I love reading Warren Buffett’s letters. I love contrasting his words with his actions.Daniel Loeb
Those were the words spoken by Daniel Loeb, activist investor and founder of the $17 billion hedge fund Third Point, at a hedge fund conference in Las Vegas on Wednesday after the moderator asked him which books he enjoys.
“I love how he criticizes hedge funds yet he really had the first hedge fund.
He criticizes activists. He was the first activist.
He criticizes financial services companies yet he likes to invest with them.
He thinks we should all pay more taxes, but he loves avoiding them.
There’s a disconnect between his wisdom and his [actions].”
His comments were met with cheers and applause from the thousand or so hedge fund managers in attendance.
Media outlets picked the story up quickly and soon headlines followed, all with some variation of “Loeb Trashes/Bashes/Slams/Unloads on Buffett.”
It’s no secret that Buffett’s not a fan of hedge funds. He’s even been willing to put his money where his mouth is.
In 2008, Buffett bet $1 million of his own money that an S&P 500 stock-index fund would outperform the cumulative returns of five funds handpicked by Protégé Partners LLC, a New York money manager, over the course of a decade. Mr. Buffett disclosed at Berkshire’s recent annual meeting that the Vanguard 500 Index Fund Admiral Shares is up 63.5%, while the Protégé funds are up by an average of 19.6%. The winner of the bet will get to pick a charity that gets the $1 million.
While I do believe many journalists are using sensationalist headlines just to grab attention and are blowing Loeb’s comments out of proportion (especially as Loeb seemed to regret what he said afterwards), his comments do raise an interesting point:
Many people feel that Buffett’s actions are incongruous with his words.
For the most part, I don’t agree with these people. So let me first clarify Loeb’s comments.
On hedge funds:
It’s true that Buffett employed many hedge fund-like strategies in his early partnerships and even when he worked for Ben Graham, including shorting stocks and related hedges. But Buffett’s biggest criticism has not been on hedge funds’ strategies but on hedge fund managers’ compensation system.
Most hedge fund managers employ a “2-and-20” structure, whereby they pay themselves an administrative fee of 2% of assets whether they make money or lose it, and 20% of annual profits. The “2-and-20” structure promotes enlarging a fund’s size and rewards nonperformance.
When Buffett made the bet with Protégé Partners it was because he believed that the fees charged by hedge funds would outweigh any overperformance by the fund manager. And so far he’s been right.
Buffett has never used the 2-and-20 compensation structure. His entire net worth has always been in the form of Berkshire equity, and his fortunes and Berkshire shareholders’ fortunes have always moved exactly together.
True, Buffett was a bit of an activist. But that was only to release untapped value within a company. Many of today’s activists are doing the opposite.
I can’t think of any activists I’d want to marry into the family.
For example, many activists today will press companies to repurchase shares in order to boost the stock price – not because the stock is undervalued but simply because the company has large amounts of cash on its balance sheet.
Activism in general is not a bad thing – and in fact can be quite beneficial. But not when an activist investor is destroying a company’s long-term value in search of short-term profit.
As Charlie Munger said at this year’s Shareholder Meeting: “I don’t think it’s a great age – this age of activism… I can’t think of any activists I’d want to marry into the family.”
On financial services companies:
I’m not sure what Loeb’s point is here. Not only does Buffett invest with financial services companies, he invests in them too (GEICO, Wells Fargo, Goldman Sachs, just to name a few).
What Buffett has criticized is not financial services companies in general, but excessive risk-taking by banks and any use of complex derivatives instruments, which he called “financial weapons of mass destruction” in 2002 (only a few years before products like CLOs helped to bring down the global economy).
This was something of a cheapshot, directed at Buffett’s investment in Burger King which used an “inversion” strategy after acquiring Canadian Tim Horton’s.
Buffett is a very shrewd businessman. I don’t doubt for a minute that he does what he legally can in order for Berkshire Hathaway to pay as little in taxes as possible.
But Buffett’s biggest beef has always been with personal income taxes on the very wealthy, the top 1% of the country, and not so much on corporate taxes.
Now that we’ve cleared up Loeb’s specific points, we can address the general idea that “there’s a disconnect between [Buffett’s] wisdom and his [actions]” – which is something I’ve actually heard several times before.
I can’t disagree with the fact that Buffett hasn’t always lived true to everything he’s said. Despite his aversion to leverage, Buffett invested with borrowed money (i.e., margin) at a point when he was younger; and I was surprised to recently learn that he studied the silver market for a while years before – despite the fact that he’s said that precious metals are not a good investments because they have no real useful economic value or cash flow (although to be fair, his trial with investing in silver did not last very long because his returns from it were pretty poor).
However, there is one topic for which Buffett’s actions have always matched his words: his reputation, his trustworthiness, and his ethical nature.
Buffett has never lied for profit. He has never said one thing for the purpose of covering his actions while doing the opposite. And he doesn’t “talk up his book” – meaning he doesn’t untruthfully speak positively about the stocks he owns in order to boost their prices (he has even stated that if anything, he would do the opposite so that he could buy more of the stock at lower prices).
For this reason, I don’t mind the minor incongruities between Buffett’s words and actions, especially when the inconsistency is between words spoken and actions committed decades apart.
Furthermore, Buffett himself has stated that he and Charlie are constantly evolving and improving on who they are as people and how they invest.
So when Buffett speaks, it has always been about what he believes to be the ideal state of things at the time. In other words, it doesn’t matter much what Warren is doing – when he talks, you better be listening.