How do you explain the money managers still on the list? 2&20 is steep, but I assume you still need great returns over an extended period to make the Forbes list from it.
One strange thing about Buffett, is that he didn’t charge a % of the incredible alpha he was producing for his investors. Maybe that is what’s really rare: most investors with alpha will charge for it.
It's a bit surprising, but some hedge fund managers made the threshold in just one year of earnings by being short housing/subprime in 2008 (ie the "greatest trade ever"):
Back of the envelope, if you are managing $10b, and you charge 3%-4% of aum a year (2 and 20 with ok returns), and you need to hit $2b to make the list, you just need to stay in business for 7 years making $300m per year. That ignores expenses and so on, but it gives you an idea. Very few managers get to $10b aum but you can expect quite a few to accumulate $2b for themselves, either through a few good years or raising a ton of money.
I don't want to overstate the case on Buffett - he definitely made his initial fortune by charging carry. $10m doesn't sound like a lot today but in the context of the 1960s, it's a fortune. It's true that he doesn't charge afterwards but remember he already personally owned around half of Berkshire, so charging the owners of the other half wasn't going to change his fortune as much.
I don’t think the money managers still on the Forbes list are really exceptions. The whole point, if I understand, is that it has gotten significantly harder to generate sustained outsized returns.
A manager like the type you describe - 3-4% on 10b aum - is less a ‘billionaire investor’ than a ‘billionaire entrepreneur’ in the capital raising business. Not to be cynical or dismissive, but that’s where the wealth is generated - an outsized ability to raise capital. Outsized returns, whether sustained (Klarman?) or one-time (Paulson?) is only a related factor.
Fascinating and insightful, thank you. I think Buffett himself would take issue with your definition of him as a completely passive investor, and would also point out that a number of his early investments were private companies. What's so interesting about the history of Berkshire Hathaway is how Buffett created such a hybrid business model: part investment partnership, part insurance company, part private equity buyout firm, part industrial conglomerate. It's hard to dispute that he was a passive investor in most of his investments, but there are many where he and his partners played outsized roles at board level and were even highly active in the day-to-day running of the underlying businesses.
I agree that Buffett is not 100% passive, although he definitely markets himself to sellers as hands-off and Berkshire as decentralized.
He definitely has at least some active involvement in his investments over time - Sanborn and Dempster in his partnership, Berkshire itself to some degree, he changes prices and makes suggestions at See's, he's involved at the Buffalo News, makes investments for Blue Chip and his insurance companies, starts some insurance companies, and so on.
I suppose the question is what % of his return would he have gotten if he never did anything active at all? 80% 90%? His biggest investments (Coke, Apple, Wells, BNSF) have mostly been passive - maybe at most a board seat where he didn't have much success influencing decisions. Even at GEICO, Jack Byrne was already there before he came in. He did have some involvement in getting Salomon to help them raise money of course.
What's interesting is you can flip this around on people you think of as entrepreneurs. Elon Musk was of course originally a Tesla investor, not a founder. How much of Zuck's wealth is directly from the value of Facebook and how much from buying Instagram at a good price?
Totally, it's hard to say how much of his wealth is due to his passive-investments only, but it's certainly most of it. Where he was active though, a lot of the time he was focussed on releasing shareholder value rather than growing the business itself. So that also begs the question of what kind of "activity" we're talking about and if it has anything to do with business strategy or development.
Your argument that the opportunities for value investment are so little compared to when Buffett was a young man definitely resonates, however. I remember reading somewhere a quote by him saying if he had a small pool of capital (say, $100k) he could easily still make 50% in today's market. But maybe that's a bit of pride creeping in. If he was us today maybe he would look among the very small, thinly traded equities that don't get much attention from money managers because they're too small?
Yes, that's one reason I think Davis makes for a cleaner case study. Buffett is doing a lot of different things and a lot of his early fortune is from performance fees - there is no way to tell exactly how much of his first $25 million was from fees, but it is a lot, and I would guess that $25 million in 1969 probably made him one of the thousand richest men in America or something like that.
By contrast, Davis doesn't do any activism, doesn't buy entire companies, never collected performance fees, and he's right up there as one of the 100 or 200 richest Americans. So it was possible to get rich purely through passive investment, we don't have to guess.
I think what you are referring to is something Buffett said in an interview in 1999: "I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
I recall that back in those days he would make trades in his personal account and sometimes he would end up filing 5% ownership because it would be a small company, and I think he was saying that from personal experience - he was probably still racking up huge returns on smaller investments in his PA. But even 1999 was a very different era.
I am not sure how easy it is to find good investments among microcaps anymore, with the growth of private equity - they tend to buy up the decent companies and provide and alternative to going public. But no doubt there are still ways to make money, they are just not as easy to find as they used to be.
For what it's worth, Buffett used to get that question all the time - it looks like someone complied a lot of the answers here (some of which contradict each other, so I don't think it's that accurate):
Do you believe that we'll have significant mispricings again? And if you were 26 today how would you generate the 50% returns that you said you might do with smaller amounts of capital?
Attractive opportunities come from observing human behavior. In 1998, people behaved like frightened cavemen (referring to the Long Term Capital Management meltdown). People make their own opportunities. They will be frozen by fear, excited by greed and it doesn’t matter what their IQ, degrees etc is. Growth of 50% per year is with small capitalization, not large cap. The point is I got rich looking for stock with strong earnings.
The last 50 years weren’t unique. It’s just capitalizing on human behavior. It’s people that make opportunities when others are frozen by fear or excited by greed. Human behavior allows for success if you are able to detach yourself emotionally.
In 1951, I got out of school at 20 years old. At the time there were two publishers of stock information, Moody’s and Standards and Poor’s. I used Moody’s and went through every manual. I recently bought a copy of the 1951 Moody off of Amazon. On page 1433, there’s a stock you could have made some money on. The EPS was $29 and the Price Range was from $3-$21/share. On another page, there is a company that had an EPS of $29.5 and the price range was $27-28, 1x earnings. You can get rich finding things like this, things that aren’t written about.
A couple of years ago I got this investment guide on Korean stocks. I began looking through it. It felt like 1974 all over again. Look here at this company...Dae Han, I don't know how you pronounce it, it’s a flour company. It earned 12,879 won previously. It currently had a book value of 200,000 won and was earning 18,000 won. It had traded as high as 43,000 and as low as 35,000 won. At the time, the current price was 40,000 or 2 times earnings. In 4 hours I had found 20 companies like this.
The point is nobody is going to tell you about these companies. There are no broker reports on Dae Han Flour Company. When you invest like this, you will make money. Sure 1 or 2 companies may turn out to be poor choices, but the others will more than make up for any losses. Not all of them will be good, but some will and those will make you rich. And this didn’t happen in 1932, this was in 2004! These opportunities will be there in the next 30 years. You’ll have streaks where you’ll find some bad companies and a few times where you’ll make money with everything that you do.
The Wall Street analysts are brilliant people; they are better at math, but we know more about human nature.
In your investing life you will have several opportunities and one or two that can’t go wrong. For example, in 1998 the NY fed offered a 30-year treasury bonds yielding less then the 29-½ year treasury bonds by 30 basis points. What happened was LTCM put a trade on at 10 basis points and it was a crowded trade, they were 100% certain to make money but they could not afford any hiccups. I know more about human nature; these were MIT grads, really smart guys, and they almost toppled the system with their highly leveraged trading.
That's really interesting. If I didn't know anything else about Buffett I'd be a bit disappointed by his answers for failing to credit the perfect timing of his birth. But he has spoken at length about this in other places. It's difficult for anyone to argue that "the last 50 years weren't unique" with certainty (they were certainly better than the preceding 50 years), but I do buy his argument that anywhere there are people trading subject to their emotions there will be opportunities for under-valued stocks.
Are you convinced with his examples? What would you say to them if you believe the party's over for value investors?
One reason it was less competitive back then is that was much harder to for a smart person to raise money and bid up the price of really cheap stocks. Buffett was the son of a stockbroker/Congressman and studied under and was endorsed by Graham and even so had to struggle to scrape together money. Davis married into his stake.
His examples were fine - I think cheap Korean stocks from that era ended up doing ok - but to put up 30%-50% returns you have to either buy good long-term assets for pennies on the dollar or have a way to buy assets at a lesser discount that you turn into full value fairly quickly and continually re-invest the proceeds into similar situations, as we he did with his workouts.
Certainly there are very undervalued securities all the time - especially so when you witness emotional lows like we saw in 2008-2011 - but today, probably not to the scale that will make you the richest man in America.
I would add that it's almost certainly the best time ever to be someone who understands how to evaluate assets and allocate capital. You don't need to scrounge to start a tiny fund or hope to inherit something, there are lots of high paying jobs out there where you can work as a professional investor or use investing frameworks.
One of my ideas behind this blog is that investing has lots of useful frameworks you can apply to your professional and personal financial life. For example, every middle manager is to some extent allocating capital and making decisions on behalf of their employer. I also had one earlier on how to evaluate a house. This one I would say is about how to think about what professional path to go down - I'm being a little facetious when I saw this is how to become a billionaire, but I think there is an important general idea that you won't be successful today by copying exactly what successful people did a generation ago. Buffett ended up carving a different path from Graham, and successful people today will end up doing something different as well.
this misses the biggest reason for buffets outsized performance which is his cost-free float being used as essentially 1.7X leverage. if you take that away his performance is not super significant in terms of alpha post Geico acquisition .
How do you explain the money managers still on the list? 2&20 is steep, but I assume you still need great returns over an extended period to make the Forbes list from it.
One strange thing about Buffett, is that he didn’t charge a % of the incredible alpha he was producing for his investors. Maybe that is what’s really rare: most investors with alpha will charge for it.
It's a bit surprising, but some hedge fund managers made the threshold in just one year of earnings by being short housing/subprime in 2008 (ie the "greatest trade ever"):
https://www.forbes.com/2008/04/15/paulson-falcone-earners-biz-wall-cz_js_0415wallstreet.html?sh=615d26f47ccc
Back of the envelope, if you are managing $10b, and you charge 3%-4% of aum a year (2 and 20 with ok returns), and you need to hit $2b to make the list, you just need to stay in business for 7 years making $300m per year. That ignores expenses and so on, but it gives you an idea. Very few managers get to $10b aum but you can expect quite a few to accumulate $2b for themselves, either through a few good years or raising a ton of money.
I don't want to overstate the case on Buffett - he definitely made his initial fortune by charging carry. $10m doesn't sound like a lot today but in the context of the 1960s, it's a fortune. It's true that he doesn't charge afterwards but remember he already personally owned around half of Berkshire, so charging the owners of the other half wasn't going to change his fortune as much.
I don’t think the money managers still on the Forbes list are really exceptions. The whole point, if I understand, is that it has gotten significantly harder to generate sustained outsized returns.
A manager like the type you describe - 3-4% on 10b aum - is less a ‘billionaire investor’ than a ‘billionaire entrepreneur’ in the capital raising business. Not to be cynical or dismissive, but that’s where the wealth is generated - an outsized ability to raise capital. Outsized returns, whether sustained (Klarman?) or one-time (Paulson?) is only a related factor.
(ps great read. Just found you via theDiff)
Fascinating and insightful, thank you. I think Buffett himself would take issue with your definition of him as a completely passive investor, and would also point out that a number of his early investments were private companies. What's so interesting about the history of Berkshire Hathaway is how Buffett created such a hybrid business model: part investment partnership, part insurance company, part private equity buyout firm, part industrial conglomerate. It's hard to dispute that he was a passive investor in most of his investments, but there are many where he and his partners played outsized roles at board level and were even highly active in the day-to-day running of the underlying businesses.
Thanks!
I agree that Buffett is not 100% passive, although he definitely markets himself to sellers as hands-off and Berkshire as decentralized.
He definitely has at least some active involvement in his investments over time - Sanborn and Dempster in his partnership, Berkshire itself to some degree, he changes prices and makes suggestions at See's, he's involved at the Buffalo News, makes investments for Blue Chip and his insurance companies, starts some insurance companies, and so on.
I suppose the question is what % of his return would he have gotten if he never did anything active at all? 80% 90%? His biggest investments (Coke, Apple, Wells, BNSF) have mostly been passive - maybe at most a board seat where he didn't have much success influencing decisions. Even at GEICO, Jack Byrne was already there before he came in. He did have some involvement in getting Salomon to help them raise money of course.
What's interesting is you can flip this around on people you think of as entrepreneurs. Elon Musk was of course originally a Tesla investor, not a founder. How much of Zuck's wealth is directly from the value of Facebook and how much from buying Instagram at a good price?
Totally, it's hard to say how much of his wealth is due to his passive-investments only, but it's certainly most of it. Where he was active though, a lot of the time he was focussed on releasing shareholder value rather than growing the business itself. So that also begs the question of what kind of "activity" we're talking about and if it has anything to do with business strategy or development.
Your argument that the opportunities for value investment are so little compared to when Buffett was a young man definitely resonates, however. I remember reading somewhere a quote by him saying if he had a small pool of capital (say, $100k) he could easily still make 50% in today's market. But maybe that's a bit of pride creeping in. If he was us today maybe he would look among the very small, thinly traded equities that don't get much attention from money managers because they're too small?
Yes, that's one reason I think Davis makes for a cleaner case study. Buffett is doing a lot of different things and a lot of his early fortune is from performance fees - there is no way to tell exactly how much of his first $25 million was from fees, but it is a lot, and I would guess that $25 million in 1969 probably made him one of the thousand richest men in America or something like that.
By contrast, Davis doesn't do any activism, doesn't buy entire companies, never collected performance fees, and he's right up there as one of the 100 or 200 richest Americans. So it was possible to get rich purely through passive investment, we don't have to guess.
I think what you are referring to is something Buffett said in an interview in 1999: "I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”
I recall that back in those days he would make trades in his personal account and sometimes he would end up filing 5% ownership because it would be a small company, and I think he was saying that from personal experience - he was probably still racking up huge returns on smaller investments in his PA. But even 1999 was a very different era.
I am not sure how easy it is to find good investments among microcaps anymore, with the growth of private equity - they tend to buy up the decent companies and provide and alternative to going public. But no doubt there are still ways to make money, they are just not as easy to find as they used to be.
For what it's worth, Buffett used to get that question all the time - it looks like someone complied a lot of the answers here (some of which contradict each other, so I don't think it's that accurate):
https://buffettfaq.com/#according-to-a-business-week-report-published-in-1999-you-were-quoted-as-saying-it-s-a-huge-structural-advantage-not-to-have-a-lot-of-money-i-think-i-could-make-you-50-a-year-on-1-million-no-i-know-i-could-i-guarantee-that-first-would-you-say-the-same-thing-today-second-since-that-statement-infers-that-you-would-invest-in-smaller-companies-other-than-investing-in-small-caps-what-else-would-you-do-differently
Here is one answer from 2007:
Do you believe that we'll have significant mispricings again? And if you were 26 today how would you generate the 50% returns that you said you might do with smaller amounts of capital?
Attractive opportunities come from observing human behavior. In 1998, people behaved like frightened cavemen (referring to the Long Term Capital Management meltdown). People make their own opportunities. They will be frozen by fear, excited by greed and it doesn’t matter what their IQ, degrees etc is. Growth of 50% per year is with small capitalization, not large cap. The point is I got rich looking for stock with strong earnings.
The last 50 years weren’t unique. It’s just capitalizing on human behavior. It’s people that make opportunities when others are frozen by fear or excited by greed. Human behavior allows for success if you are able to detach yourself emotionally.
In 1951, I got out of school at 20 years old. At the time there were two publishers of stock information, Moody’s and Standards and Poor’s. I used Moody’s and went through every manual. I recently bought a copy of the 1951 Moody off of Amazon. On page 1433, there’s a stock you could have made some money on. The EPS was $29 and the Price Range was from $3-$21/share. On another page, there is a company that had an EPS of $29.5 and the price range was $27-28, 1x earnings. You can get rich finding things like this, things that aren’t written about.
A couple of years ago I got this investment guide on Korean stocks. I began looking through it. It felt like 1974 all over again. Look here at this company...Dae Han, I don't know how you pronounce it, it’s a flour company. It earned 12,879 won previously. It currently had a book value of 200,000 won and was earning 18,000 won. It had traded as high as 43,000 and as low as 35,000 won. At the time, the current price was 40,000 or 2 times earnings. In 4 hours I had found 20 companies like this.
The point is nobody is going to tell you about these companies. There are no broker reports on Dae Han Flour Company. When you invest like this, you will make money. Sure 1 or 2 companies may turn out to be poor choices, but the others will more than make up for any losses. Not all of them will be good, but some will and those will make you rich. And this didn’t happen in 1932, this was in 2004! These opportunities will be there in the next 30 years. You’ll have streaks where you’ll find some bad companies and a few times where you’ll make money with everything that you do.
The Wall Street analysts are brilliant people; they are better at math, but we know more about human nature.
In your investing life you will have several opportunities and one or two that can’t go wrong. For example, in 1998 the NY fed offered a 30-year treasury bonds yielding less then the 29-½ year treasury bonds by 30 basis points. What happened was LTCM put a trade on at 10 basis points and it was a crowded trade, they were 100% certain to make money but they could not afford any hiccups. I know more about human nature; these were MIT grads, really smart guys, and they almost toppled the system with their highly leveraged trading.
This was definitely a good time to act.
That's really interesting. If I didn't know anything else about Buffett I'd be a bit disappointed by his answers for failing to credit the perfect timing of his birth. But he has spoken at length about this in other places. It's difficult for anyone to argue that "the last 50 years weren't unique" with certainty (they were certainly better than the preceding 50 years), but I do buy his argument that anywhere there are people trading subject to their emotions there will be opportunities for under-valued stocks.
Are you convinced with his examples? What would you say to them if you believe the party's over for value investors?
One reason it was less competitive back then is that was much harder to for a smart person to raise money and bid up the price of really cheap stocks. Buffett was the son of a stockbroker/Congressman and studied under and was endorsed by Graham and even so had to struggle to scrape together money. Davis married into his stake.
His examples were fine - I think cheap Korean stocks from that era ended up doing ok - but to put up 30%-50% returns you have to either buy good long-term assets for pennies on the dollar or have a way to buy assets at a lesser discount that you turn into full value fairly quickly and continually re-invest the proceeds into similar situations, as we he did with his workouts.
Certainly there are very undervalued securities all the time - especially so when you witness emotional lows like we saw in 2008-2011 - but today, probably not to the scale that will make you the richest man in America.
I would add that it's almost certainly the best time ever to be someone who understands how to evaluate assets and allocate capital. You don't need to scrounge to start a tiny fund or hope to inherit something, there are lots of high paying jobs out there where you can work as a professional investor or use investing frameworks.
One of my ideas behind this blog is that investing has lots of useful frameworks you can apply to your professional and personal financial life. For example, every middle manager is to some extent allocating capital and making decisions on behalf of their employer. I also had one earlier on how to evaluate a house. This one I would say is about how to think about what professional path to go down - I'm being a little facetious when I saw this is how to become a billionaire, but I think there is an important general idea that you won't be successful today by copying exactly what successful people did a generation ago. Buffett ended up carving a different path from Graham, and successful people today will end up doing something different as well.
this misses the biggest reason for buffets outsized performance which is his cost-free float being used as essentially 1.7X leverage. if you take that away his performance is not super significant in terms of alpha post Geico acquisition .