A few months ago, I had the pleasure of doing a six-hour live stream broadcast on the Hathaway Annual Meeting in quarantine while feeling sad I couldn’t be there in Omaha for the first time. This year would have marked my 15th consecutive year of making my yearly mecca to Omaha to see the oracle himself. There were a few large takeaways I had from the meeting. One of the things that Warren Buffett is masterful at is leaving things unsaid for savvy listeners to read between the lines. I noticed he did that quite a bit this year.
Buffett reiterated his view that it was wise to bet on America and recommended the average investor purchase index funds as a way to invest for the long-term. While Buffett did say that most professional money managers fail to beat the market, what was left unsaid was that most index fund investors do too. The average investor only captures about 20% of the gains of the vehicle they are invested in. This is due to investor psychology of wanting to buy when things are good and sell when things are bad. While the common mantra is to buy low, sell high, it is clear by the data that the average investor does exactly the opposite. The long-term approach to index funds will have the average investor outperform the average investment track record simply by doing “the average”. Results are further enhanced by the lack of selling, meaning you defer capital gains for as long as you hold onto the index fund.
However, there is an elephant in the room. If Buffett thinks index funds are so great and that most investors won’t be able to outperform an index fund, and that Buffett wouldn’t make a huge bet that he will outperform an index fund over the next ten years, then why does he spend any energy picking stocks or paying a base salary to his investment officers Ted and Todd? The answer is that he is most likely underpromising and over-delivering like he has been doing since the 1970s, or even earlier and that he believes strongly Berkshire can outperform an index fund over time. One large advantage that Berkshire has over index funds is Berkshire’s insurance float, which is the money received from insurance premiums upfront that has yet to be paid out. This essentially acts as a form of leverage where you are actually getting paid to borrow money as opposed to paying a lender an interest rate. This is a significant advantage that Berkshire has structurally over an index fund. The other thing he doesn’t mention is that over the long-term value investors have outperformed the market as a whole. In an article, Buffett wrote on May 17, 1984, in Hermes, Columbia Business School Magazine, he made the case that the edge value investors had was not merely due to survivorship bias and luck.
The other elephant in the room was Berkshire’s lack of investment activity during the past few months, even as markets bottomed out in late March. What happened to the Buffett mantra “be greedy when others are fearful”? Perhaps, Buffett is more fearful then he lets on. One thing Buffett did note during the meeting was that he is managing Berkshire for the long-term and for wealth preservation. We have to remember that many Berkshire shareholders have owned the stock for many years and are already wealthy. If we do enter a Great Depression-like scenario that Buffett clearly underwrites at more than a 0% chance, risking capital that may not break-even for another decade or two could destroy the wealth of many long-term Berkshire shareholders, many who have Berkshire shares consisting of the vast majority of their wealth. Buffett is managing the business for these stockholders in mind, with himself and the Munger family included in that.
This leads to the third elephant in the room which Buffett did not discuss this year which is that the small investor can significantly outperform Berkshire Hathaway at this point. While Buffett is looking to preserve wealth and is also limited to his large sums of capital, many much smaller businesses that were profitable were being valued for bankruptcy just a few weeks ago. Berkshire could not take advantage of any of these due to the companies being too small.
