2nd May 2014
Tens of thousands of US investors will fetch up in Omaha, Nebraska this Saturday. It’s not Wall St, or the City of London or Tokyo or Frankfurt but for those making the trip, it is the centre of the financial world.
Even UK investors have heard of Omaha, although precious few could place it on a map. For it’s the home of Warren Buffett, probably the most successful investor over the past fifty years – perhaps ever. His idiosyncratic letters to investors are seen as the Holy Grail – and he has certainly delivered the promised financial land to his loyalists. Buffett’s investment vehicle – Berkshire Hathaway – is one of the world’s top ten companies, valued at over $300bn, roughly on a par with Microsoft, although still short of Google, Exxon, and Apple.
But the “Sage of Omaha”, as his fans call him, is 83. And while he is hailed as the exceptional disproof of theories such as the efficient market hypothesis (which suggests that all investment strategies and all investment managers must fail to beat the averages over time), both he and his followers know that he cannot beat mortality. Tony Levene looks at the issues.
Who can follow the Sage?
Omaha will be full of “succession chatter”, with investors asking who could continue his market beating strategy. They are obviously hopeful that a new sage will arise. But they have to be realistic. Buffett may well have been a one-off, taking advantage over the past half century of conditions that will perhaps never be repeated.
They fear this is their Manchester United moment, and as United is listed in New York, some will have heard of it. The Reds had an unprecedented run of success under the quarter of a century Sir Alex Ferguson managerial reign. He appointed David Moyes, who had been feted at Everton, as his chosen successor around this time last year. It was not to be – as anyone who reads the sports pages knows.
Football followers can argue over what went right for Ferguson and wrong for Moyes. They can also discuss whether Ferguson should have had such a say in his successor’s appointment.
But although the passion is undoubted, the money at Berkshire Hathaway could buy the entire Premier League many times over.
What is Berkshire Hathaway?
Unlike the other mega US companies listed above which are all household names with clear products, Berkshire Hathaway is halfway between a conglomerate and a super investment trust. It has huge long term stakes in companies as disparate as General Motors, Moody’s, Goldman Sachs and Wal-Mart.
The question investors must ask is whether a Buffett Mk II is either possible or desirable. Some don’t believe Berkshire Hathaway can continue – they say it should be broken up in more manageable bites or sold off altogether.
Just as Ferguson’s final years were with an ageing team, Buffett’s last half decade has been far from spectacular. Berkshire Hathaway has failed to beat the S&P 500 over the past five years – the firm’s chosen benchmark.
Will past performance replicate in the future?
The shares have risen from $11 to $190,000 over the past fifty years, but most of the stellar performance years are in the past. Ferguson suffered from a Glazer induced lack of money in the final years – much of Buffett’s success was built on leverage in an earlier era where it was possible to borrow low and get higher returns with ease.
Buffett has not run into the buffers but he seems to have encountered that age old problem affecting successful money managers. As you grow, you need to take bigger and bigger bets to impact the share price – just as football managers must pay more and more for players.
This causes two financial management problems. The investment universe is reduced. You can no longer go for smaller companies or start-ups with their ability to surprise the market, because buying a significant stake will not make sufficient difference to the overall – a million dollar investment makes little difference to a 300 billion dollar fund even if it doubles and doubles again.
It is also harder to find hidden value in larger companies as they are both mature and they are followed by so many analysts that little escapes investor attention.
In addition, it has become increasingly difficult to take a meaningful stake in a large company because the market notices the activity and moves against you.
There’s a huge list of funds both in the UK and the US that have run into the “success” barrier. Some have solved this by effectively closing the fund to new investors – a strategy commonly used by hedge funds – but others have suffered as their returns increasingly revert to the norm.
Superstars create their own momentum
But superstar managers such as Buffett can offset the downsides of growth because they know they have a market following. Buffett’s letters to investors are more than just folksy. They tell the world that something has value, hoping that others will buy as well, which, in turn, brings in more, creating a virtuous circle. Nothing succeeds like success.
And they tell other investors what to dump – reinforcing the decision as others sell, pushing that stock onto a vicious spiral of underperformance. Berkshire Hathaway has been reducing exposure to consumer stocks or those that depend on consumer spending. It has ditched shares in healthcare firm Johnson & Johnson, and totally sold out of computer chip maker Intel.
The future may be more as long term investment bank. It bought Heinz along with a private equity fund – a partnership template according to Omaha jargon – so it now owns 8½ companies that, measured by size would be in the Fortune 500.
Buffett is not always successful – Sir Alex used to sometimes lose key games – but as the stakes become bigger, the failures become more noticeable. At least, Buffett owns up to “big mistakes” such as the now failed Energy Future Holdings.
Buffett has given no indication of when he will step down – that would cause too much of a market shock without very careful handling. But as time progresses, so will the noise of break-up or succession. The fear is that he will retire on a high, leaving the next person to deal with what follows just as Sir Terry Leahy’s departure from Tesco was such a telling moment.
Fears for the future
Just as Man U fans worried what would happen when Sir Alex retired, there are many concerns among the Omaha crowd as there is no obvious “son of the Sage”. One investor wrote this week:
“As long as there are no clear signals that the company will be able to keep growing at a satisfactory rate without Buffett as head, I assume that the future, just as the past, will depend on one great player, the best player, the Michael Jordan of the finance world, Mr. Warren Buffett. Unfortunately the Bulls, even with great players in their line-ups and a great coach, stopped being the Bulls once their star player retired. Buffett is a star among stars — he is the sun of the financial market solar system — and the fact that this great star is not showing us that he has designed a system capable of continuing with success without him having to brighten up the heavens concerns me rather than comforts me, as I see it does many other shareholders.”
English readers unfamiliar with basketball should substitute Manchester United for the Chicago Bulls and Sir Alex for Michael Jordan (there is no current footballer comparable).
But these fears will not stop the Omaha gathering from being one big love fest. The faithful will even be able to buy Buffett-signed diamonds directly from the man himself with 26 loose diamonds on sale, ranging in price from $5,000 to more than $200,000. Even Sir Alex just signed the match programme.