In 1956, when he was just 25 years old, Warren Buffett formed Buffett Partnership, Ltd.
Buffett started with $105,100 and seven limited partners: his mother, sister, aunt, father-in-law, brother-in-law, college roommate, and lawyer. He charged no management fee, took 25% of any gains beyond a cumulative 6%, and agreed to personally absorb a percentage of any losses.
By 1962, Warren Buffett became a millionaire because of his Buffett Partnership, which in January 1962 had a value of over $7 million (of which over $1 million belonged to Buffett). Yet four years later, Buffett announced that he would no longer be accepting new partners.
Following this announcement, Warren Buffett continued to run the partnership, and he continued to crush the stock market. In 1968 the Buffett Partnership returned 58.8% vs. 7.7% for the Dow – Buffett’s best year ever.
By 1969, $100,000 invested in the Buffett Partnership in 1957 would have become $1,719,481! If you had invested the same amount in the Dow, it would have only grown to $252,467. For over a decade, Buffett achieved an annual compound return of 24.5% net of fees (29.5% before fees). The annual return of the Dow over the same time with dividends? Only 7.4%.
And yet despite all of this success, Warren Buffett announced to his limited partners in May 1969 that he would be closing down the Buffett Partnership.
Warren Buffett was young, he was having extraordinary success, and he was having to actually turn away investors.
So why did Warren Buffett decide to close down his investment partnership in 1969?
…Because of one word: Integrity.
The Buffett Partnership Letters
As Michael Batnick over at The Irrelevant Investor points out, Warren Buffett was essentially a blogger 60 years ago via typewriter – just as Buffett writes an annual letter every year for Berkshire Hathaway shareholders, he also wrote many letters to his limited partners.
In January 1967, after a decade of incredible results, Warren Buffett warns his limited partners to dial back their expectations.
The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade.
In October 1967, Buffett explains why his investors why he didn’t think he’d be able to achieve the same results as before.
Such statistical bargains have tended to disappear over the years… When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were – not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing large and apparently easy profits to embrace an approach which I don’t fully understand, I have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital.
Buffett is saying that the easy bargains he was finding before are now few and far between. He acknowledges that it’s easy to say that new investing approaches are bound to lead to trouble while blindly clinging to the past, yet he is unflinching on one point: that he will not abandon the investing strategy that he understands – even if it means lower profits – in favor of a new investing strategy that he doesn’t understand which could cause him to lose his and his investors’ money.
In July 1968, even after the Buffett Partnership’s best year ever, Buffett continues to stand his ground.
At the beginning of 1968, I felt prospects for BPL performance looked poorer than at any time in our history… We established a new mark at plus 58.8% versus an overall plus 7.7% for the Dow, including dividends which would have been received through the ownership of the Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge game.
In May 1969, Warren Buffett says he’s running out of really great ideas. Buffett says he could take some chances and gamble with his investors’ money so that he can go out a hero, but he refuses to do so.
Quite frankly, in spite of any factors set forth on the earlier pages, I would continue to operate the Partnership in 1970, or even 1971, if I had some really first class ideas. Not because I want to, but simply because I would so much rather end with a good year than a poor one. However, I just don’t see anything available that gives any reasonable hope of delivering such a good year and I have no desire to grope around, hoping to “get lucky” with other people’s money. I am not attuned to this market environment and I don’t want to spoil a decent record by trying to play a game I don’t understand just so I can go out a hero.
Finally, in October 1969, Warren Buffett essentially retires (briefly) from investing and closed down the Buffett Partnership.
In his final letter, Buffett writes his partners a 10 page explanation of why he recommended tax-free municipal bonds – even offering to sit down with each of them individually to explain the rationale, as well as make the actual purchases for them. But for those who wished to continue to invest in stocks:
I feel it would be totally unfair for me to assume a passive position and deliver you to the most persuasive salesman who happened to contact you early in 1970.
So Buffett recommends his clients invest with his Columbia classmate, Bill Ruane – not because he was the best investor Buffett knew besides himself, but because Buffett viewed him as a man with great integrity and moral character (remember, most of Buffett’s limited partners where his family and close friends). According to Buffett, Ruane was “the money manager within [his] knowledge who ranks the highest when combining the factors integrity, ability and continued availability to all partners.”
Bill Ruane, as history would have it, turned out to be a legendary investor in his own right, and his Sequoia Fund returned 289.6% over the next decade, versus 105.1% for the S&P 500 (he’s also included as one of the superinvestors in Buffett’s The Superinvestors of Graham-and-Doddsville).
Investing with Integrity
There are several key themes from the Buffett Partnership story that have carried on throughout Warren Buffett’s career.
One of these is his focus on his investors and shareholders. Warren Buffett is a true American capitalist, and any good capitalist knows that there are two types of people in any capitalistic organization: principals (who own the organization) and agents (who act on behalf of the principals) (see The Principal-Agent Problem). For a company, the principals are the shareholders and the agents are the managers, who are hired by the shareholders to run the company on their behalf. For an investment fund, the principals are the limited partners and the agents are the general partners (i.e. the fund managers).
In all cases, it is very easy when you are the a shareholder or limited investor (i.e. the principal) to expound on how important it is for managers to always act in the best interest of the shareholders’ (i.e. to act in YOUR best interest). But when you’re the manager, do you really think you’re going to put the shareholders first? Or will you put your salary, your bonus, your job security, your perks, and your personal ego first? I’d say in 9 times out of 10, the manager puts himself first – it’s really only human nature.
Warren Buffett, of course, is in the 1 time out of 10 category. As CEO of Berkshire Hathaway and as the investment manager for the Buffett Partnership, Buffett has ALWAYS put his shareholders’ interests first. This is clear when you read any of his letters. And it’s pretty easy to understand why he acts this way: he has virtually all of his wealth tied up in Berkshire Hathaway (and over 90% of his wealth was in the Buffett Partnership), so he is also one of the largest principals as well as the agent. Other investors also include his family and closest friends, making it even more important to Buffett to act in their best interest.
But there is another reason why Buffett acts this way, and that’s because of his integrity. In the whole Buffett Partnership saga, you can see how Buffett acted with integrity toward his limited partners, and how he acted with integrity in regards to his investment strategy – he was unwilling to try a new, untested method just because it was becoming harder and harder for him to continue with his tried-and-true approach. He even closed down the partnership because he refused to gamble with his LPs money, even though he could’ve gone on for at least several more years. Finally, after he closes the partnership, Buffett even hand picks a new fund manager for his partners – not based on his resume or his IQ – but based on his moral character.
The story of the Buffett Partnership is a pretty rare one in the world of finance. After 12 remarkable years, Buffett feels like he’s run out of really great ideas, so he closes the partnership down. That is like Jim Brown retiring at age 29 – at the peak of his career – after only 9 seasons.
But Buffett, of course, did not really retire, and he went on to build Berkshire Hathaway into one of the world’s largest and most valuable companies. And as it turns out, when Buffett closed down the Buffett Partnership, he paid his partners in Berkshire stock. When Buffett first bought Berkshire Hathaway stock for the Buffett Partnership in 1962-65, he paid $7.60-$14.86 per share. Today, Berkshire Hathaway stock trades for over $215,000 per share.
Using the letters Warren Buffett wrote to his partners between 1956 and 1970, veteran financial advisor Jeremy Miller presents the renowned guru’s “ground rules” for investing—guidelines that remain startlingly relevant today.
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