An Investor's Buffet: Eat Your Own Cooking

Last week saw Warren Buffett mail out Berkshire Hathaway’s annual letter to shareholders. As always, the letter is filled with gems. Below are nine such gems that stood out to me in terms of the way sensible investment thinking is fashioned and great businesses are run.

1. Big Does Not Equal Good, Especially In Investment Management

Buffett makes the point about the relationship between size and performance clearly: “The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue.” This is an important recognition. Whilst Buffett is making the argument in relation to a few hundred billion dollars, the point is valid throughout the investment management industry. Size counts, because investment performance and size are inversely correlated. The bigger you are, the fewer the opportunities.

2. Why Pay For Passive Investment That Poses As Active Investment?

A characteristic of many so-called “active” investment managers is that they tend towards being closet trackers. Their portfolios are heavily weighted to holding index positions and to holding what others in the industry hold. Consequently, a sadly large proportion of active managers deliver market-like performance yet charge active management fees, thereby delivering worse than market results.

In considering Berkshire Hathaway’s relative performance, Buffett notes: “Selecting the S&P 500 as our bogey was an easy choice because our shareholders, at virtually no cost, can match its performance by holding an index fund. Why should they pay us for merely duplicating that result?”

3. Investing Is As Much About What You Do As What You Don't Do

Successful investment management is as much about what you don’t own as it is about what you own. In this regard, Charlie Munger quips: “All I want to know is where I’m going to die, so I’ll never go there.”

4. Hype Kills

Hype is an investment killer. Equally, hype sets the foundation for unhappy clients as expectations become sentiment charged and unrealistic: “We make no attempt to woo Wall Street. Investors who buy and sell based upon media or analyst commentary are not for us. Instead we want partners who join us at Berkshire because they wish to make a long-term investment in a business they themselves understand and because it’s one that follows policies with which they concur.”

5. Forecasting Is Inherently Flawed And Wasted Effort

Despite our industry’s slavish obsession, forecasting is futile. Buffett notes with regard to his and Charlie Munger’s expectations: “We are certain, for example, that the economy will be in shambles throughout 2009 – and probably well beyond – but that conclusion does not tell us whether the market will rise or fall.”

6. Success Will Flow From Finding Your Element And Living It

Great businesses involve the contribution of people who love what they do, and consider their work to be a passion and a privilege. Buffett notes: “We both feel lucky to work at a business we love.”

7. Buffett's Buffet: Eat Your Own Cooking

A true test of a person’s conviction is whether they are willing to eat their own cooking. Buffett notes with regard to Berkshire Hathaway’s investment in the aviation business, NetJets: “... we eat our own cooking ... no other testimonial means more.”

8. On Leadership

On the subject of leadership, Buffett is unequivocal: “Charlie and I believe that a CEO must not delegate risk control. It’s simply too important. At Berkshire, I both initiate and monitor every derivatives contract on our books, with the exception of operations-related contracts at a few of our subsidiaries ... If Berkshire ever gets in trouble, it will be my fault. It will not be because of misjudgments made by a Risk Committee or Chief Risk Officer.” This stance differs sharply from the common business practice of “the buck stops there”.

9. A Rare Example Of The Much-Loved Business School Principle Called "Synergy"

Finally, great businesses can feed great businesses. This makes a rare example of the business school principle of “synergy”. Thus, Buffett signs off his letter imploring the shareholders to come to the annual meeting in Omaha by rail: “P.S. Come by rail”, he writes. Berkshire Hathaway recently made a substantial investment in the rail industry in buying Burlington Northern Sante Fe.

The library of Buffett's shareholder letter can be found at www.berkshirehathaway.com/letters/letters.html. Enjoy the read.

Currency Has Little To Do With Competitiveness

The article below by Chanel Pringle was published in Engineering News in late January. amongst other things, it draws on a talk that I gave at the Gordon Institute of Business Science that considered the outlook for South Africa in 2010 and grappled with the greater issue of South Africa's long-range economic competitiveness The original article can be located here.


Inflation A Bigger Worry Than Strong Rand

Inflation is a bigger problem than the strong exchange rate for South Africa''s competitiveness, and should, therefore, be of more concern, former Rand Merchant Bank economist Rudolf Gouws said on Monday.

Speaking at an economic outlook conference, held at the University of Pretoria''s Gordon Institute of Business Science, he said that there was little the South African Reserve Bank (SARB) could do about the exchange rate, as this was mostly influenced by global occurrences.

He noted that the recent strengthening of the rand had not been as strong as was often assumed. Rather, the currency had regained some of the strength that it had lost during the global economic crisis in 2009.

Nevertheless, the strengthening of the rand had impacted on many sectors, leading to debates about whether the central bank should intervene, or not.

The Confederation of South African Trade Unions (Cosatu) has long demanded a weaker currency and has also called for the scrapping of the inflation targets that guide monetary policy.

Late last year, the ruling African National Congress, Cosatu and the South African Communist Party agreed to look at broadening the mandate of the SARB.

However, Gouws noted that South African policymakers did not have a fixation with inflation targeting at the expense of economic growth and added that the country''s inflation targets of between 3% and 6% were among the most lenient.

South Africa had the fourth highest inflation targeting range out of the 26 countries that used this practice, while the country also had the third-largest inflation rate.

Further, he noted that, contrary to popular belief, there was no global move away from inflation targeting.

The SARB''s scope for influencing the nominal value of the local currency was limited, said Gouws, adding that depreciating the rand would only have lasting benefits if tighter monetary policy were followed.

Depreciating the rand would also lead to higher inflation and raise the cost of acquiring capital goods, while South Africa was still in a long-term fixed investment cycle.

Slow economic growth and unemployment could not be blamed on inflation targeting, he asserted, noting that this was rather a result of shortcomings in terms of skills development, infrastructure, electricity generation and distribution, the State''s capacity and efficiency, the labour market and a low savings rate.

Last week, global ratings firm Standard & Poor''s said that South Africa''s inflation target and flexible exchange rate were the cornerstones of its current macroeconomic framework and warned that a move away from inflation targets could affect the country''s sovereign ratings.

HUMAN CAPITAL

Cannon Asset Managers chief investment officer Professor Adrian Saville , meanwhile, highlighted that the strength or weakness of a currency and cutting the repo rate, would not drastically change a country's prosperity or its competitiveness.

He noted that while these were helpful for business and consumers, the recipe for success, in terms of the national competitiveness, resided in the long-term structural investments in human capital.

If South Africa did not invest and improve the health, education and skills development of its citizens, its competitiveness would not improve.

Saville noted that while South Africa's government had developed a lot of policy to try to improve economic growth and the competitiveness of the country, this has had little impact for the majority of the country's citizens.

He added that the country's policies were regressive, with the poorer citizens becoming worse-off and being given the fewest opportunities.

Further, while South Africa's spend on education was the highest in Africa and among the highest in the world, 80% of schools were "dysfunctional".

The country, including citizens and not only government, had to identify a national purpose towards which it could work.

ECONOMIC GROWTH

Meanwhile, Saville noted that there were some reasons to be positive about South Africa's economic prospects in the near term, despite the economy having experienced its first recession in 17 years in 2009.

These would not shape South Africa's competitiveness, but would make things easier for the country in the coming years, he added.

The low government debt as a percentage of gross domestic product, the strong currency, the high gold price and other commodities and the 2010 FIFA World Cup, could all benefit the economy.

This would allow the country to continue to extend the growth it had achieved after 1994.

Saville noted that since South Africa became a democratic country, it had recorded cumulative growth of 85% in US dollar terms between 1994 and 2008.

This was much higher than the 36% average cumulative growth recorded by other democratic countries over the same time frame, as well as the 7% cumulative growth achieved by nondemocratic countries between 1994 and 2008.