money managers reveal about their portfolios? While some fund houses in India are open to long debates on their sector and stock-specific calls, others refrain from it by policy.

Buffett surprisingly endorses the second camp - the one that makes less portfolio disclosure - when an investor asked him why Berkshire, which holds over $200 billion in stocks, doesn't talk much about portfolio performance.

He simply said, "We're not in the business of explaining why we own a stock. We're not looking for people to compete to buy it." His logic is that when you tom-tom your stocks, it gets harder for you, as a money manager and for the company doing stock buybacks, to acquire the stock at a reasonable price.

Buffett believes if he were to go out and announce to the world that a stock is undervalued or overvalued, that would move the price and make it harder for Berkshire to move in or out of the stock. He also considers his firm's insights on sectors and companies to be proprietary information, not to be shared in public.

The valuable lesson for Indian fund investors is that they shouldn't flock to fund managers or big investors who discuss their stocks at length in the media. A fund manager who gives few interviews and refuses to discuss stock-specific calls may be doing a better job with your money.

On a related note, fund investors should also get out of the habit of trying to second-guess their manager's calls. If you have been digging deep into your mutual fund portfolio to see if they own too much exposure to NBFCs, the Zee group or DHFL, it is best to refrain. Once you've handed over your money to a good professional manager, don't go overboard analysing month-end portfolios and doubting every position.

The winner's curse
An astute investor asked Warren Buffett what he would be doing if he had only a million dollars to invest instead of many billions.

Buffett's take was that with a million dollars, a 50 per cent return was not difficult. But "when you change that million to a hundred million, the 50 per cent goes down like a rock." This is because large amounts of money introduce 'little inefficiencies' that add up over time.
Munger also backed Buffett on that one, saying that generating equity returns became harder and harder with large amounts of money. "I've seen genius after genius with a great record and pretty soon they got $30 billion and two floors of young men, and away goes the record."

Even the biggest mutual funds in India are at a fraction of Berkshire's size. But the insight is that the strategies that small funds use to generate big returns may be harder to replicate as they scale up.

Life lessons
Finally, as people who've made it big rather late in life and who have a ball at work (Buffett is now 88 years old and Munger is 95), the pair are quite good at dispensing life advice.

So, when asked what they value most in life, Buffett and Munger list just two things - time and love. Wealth basically frees up a lot of time to do what you like.

When a 13-year old boy from San Francisco asked Buffett how he could develop the quality of delayed gratification, which seems to be the key to success, he got an unexpected answer. Buffett pointed out that pushing your needs and wants to the future is not a good idea at all times. For instance, if you told your kids that if you saved money today and never went to the movies or Disneyland, they would be able to spend weeks in Disneyland thirty years later, that would be quite stupid. One can't enjoy Disneyland quite the same then. He advises spending money on stuff that brings you great enjoyment and not putting it off.

He also has wisdom to offer on money and happiness. "A certain amount of money makes you feel secure. But loads and loads of money never made anyone happier." Make enough money not to have to worry about it. But being super rich doesn't really make you happy.