Against Mr. Lynn’s Buffett Bashing Philippic
Read Matthew Lynn’s Buffett Bashing Philippic
Warren Buffett’s annual letter to Berkshire Hathaway (BRK.B) shareholders was released on Saturday, March 4th.
Since the letter’s release there has been some Buffett bashing – much of it coming from the mainstream financial press. The most brazen Buffett bashing to date came from Bloomberg columnist Matthew Lynn, who began his article by writing:
Maybe it is his age, his probable retirement or the mediocre performance of Berkshire Hathaway’s shares the past two years. Whatever the cause, Warren Buffett’s ruminations on the financial markets have taken on a grouchy, quarrelsome tone recently.
For years, investors have pored over the annual statements of the world’s second-richest man. Buffett, 75, has been called the Oracle of Omaha, with every folksy, homespun piece of wisdom elevated to the status of unimpeachable truth.
Stop and look more closely, however, and it turns out you would have more chance of success by checking some tea leaves, or a pack of tarot cards, for financial predictions.
Mr. Lynn’s article is not worth reading – not because it criticizes Buffet, but rather because it is a confused piece of drivel. The article ignores inconvenient facts, and does not bother to scrutinize the author’s own argument or the evidence he puts forward.
Still, I can’t say it’s badly written. If you judge the article by the standards of propaganda writing, it scores pretty well. The tone is bitter yet engaging; the message is clear; and there is the requisite illusion of a logical edifice built upon actual facts.
Like any good propagandist, Mr. Lynn makes liberal use of the straw man technique. The result is effective rhetoric that takes on the appearance of Swiss cheese when viewed by those who value logic above impudence.
Early in the article, Mr. Lynn writes, “And now Buffett tells us that hedge funds and buyout firms are fleecing us all. Once again, the evidence is threadbare.”
Then, he quotes a Mr. Tim Price of Ansbacher & Co. in London as saying: “There is an element of protesting too much…When you look at it, Berkshire Hathaway is not a million miles away from being a giant hedge fund or private-equity fund itself.”
There are two problems here. First, the evidence that hedge funds are fleecing investors is not “threadbare”. Managers are making a lot of money. That fact is not disputed. What is disputed is whether they are worth it.
There is a case to be made that individual managers are worth it. That case is similar to the example I laid out in my first podcast, where I basically said: Lance Berkman and Tony Womack both play baseball and both make a lot of money. One of them is overpaid – he just happens to be the guy making less money.
At the time, I was making a point about executive compensation, not fees paid to money managers. However, the two cases are substantially similar. If, over an investing lifetime, the compound annual return provided by a fund exceeds the fund’s fees and expenses by a margin greater than the readily available return (e.g., an index fund) the manager has earned his keep. Of course, investors in the aggregate are no richer because of his actions; but, those individuals who have paid for his services are better off.
Society does not benefit from money managers. That isn’t to say they are bad people. Good money managers can benefit themselves, their clients, their families, and their communities. However, they can not benefit society as a whole, because they are playing a zero-sum game.
Neither the card counter nor the money manager adds to a society’s wealth; he just redistributes it. Essentially, the two men are playing the same game, and there is nothing dishonorable in playing it well. In fact, it is a great intellectual achievement to play the game well and to benefit yourself and those you care about. But, that’s all it is.
Money managers do not add to the pie; they just carve it up. In the aggregate, they are nothing but parasites. Individually, they are useful as long as they charge less than they’re worth.
The quote from Tim Price is just bizarre: “When you look at it, Berkshire Hathaway is not a million miles away from being a giant hedge fund or private-equity fund itself.”
I’m not sure what the logic is here. Buffett’s criticism of hedge funds is restricted to frictional costs. In fact, Mr. Buffet states this explicitly when he writes:
Indeed, owners must earn less than their businesses earn because of frictional costs. And that’s my point: These costs are now being incurred in amounts that will cause shareholders to earn far less than they historically have.
What are Berkshire shareholders’ frictional costs? It’s true that if an individual owned each of Berkshire’s constituent businesses and its marketable securities portfolio directly, he would be able to avoid certain costs associated with Berkshire’s corporate structure and the premium over book value he had to pay to acquire Berkshire shares.
But, how exactly would one own these businesses directly? There is literally no individual on the face of the Earth who is rich enough to directly own all of Berkshire’s assets. Investors would still have to pool their money if they wanted to own Berkshire without having to pay Buffett.
Let’s imagine Berkshire shareholders could create their own partnership and thus own Berkshire’s assets directly. If this were possible, they could cut the “bloat” at HQ. They could dump the manager and get out from under the burden of Buffett’s annual salary. What would all of this accomplish? How much would they save? An almost infinitesimal fraction of the assets Buffett is currently managing for them.
The situation is quite different at most hedge funds. Direct ownership of assets would have resulted in far greater returns. Of course, the idea is that investors wouldn’t have been smart enough to acquire the assets themselves; so, paying the manager’s fee is well worth it. Once again, to the extent that the fund’s return less fees and expenses have exceeded the return on an index fund, the investors have benefited from active management.
Because Buffett is himself an owner of Berkshire, he has been providing a (virtually) free service to his fellow owners. If “Berkshire Hathaway is not a million miles away from being a giant hedge fund”, then, a soup kitchen is not a million miles away from being a restaurant. Yes, Buffett is running an investment fund – he just happens to be doing it free of charge (actually, Buffett does collect a salary, but the resulting expense is not material to Berkshire shareholders).
Of course, Lynn could have, and should have, pointed out that Buffett ran a hedge fund of his own (just as Graham did). Buffett earned his keep; the limited partners made out quite nicely. Just as importantly, Buffett’s arrangement with his partners wasn’t of the “heads I win, tails you lose” sort. Warren only collected a percentage of the partnership’s returns in excess of 6%. For purposes of Buffett’s compensation, losses would have offset past profits. I say “would have” because, as you probably know, the partnership never had a down year.
I don’t want to make it sound like Lynn plays down Buffett’s record in any way; he doesn’t. In fact, Lynn writes:
Nobody can argue about Buffett’s track record. Plenty of investors have made money sporadically, but almost nobody has done so as consistently and cleverly as Buffett. You don’t get to be the world’s most respected investor without having a feel for how the markets are moving.
I actually disagree with the last point. I’m not sure Buffett has ever had “a feel for how the markets are moving”. If he has, he’s clearly ignored it by buying too early.
Lynn spends most of the article outlining Buffett’s recent “wayward calls”. Regarding derivatives Lynn writes:
In 2003, Buffett said derivatives contracts were like a “time bomb” ticking in global markets. Maybe they are. Yet they have been ticking for an awfully long time, with remarkably little damage so far.
Obviously, a time bomb does no damage before it explodes; so, the fact that there’s been “remarkably little damage so far” is consistent with Buffett’s figurative language.
Otherwise, there’s very little to say about Mr. Lynn’s discussion of derivatives. He makes the case that derivatives have made global markets safer rather than more dangerous. Of course, that doesn’t mean they aren’t a time bomb. In Lynn’s defense, there’s no way to prove something isn’t a time bomb. You can only hope to prove it hasn’t gone off yet.
Regarding Buffett’s dollar prediction, Lynn writes:
Last year, Buffett told us the dollar was poised for a fall. “The policies that we’re following are likely to lead to a weaker dollar over a long period of years,” he was quoted as saying last June.
The dollar has actually gained against the world’s main currencies since then. It might fall one day, though most predictions come true if you wait long enough. The point is to call the market at the right time, and Buffet clearly didn’t do that this time.
The point is to call the market at the right time? Mr. Lynn clearly respects Buffett’s past record; so, let me finish by asking three questions:
1) When in Buffett’s long career has he called the market at the right time?
2) If one of the world’s most successful investors doesn’t call markets, is calling the market at the right time really the point?
3) Or, is there a better way to “consistently” and “cleverly” make money?
Lynn concludes:
Well, it has been a good run for Warren Buffett. But there is a whistling sound. Someone should point it out to him.
As you can see, I’m more inclined to blow the whistle on the author than on his subject.