Last week it was Charlie Munger holding forth at the Daily Journal (DJCO) on the virtue of index investing. This week it is Warren Buffett in the much-anticipated Berkshire Hathaway (BRK.A) Annual shareholder letter. Warren wrote in the letter, "Over the years, I've often been asked for investment advice, and in the process of answering I've learned a good deal about human behavior. My regular recommendation has been a low-cost S&P 500 index fund. To their credit, my friends who possess only modest means have usually followed my suggestion. I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed that same advice when I've given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant."
With both Warren and Charlie emphasizing the merits of index investing, I really feel like I should spend some time with all the recent year's 13Fs and footnotes to other SEC filings and make sure that they do not own some shares of Blackrock (BLK) -- or have a secret stake in Vanguard that I don't know about.
Some of my value-oriented friends have already said that they think Warren is being disingenuous with this advice, since he doesn't index. That's not the case these days. If you look at Warren's holdings, as revealed in the letter and the most recent 13F, his holding look a lot like a condensed version of the S&P 500. If you take the time to comb through a decade or more of the 13F filings, you find that his outperformance over time has as much to do these days with when he buys and how long he is willing to hold his investments as it does what he buys.
The biggest driver of Berkshire's performance today is the results of his operating businesses -- not his public investment. If you read the letter, he goes over the various operations, and it becomes clear that while he started in life as a brilliant investor, he has morphed into a brilliant business man. Most of Berkshires Hathaway's value today has to do with the results of the businesses they own -- and not the stock portfolio.
To beat the market today, you cannot do what Warren does today. You have to go back and do what Warren used to do before he had too much money to generate high returns out of the securities markets. He even addresses this in the letter, writing that "What is easy with millions, struggles with billions."
I had a chance to talk with Ed Thorp not long ago -- creator of the famous blackjack card-counting system outlined in his book "Beat the Dealer." Thorp also had a fantastic career as an investor, using his superior math skills and intellect to rack up some excellent returns. I asked him how an investor might beat the market today and he told me, "That depends on the person. I think to myself, 'Gee, if I were 25 and I got interested in this, what I would do?' And I'm not sure, but for what I know now, I'd say the Warren Buffett way is a good way -- if you want to put your whole life into it."
As an aside, if you have not yet read his new book, "A Man For All Markets," I recommend you do. It is destined to be one of the best investing and life-advice books of all time, in my opinion.
Buffett got rich by buying undervalued, illiquid securities. He had what he called his generals -- stock he felt were undervalued -- and then he had a portion of the portfolio for what he called special situations. These were spinoffs, arbitrage situations and other securities where a value-realization process was underway.
If you are willing to put in the time and the effort, it can be done. But you must be willing, as Munger put it once, to sit there with cash and wait for an extraordinary opportunity, rather than chasing mediocre ones every day. It can still be done. Ironically, Buffett and Munger may be making it easier for us by urging folks to invest in the index -- thereby creating tremendous opportunities in stocks that are not included in the broad market indexes.