Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [37]
Prime brokers provide hedge funds with a variety of services:They provide financing for leverage; they set up custody accounts for their assets; they act as a settlement agent; and they prepare account statements for customers. Smaller hedge funds often rely on their prime brokers for risk management and trade ideas. These smaller hedge funds also tend to drastically underestimate the cost of doing business. Fortunately for hedge fund managers, the fees fund managers charge can add up faster than the miscellaneous charges on a phone bill. If the hedge fund documents allow loans to management, the lowest returning asset in the hedge fund portfolio may be an invisible low-cost loan to management.
The investment bank symbiosis did not stop with hedge funds. Investment banks also provided loans, assistance, and even management staff to structured investment vehicles (SIVs), and collateralized debt obligation (CDO) managers, some of which also manage hedge funds.
Undercapitalized managers are easily influenced by an investment bank that set them up in business and trades with them. If an investment bank has a large inventory of overrated and overpriced mortgage loan or leveraged loan-backed securities that it needs to get off of its books, it is very convenient to have symbiotic relationships with structured investment vehicles, collateralized debt obligation managers, and hedge funds. As investment banks needed to get bad loans off of their balance sheets, institutional investors became the prey of both hedge funds and investment banks.
As General George S. Patton observed: “A pint of sweat saves a gallon of blood.” Warren Buffett and Charlie Munger would not tolerate the kind of risk that would wipe out a lifetime of hard work, and look for a margin of safety when they make a purchase. Their decades-long track record beats all of the top hedge fund managers. Berkshire Hathaway does not promise to do well in both up and down markets. There are years when the value of the stock decreased or underperformed the S&P; but long-term value investors do not concern themselves with chasing a market return.Warren looks for value and for companies that he is happy to own even if the market closed for five years and he couldn’t trade any of the shares.
As a disciple of Benjamin Graham, Warren Buffett does not distinguish between value and growth companies, since the concepts are Siamese twins. Why would you buy a fair company at a good price instead of a good company at a fair price? If possible, try to buy a good company at a good (cheap) price, and a good company has good growth potential.
Berkshire Hathaway defines value companies as those selling at or below a fair price—book value combined with earnings—that have high earnings growth potential relative to alternatives. The price has to make sense and the fundamental economics have to be good. A company (or hedge fund) could produce steadily rising earnings by investing in T-bills, and passive compounding would cause capital earnings to steadily rise even if the company did nothing to generate additional shareholder value. Yet Warren would not consider this to be a value company.
Returns are not kept secret.They are available to the general public on Berkshire Hathaway’s Web site. From 1965 to 2007, the S&P 500 (including dividends) has had a compound annual gain of 10.3 percent and an overall gain of 6,840 percent. For the same period, Berkshire Hathaway has shown adorable alpha; it had a compounded annual gain of 21.1 percent and an overall gain of 400,863 percent.42
In June 2008, Warren Buffett issued a challenge to hedge funds. He has bet Protégé Partners LLC, a fund of hedge funds, that five hedge funds of its choosing will not produce averaged