I am surprised at the reaction among investors and the media over Buffett’s selection of Ted Weschler as one of his portfolio management successors, but I suppose I should be used to it by now. The general reaction has been:
- Who is this guy? Why would Buffett pick an unknown manager/firm?
- How could someone be such a good investor and remain relatively unknown?
- Weschler has one investment employee working at his firm and one assistant. How could someone running a tiny office fill Buffett’s shoes?
- Why is Buffett once again tapping a hedge fund manager for a successor? Is he changing his approach to value investing?
I will address each question:
Why Would Buffett Pick an Unknown?
Of course Buffett has to pick an unknown investor from an unknown firm. Virtually all of the known investors at known firms are employees of great marketing firms–that’s how you know who they are–but they are usually not great investors. Virtually all of the known firms have business models that rely on well-oiled marketing machines to gather assets because they are paid on the size of the assets that they manage, not on their performance.
As asset gatherers, the known investors must ensure that they never fall too far behind the rest of the market and their competitors. The only way that they can ensure that they keep pace is by becoming a closet indexer–someone who pretends to spend a lot of effort on security selection but who, in reality, merely invests in each of the large companies in a large-company index, plus or minus minor adjustments for aesthetics. Of Course, Buffett, a value investor, does not invest that way even now.
How Could Someone be a Good Investor and Remain Relatively Unknown?
For almost their entire careers, most of the world’s best investors remained unknown by the overwhelming majority of the investing public. They generally have long periods when they are accessible to only a few savvy people/firms, and then they suddenly find themselves in the spotlight after reaching a tipping point. Welcome to Ted Weschler’s “moment.” Another example: Hardly any but a small number of savvy professionals heard of Peter Cundill before he died in January 2011. It took a posthumously published biography for many to know his record and style, and even now few have heard of him. Ironically, the lack of attention is what helps make value investors, great investors. By the way, it is no coincidence that most of the world’s best investment managers (by long-term performance) also happen to be value investors.
How Could Someone Running a Tiny Office Fill Buffett’s Shoes?
Are you kidding me? Most of the world’s best investors work alone; they avoid investment committees like the plague. Committees lead to group-think and group-thinking leads to bad investment decisions. They diligently read through financial statements, talk to a company’s customers, and meld dozens of pieces of information to form a unique view; they do not delegate that very important work.
The general attitude behind this third question is: “You aren’t structured like Fidelity or American Funds, you don’t have the resources that they do, and you don’t have a lot of experts on staff to which you can delegate work, so how can you be any good?” They fail to grasp that great investing does not take a lot of experts and IQ points, and that because of technology, a single investor has more resources at his fingertips than Fidelity did just ten years ago; it is how those resources are used that matter, not the number of them. As Buffett himself once said about what it takes to be a successful investor (I paraphrase), “Any IQ points over 125 are wasted.”
Also, contrarian value investors who run concentrated portfolios don’t need experts on staff as much as they need a strong constitution. Great investing is simple, but it is not easy. It is not difficult to read financial statements, have a view of a business’s competitive position, draw conclusions about the business’s prospects, and know whether its market price is low enough to offer a margin of safety. But, it is difficult to invest only when one has a margin of safety because for the price to be low enough to provide a margin of safety, nearly everyone else has to disagree with your view.
Contrarian, margin-of-safety investors must go against the herd. As Michael Mauboussin has explained about great investing: “A proper temperament beats a high IQ every time.” Finally, most of the Superinvestors that Buffett highlighted in his Superinvestors speech at Columbia University (see tab above) worked alone or with minimal staff. It is only the marketing machines that need a large staff and that consists mostly of marketing and legal professionals. Oh, and by the way, Buffett himself invests alone in a tiny office.
Why is Buffett Hiring Another Hedge Fund Manager to Succeed Him?
True value investors must use something like a hedge fund structure (or be an insurance company like Berkshire Hathaway with permanent capital) to improve the odds of generating alpha. Value investors must have a long-term view and hedge funds can be structured so that their investors cannot redeem for extended periods. Value investors must run concentrated portfolios and hedge funds allow the most freedom to do that. Value investors must be contrarian and hedge funds help insulate hedge fund managers from the daily scrutiny that would make contrarianism nearly impossible for the average person.
Finally, as I demonstrated in investor communications, Warren Buffett began his career as a hedge fund manager and remained one for ten years. Buffett contributed $700 of capital at the launch of his hedge fund in 1957 and his friends and family contributed another $100,000; most of today’s great investors started that way with small amounts of capital from friends and family.
Today, Buffett still behaves as a hedge fund manager but one with the ultimate luxury–permanent capital. I listed Buffett’s first business model as one that I would emulate for my own fund. It should not be a surprise that many still relatively unknown, but extremely successful value investors also emulated Buffett’s hedge fund structure and philosophy. It should not be a surprise that virtually all of these great investors started small and stayed small for a long, long time thus enabling them to stay under the radar.
But don’t just take my word for it, read what Buffett wrote in a letter to his hedge fund partners on January 20, 1966:
“Last year in commenting on the inability of the overwhelming majority of investment managers to achieve performance superior to that of pure chance, I ascribed it primarily to the product of: “(1) group decisions – my perhaps jaundiced view is that it is close to impossible for outstanding investment management to come from a group of any size with all parties really participating in decisions; (2) a desire to conform to the policies and (to an extent) the portfolios of other large well-regarded organizations; (3) an institutional framework whereby average is “safe” and the personal rewards for independent action are in no way commensurate with the general risk attached to such action; (4) an adherence to certain diversification practices which are irrational; and finally and importantly, (5) inertia.”
In each of these ways, Ted Weschler is an ideal candidate to eventually replace Buffett.
For some of the media reaction, see:
I’ll bet that Jason Zweig, a Ben Graham biographer, is as amused by the reaction as I am, but he keeps it together on the video in the story.
For an interesting take on Buffett’s transition from an obvious hedge fund manager to a less obvious one with permanent capital, see the Joe Taussig paper embedded in a link at the bottom of this blog post:
Taussig Capital is a Zurich based consultant to hedge fund managers.