Category Archives: Local Charterholders

3 Ideas to Implement Today from Buffet’s Annual Letter

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Adam Schwab, CFA, CFP

Warren Buffet’s annual letters are usually packed with interesting insights, but for the past couple years I had been a little underwhelmed by his thoughts. This year’s letter was the exception. As I read the letter for the second time, I realized Buffet laid out exactly how an investor should construct an investment portfolio and evaluate businesses. Although investors won’t find actual recommendations, he delivers something more valuable: a framework for selecting and analyzing businesses that any serious investor can follow. If these lessons make sense to you, you will want to read the entire letter here.

It’s ironic that the lessons seem logical and obvious as he describes them, yet 90% of investors (both individual and institutional) will completely fail at following half of his advice. We can attribute that to attention spans of zero and the general get rich quick mentality. If investors can avoid those handicaps, this year’s letter was a real goldmine for investors who are looking for a sensible way to think about investing.

Although he gives his secrets away for free every year, implementation is always the hard part! I picked out a few of the best and most practical insights that you, the investor, need to follow. By shamelessly stealing Warren’s investment principles, you will be 95% of the way to an effective investment portfolio. Now, the lessons…

One: Businesses > Treasuries

Warren wasted no time describing the tremendous outperformance of U.S. businesses over US dollar denominated bonds over the past half century. As most investors flock to “safe” U.S. treasuries, Warren’s extols the impressive track record of owning American businesses over long time periods. The common perception that stocks are risky and bonds safe is completely discredited by the long term data. Of course, this is no absolute guarantee this will repeat in the future. But consider what you would rather own for the next 30 years: a sensibly priced business that can compound value at 10-15% per year or a 30 year treasury delivering 2.7%?

Investing should be thought of as buying businesses, not trading stocks. Buffet has slowly and methodically built his portfolio of great businesses without the manic-depressive emotions that occupy most investors. Your portfolio should be structured the same way. If you have the time and aptitude to evaluate businesses, wait until they go on sale, and then start building your portfolio.

Two: What Matters Most: Durable, Competitive Advantages

Buffet highlights one the best but most forgotten elements of investing. Warren and Charlie own businesses with durable competitive advantages that can compound value over time without needing excessive capital investment. Notice how he didn’t mention fast growth, growing market share, exciting technology, or world-changing products. He distills a great business into one line.

But how quickly do most investors forget what really matters! 99% of investing conversations revolve around superficial topics that are heavy in excitement but rarely touch on the elements of investment success. Do your investments satisfy this simple test? This idea is powerful because 1) it’s free and 2) most investors won’t use it! Resist the urge to fool yourself into thinking you can ignore this advice and “beat the market”. Your portfolio will thank you.

Three: Price Matters

Although Buffet expounds on the promise of great businesses, he doesn’t pay any price for them. Even Buffet admits that at close to 2x book value, Berkshire may likely see price declines in the near future. How refreshing to have a CEO give an honest assessment of the stock price! Not many CEO’s admit their companies are priced to perfection; in fact today most CEO’s are paying egregious prices for their own stock!

Great businesses still need to be bought at sensible prices! What is sensible is debatable, but if your business evaluation skills are sufficient it’s generally achievable to be roughly right on the price. Great businesses are not on sale very often, but it certainly happens. The key is buying with deployable cash to pounce on opportunities (The 2008-2010 timeframe being the last great opportunity).

Price is an area where most investors screw up. We are hardwired to buy high and sell low, and even the best businesses make poor investments when bought at the wrong times. Activity will be skewed toward inaction 90% of the time, but the other 10% will provide incredible opportunities to pick up wonderful businesses at bargain prices.

Bonus: Charlie Munger’s Thoughts

Followers of Berkshire know the wisdom of Charlie Munger. Charlie didn’t disappoint as he gave us a few pages of insight in this year’s letter. I’ll leave you with one piece of advice that applies to both investing and life. Here Charlie describes one of the many aspects of how Warren set up his system for Berkshire Hathaway:

“His first priority would be reservation of much time for quiet reading and thinking, particularly that which might advance his determined learning, no matter how old he became…”

What great advice for investors and people in general! Notice he didn’t mention checking stock prices, scheduling meetings, or email. Great investors and great ideas are not built from at frantic pace at which the market operates. The compounding of knowledge over time will pay some large dividends if you don’t interrupt the process!

There is a treasure trove of great advice from Warren and Charlie on the Internet. Let me know and I can directly point you to the best material out there.

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Adam Schwab is a portfolio manager at Elgethun Capital Management. Prior to joining Elgethun, Adam was a portfolio manager at the South Dakota Investment Council. He managed a $250 million large-cap global equity portfolio for 5 years and a $90 million SMID portfolio for 3 years. Adam is a CFA charterholder and a CPA. He has an MBA from the University of Chicago Booth School of Business and a degree in Finance from the University of South Dakota. He currently serves as a Trustee for the University of South Dakota and also serves on the boards of the Sioux Falls City Employee’s Pension Fund and Alta Trust. Outside of work, Adam has been married to his wife Sarah for 6 years. He is active in powerlifting, competitive taekwondo, and the outdoors.

An Evening with a Portfolio Manager (Thirty Years Ago)

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Tom Brakke, CFA

Those of us who are packrats (it’s harder to identify one these days, when PDFs pile up on the computer rather research reports being stacked on desks in plain sight) sometimes actually go back and look at some of what we have saved – just as we imagined that we would.

If you are of a certain age, the cache of documents might provide a certain nostalgia, some historical perspective, and quite a bit of “shoulda, woulda, coulda.” Just today, I found an interesting article on Michael Milken from a 1986 issue of Institutional Investor, a 1977 Morgan Stanley piece by Barton Biggs on the craft of asset management, a “conversation with Richard Feynman” on a range of interesting topics, and articles that had been copied on a “Xerox machine” which argued back and forth about whether active managers could beat the market (some things never change).

I also discovered a page of notes written in my own hand, from thirty years ago, with the title, “An Evening with __________.” I was pretty new to the business at that point; the small cap growth portfolio manager whose name was in the blank was on a rocket ship of performance and business success.

The night had started out in a dismal fashion. We were to be hosted by a broker at Il Mulino in New York City, one of the hottest places in town, but when we got there we found that a pipe had burst and that we would be dining elsewhere. (As we left the restaurant, we informed a man getting out of a taxi that he was out of luck. He waved us off and said, with an air about him, “I’ve got a reservation.”)

We walked down the street, found another place to eat, and had a great conversation. With a few explanations and clarifications [which are added in brackets], these are the notes I wrote down shortly thereafter about the advice that I had received:

“Work for one of the 10-15 great managers for free for 5 years.”

“Learn all you can, find yourself, fit your style to yourself.”

“Don’t let it get to your head if you do well.”

“Play the game and have fun – you gotta like it.”

“Use everyone, even contrary indicators.”

“Know human nature – not business – read Panic on Wall Street.”

“Sell when there’s a slip [by a company].”

“[Ask yourself], which small companies will get to $1 billion?”

[At this point, there were a few disparaging comments about the investment abilities of some of my co-workers, including one he called “a stopped clock”.]

“If you knew that a stock was going to go from $30 to $15, but that it was guaranteed to go to $300, you should be willing to buy it right away (and institutions won’t do so).”

“Ask questions; don’t worry [about how you’re being viewed]; one in ten will catch a management off guard.”

[Then, in my notes, there was just the name of a person; I’d love to remember what was said about him.]

“Make mistakes; see stocks go from 35 to 1.”

“Don’t kill the messenger.”

“Don’t think conventionally.”

“Buy people.”

“You need some clean-up hitters [big winners].”

“Learn the basics; adapt your style; be unique.”

All these years later, it is interesting to read the portfolio manager’s comments – and to think about them in light of the events of his career as it unfolded, and of my own.

When I encourage young analysts to study other investors and learn from them (even over dinner), I sometimes forget to tell them how personal the advice they receive will be. The notes I found matched the man I watched in subsequent years – focused on high-risk, high-return companies, entrepreneurial, outspoken by instinct, and, it should be said, lucky in a number of respects (although he took advantage of that luck when it presented itself).

His advice would be ill-fitting for so many (after all, you should “fit your style to yourself”), and parts of it match the world of 1985 better than that of 2015. But it stands up pretty well overall.

I knew I saved that sheet of paper for some reason.

A Successful 2015 Annual Economic Dinner

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More than 500 people packed the Marriott City Center ballroom for our 2015 Economic Dinner featuring Jim Grant, founder and publisher of Grant’s Interest Rate Observer. Jim spoke with wit and insight about the causes and implications of our current zero-interest-rate environment. Zach Pandl, Portfolio Manager and Strategist at Columbia Management, moderated the Q&A session immediately afterwards.

Click here to read “Low interest rates have us in uncharted territory,” a recap of Jim’s presentation by Star Tribune columnist Lee Schafer.

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Photos Credit: Knoebel Portrait Design

Thought Leadership by Investment Organizations

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Tom Brakke, CFA

Over the last few years, there has been a noticeable increase in electronic communications from asset management and investment advisory firms. As clients have gotten more and more comfortable online, organizations have tried to reach them through blog postings and tweets and electronic white papers and Facebook status updates and LinkedIn Pulse dispatches and emails (lots of emails).

The activity is largely an exercise in brand awareness, filling nearly every channel with something. But what?

Some firms openly aspire to a position of “thought leadership,” although, in the minds of many, that’s an empty term these days. It’s certainly overused. A lot of companies talk about their thought leadership, there are openings posted for jobs that carry the title of “thought leader,” and there are webcasts, seminars, and conferences that use the term to describe the presenters that are being promoted.

Joel Kurtzman, who is given credit for coining the phrase, agrees that it has become “diluted, and largely meaningless.” His intent was to identify genuinely original work – the kind that leads to real breakthroughs. Instead, “thought leadership” has become a sales tool. Kurtzman says that “it can’t be real thought leadership if the only answer is ‘buy my product.’ That’s marketing.” Consequently, he doesn’t use the term any more.

Proclaiming yourself or your organization as a thought leader can run the risk of being viewed as too promotional, short on both innovative thought and actual leadership. (A recent tweet from @PlanMaestro summarized what he found when doing a search on the term: “Funny stuff since 2010.”)

Therefore, investment organizations need to think carefully about how they use the phrase in positioning themselves and their professionals. But, throwing the label aside, what should they be trying to do across all of the communication channels at their disposal these days?

They could start by considering the advice provided by Gordon Andrew in a recent newsletter on “Marketing Alternatives” from BarclayHedge: “True thought leaders seek to manage rather than to control the conversation. They determine the issues and voices worthy of attention, but do not exclusively push their own perspective. They also shine a light on the ideas of clients, prospects, referral sources and recognized authorities. By displaying the self-confidence to share the microphone, they are viewed as legitimate opinion leaders, not simply carnival barkers.”

By that standard, most investment firms fail miserably. They promote their products, they talk their portfolios, and they seem disconnected from ongoing debates about important investment issues. Their communications instead revolve around the headlines of the day and the squiggles of market activity. Plus, they provide constant predictions of this and that, most of which end up being wrong anyway. (Need we bring up the interest rate and crude oil forecasts?)

A big part of the problem is that most firms can’t ever get out of asset-gathering mode. So, blog postings leave out important issues that a balanced analysis would include, and anything that would be viewed as hurting the firm’s case never sees the light of day. A [fill in the blank] asset manager is always ready to defend [fill in the blank], despite the analytical gymnastics that might be required to make the case.

For example, as valuations have increased on stocks, there has been some “shopping” for more attractive valuation comparisons and a muddying of the terminology used; sometimes it amounts to a perversion of the historical record and outright fudging of the truth. And, earlier this year, many high yield bond managers were particularly outspoken (and one-sided) in their defense of the sector, even as other observers noted the risks of those vehicles in comparison to the apparent prospective returns.

Investment advisors face similar temptations too: Giving the whole story sometimes increases the chances that you will lose assets. In an industry that runs on assets-under-management fees, that’s a line in the sand at most firms.

So, long-term credibility is sacrificed to protect today’s business model. Is there a cost associated with that?

Look at sell-side analysts. They are very well versed in the companies and industries that they follow and can serve as great sources of information if you know how to use them. But they have long since been viewed as marketers first and foremost, extensions of the interests of their firms instead of true objective observers of a situation on behalf of their clients. (Something we were reminded of again recently.) As a group, they provide a case study of the principal-agent problem in finance, defined by information asymmetry and misaligned incentives between the parties.

Real thought leaders minimize those problems by focusing on the merits of ideas, not on the potential impact of them on their own book of business. That’s a tough standard indeed, one rarely met in the investment world.

Therefore, investment organizations usually come across as mere pushers of product, not true partners with their clients, and certainly not thought leaders. Does that matter? Time will tell, but perhaps authentic voices increasingly will be recognized and trusted in a way that conflicted ones will not be. Oddly enough, going beyond the party line today might end up being a powerful way of building a lasting brand and, yes, being seen as a thought leader rather than just another voice in the marketing din.

Happy Thanksgiving from the Freezing Assets Editorial Board!

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We at Freezing Assets would like to wish everyone a very Happy Thanksgiving. We are thankful for a lot here at our blog. First and foremost, we are thankful for your readership. We value your time and attention more than anything, and we know that you have thousands of other reading options so we appreciate you choosing us.

Additionally, we are thankful for our contributors. Like every other website, our content is everything to us. Nothing happens without it. Here at Freezing Assets we are blessed with many outstanding local volunteer content contributors. This is what makes our site unique—excellent and diverse material submitted by our peers and friends for our CFA Minnesota members.

Though this is a site specifically designed for our region, others are taking notice. In fact societies around the country have either launched a site like ours (e.g. CFA Society Chicago), or from what we hear are in the process of starting or considering one of their own based on the success we have had with Freezing Assets.

That is just one reason we feel blessed this Thanksgiving. Let us know what you think of the site, and how we can make it more useful for you. Better yet, consider becoming a contributor yourself. Just write to info@freezingassets.org, and we’ll let you know how to get started. It really is very easy. If you wish to help out in other ways besides writing, that’s great too. We take all comers.

Thanks for your readership, and everyone at the CFA Society of Minnesota for making Freezing Assets special.

 

Have a great Thanksgiving,

The Freezing Assets Editorial Board