In future issues of this Unconventional Wisdom newsletter we will be undertaking a detailed analysis into the investment strategies of the most successful investors in the world. The aim of this recurring piece will be to identify what makes the endowment, sovereign wealth and pension funds from around the world so successful, and what our readers and clients can glean from their experiences. As a pre-cursor to this series of articles, we thought an interesting starting point would be to understand how the most quoted person in the world, Mr Warren Buffet, the ‘Oracle of Omaha’ really invests.
It’s difficult to pass through a day without hearing a Warren Buffet quote taken out of context. Seemingly every financial advice, accountant, fund managers, index manager of investor in Australian quotes the Oracle from time to time. Many businesses actually list Warren as the source of their investment inspiration. I’m sure you have seen them before, they may be a one-man investment firm, that lists their investment philosophy around Buffet quotations like:
- ‘Always invest for the long-term’
- ‘Never invest in a business you cannot understand’
- ‘Buy and business, don’t rent stocks’
- ‘Most people get interested in stocks when everyone else is, the time to get interested is when no one else is. You can’t buy what’s popular and do well’
- ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price’
- ‘Forecasts may tell you a great deal about the forecaster, they tell you nothing about the future’
Yet, as it always tends to be in the financial planning, stock broking and investment management industry, the same advisers that publish these quotes, tend to recommend the exact opposite of the values they espouse. For one, they rely solely on economic forecasts and broker research reports to make decisions, whether that is in sticking to a strategic asset allocation or recommending the new stock with a buy. If you ask most stockbrokers or investment advisers, they seemingly always think it’s a good time to buy and its never time to sell. Whilst they constantly stress the importance of investing for the long-term, as soon as markets become volatile, the long-term goes out the window, particularly if you call asking them what they would recommend. Most worryingly, Australian investors tend to chase the most popular companies after they have already gone up. One only needs to review the broker reports on the likes of Newcrest or BHP Billiton over the last decade, or look closely at the excessive multiples, even by US terms, that are afforded to up and coming technology businesses.
So how does Buffet really invest?
For those people willing to take the time to research and consider how Warren Buffett really invests, the approach is markedly different to the perception of a buy-and-hold, fundamental investor. We have summarised Buffet’s investment strategy down to five key factors.
This would likely be Warren Buffet’s most successful investing trait. Buffet’s substantial balance, investing gravitas and influence over markets is such that he is afforded opportunities very few people have access to. Buffet’s Berkshire Hathway made four key investments in the dark days of the GFC following the collapse of Lehman Brothers. The investment in Goldman Sachs was likely the most successful. It came at a time when confidence in the sector had disappeared and share prices were in free-fall. Buffet negotiated with Goldman Sachs to provide capital of $5bn under a preference share and warrant agreement that afforded him interest payments of 10%, dividends and the ability to convert his shares at a discount to the market price in a few years’ time. Berkshire Hathaway provided this offer to a series of businesses when they were on their knees, resulting in outsized returns with markedly lower risk.
Whilst it may not appear so from reading updates on Berkshire Hathaway’s annual meeting, Buffet actually prefers to take control of businesses and move them off publicly listed sharemarkets. Berkshire’s common equity holdings represent just $170bn of the $702bn under management in December 2017. The entire team share his views that the most successful companies are run for their customers, not solely for their shareholders; importantly they know that this can take time. The only way to afford companies an appropriate amount of time is to ensure they are not burdened with the stress of daily market volatility, broker research reports and profit projections. Most of Buffet’s successful investments have been off market, including the famous Geico insurance business, the US railroads and utility networks.
Buffet has been quoted as saying ‘I am a better investor because I am a businessman, and a better businessman because I am an investor’. If this could be said for the majority of advisers, brokers and planner in Australia, we believe their clients would be getting much better results than they have. There has simply been too little interest effort applied to what is in the best interests of clients, which is the key to a successful business, as opposed to selling products for commission.
Aggressive & Involved
Many believe Buffet is somewhat of a passive, fundamental value-oriented investor, however, his actions indicate it’s the opposite. Buffet is inherently an aggressive investor. His firm seeks acquisition and expansion opportunities for his businesses, negotiates and mergers and acquisitions with other portfolio and external companies and is willing to back his views with substantial amounts of capital. When Buffet allocates capital to a business, the ASX’s Insurance Australia Group is one such example, he does whatever he can to ensure it will be successful, offering resources, additional capital, network and management opportunities.
One of Buffet’s greatest traits is no doubt his patience and trust in his management team. Every investment is viewed as a business ‘not as a ticker symbol to be bought or sold based on their ‘chart’ patterns or analyst ‘target’ prices’. The result is that Buffet is willing to wait 5, 10 or 15 years for businesses to provide returns on his capital. He focuses on identifying the strengths and requirements of each business and putting together the best management team possible together. Most importantly, he is trusting enough to let these people run the businesses themselves, and affords them the time, flexibility and capital they need to achieve excellent results.
A quick review of Berkshire’s balance sheet shows that most of their capital is invested into businesses they control, of in which they have a substantial stake and a chair at the boardroom table. Among his direct US shareholdings, the ownership of American Express, Moody’s and Phillips, all exceed 13% of the issue capital, and the ‘smallest’ is the 3% ownership of Apple Inc. making it the third largest investor behind index managers Vanguard and Blackrock. Berkshire does not seek to be a passive investor, they want control of each business and the ability to install their own management team and guarantee success.
This is only a short analysis of Buffet’s investment strategy, if you are interested in learning how you can apply some of these concepts to your portfolio don’t hesitate to get in touch.