Warren Buffett on 'The Father of Hedge Funds'

hi i'm steve rosenberg i'm 22 from ann arbor michigan uh it's a privilege to be here first i'd just like to thank you both for serving as a hero and positive role model for me and many others much more than your success itself i respect your unparalleled integrity i have three quick questions for you the first is how a youngster like myself would develop and define their circle of competence the second involves the role of creative accounting and the stories of tremendous growth and success over many years ge tyco and ibm immediately come to mind for me but i was hoping you could also discuss that issue in relation to coke some people have said that their decision to lay off much of the capital in the system onto the bottlers who earn low returns on capital uh is a form of creative accounting on the flip side others counter that koch's valuation uh at first glance on say a price to book metric is actually less richly valued than it seems because they earn basically all the economic rents in the entire system my final question uh is if you could comment on the a w jones model the long short equity model i understand that it doesn't make sense for uh capital the size of berkshires to take that type of a strategy but it just seems to me that playing the short side in combination also seems incredibly compelling even giving the inherent structural and mathematical disadvantages of shorting and i was wondering if you could talk a little bit more about why you would have lost money on your basket of a hundred frauds yeah it's an interesting question and uh we'll start we'll go in reverse order many people think of a.w jones uh who was a fortune writer at one time uh and who developed the best known hedge fund uh whenever it was in the early 60s or thereabouts maybe the late 50s even and for the rest for some of the audience the the idea originally with aw jones is that that they would go long and short more or less equal amounts and have a market neutral fund so that didn't make any difference which way the market went they didn't really stick with that over time and i'm not even sure whether aw jones said that they would but uh they you know sometimes they'd be 140 percent long and 80 short so they'd have a 60 that long or whatever it might be they they had they were not market neutral throughout the period but they did operate on the theory of being long stocks that seemed underpriced and short stocks that were overpriced uh even the federal reserve in a report they made on the long-term capital management situation a few years ago credited a.w jones with being sort of the father of this theory of hedge funds as mickey newman if he's still here knows i think it was in 1924 that ben graham set up the benjamin graham fund which was designed exactly along those lines and which even used paired securities in other words he would look at general motors and chrysler and and and this side which he thought was undervalued relative to the other and go long one and short the other so the idea and he was paid a percentage of the profits and it had all today's hedge funds except it was started in 1924 and i don't know that ben was the first on that but i know that he was 30 years ahead of the uh the one that the federal reserve credited with being the first and that many people still talk about it being the first aw jones ben did not find that particularly successful uh and he even wrote about it uh some in his in in terms of the problems he encountered with that approach and my memory is that a quite high percentage of the paired investments worked out well he was right the undervalued one went up and the overvalue were the spread between the two narrowed but the one time out of four or whatever it was that he was wrong uh lost a lot more money than than the average of the three that he was right on and uh you know all i can say is that uh uh i i've shorted stocks in my life and had one particularly harrowing experience in 1954 um and i have i can't i can hardly think of a situation where i was wrong if viewed from 10 years later but i can think of some ones where i was certainly wrong from the view of 10 weeks later which happened to be the relevant period and and during which my net worth was evaporating and my liquid assets were getting less liquid and so on so it's all i can tell you it's very difficult and the interesting thing about it of course is a.w jones was a darling of the uh of the uh late 1960s and carol loomis is here and she wrote an article called the jones nobody keeps up with and it's a very interesting article but nobody's writing articles nobody was writing articles about aw jones in 1979. uh i mean something went wrong and there were spin-offs from his operation carl jones spun off from his operation dick radcliff's but this went off from his operation they were you can go down the list and out of many many many that left they a very high percentage of them bit the dust including suicides cab drivers subsequent employment the whole thing and these people were there was a book written in the late 60s had a lot of pictures and i don't remember the name of it but it showed all these portraits of all these people that were highly successful in the hedge fund business but they didn't bring out a second edition uh so it it it's just tough i i logically it should work well but the math of only you can't short a lot of something you can buy till the cows come home if you got the money you buy the whole company you can't short the whole company uh thought i'm robert wilson there's some interesting stories but he's a very very smart guy and he took a trip while asia one time being short i think it was resorts international or maybe mary carter paint it was still calling those days and he lost a lot of money before he got back to this country he's a very smart guy he made a lot of money shorting stocks but it just takes one to kill you and you need more and more money as the stock goes up you don't need more and more money when a stock goes down if you paid for it originally you didn't buy it on margin you just sit and find out whether you were right or not but you can't necessarily sit and find out whether you're right on being short of stock uh i think i'll let charlie comment on that before i go to your other two questions well he asked about creative accounting and he named certain companies i wouldn't agree that all those companies were plainly sinful although i'm sure there are very significant sins in the group as a whole creative accounting is an absolute curse to a civilization you can argue that one of the great inventions of man was double entry bookkeeping where we could keep our economic affairs under better control and it was a north italian development spread by a monk and uh anything that sort of undo's the monk's work by turning this great system into uh kind of a tool for fraud and folly uh i think does enormous damage to the country now i think that democracy is ordinarily set up so it takes a big scandal to cause much reform and there may be some favorable fallout from from enron because that was certainly the most disgusting example of a business culture gone wrong than any of us has seen in a long in a long long time what was it took in eventually a lot of nice people that you wouldn't have expected to sink into the whirlpool and and i think we'll always get enron-type behavior but it may be moderated some in the next few years the question of accounting and and and the economic profits to be gathered in the bottling system versus the production of the the syrup uh coke uh i've just gotten through reading the annual reports of coca-cola feminism and and panamco which are two big latin american bottlers and i mean they they make pretty decent money uh quite significant money and uh uh there is more money in owning the trademark it isn't the plants that that make uh the syrup or anything and so the trademark is where a huge amount of value is the trademark is where a huge amount of value is and sees candy uh you know that those are those are big big assets uh and i would say that that uh you can make good money as a bottler a lot of bottlers have become rich over the years uh if i had a choice between owning the trademark annoying a bottling business i'd rather own the trademark but that doesn't mean the bottling business is a bad business at all and it's it's riding on the back of a trademark i mean that is why a bottling system is valuable is because it has the right to sell a trademark product which hundreds of millions of people every day are going to go in and ask for by name and the right to distribute that product is is worth good money and it really i don't see any accounting questions and and that sort of thing and there was that the coca-cola company did not own a share in any of its bottlers and for many years it either owned 100 of a bottle or a large part or and very few of those are none of it but if they owned if they own no interest in their dollars i think the economics would be very very similar to what they are now i mean the the the bottlers would still be able to borrow a lot of money because they would have contracts with the coca-cola company and that were important and that would allow them to make decent money distributing the product product but they don't make the kind of money that you make if you own the trademark just the way it works what was the first question again that uh it was how a youngster like myself would define and develop a circle of competence oh yeah that that's a good question and i'm you know i i i would say this if you have doubts about something being in your circle of confidence it isn't you know i mean i never was i would i would i would look down the list of businesses and i will bet you that you can i mean you can understand a coke bottler you can understand the coca-cola company you can understand mcdonald's you can understand you know you can understand in a general way general motors you may not be able to value it uh but there are all kinds of business you can certainly understand walmart that doesn't mean whether you decide whether the probably what the price should be but you understand walmart you can understand cost coaching uh and if you get to something that your friend is buying or that everybody says a lot of money is going to be made in you and you don't you're not sure whether you understand it or not you don't you know and it's better to be well within the circle than to be trying to tiptoe along the line and you'll find plenty of things within the circle i mean it's it's not terrible to have a small circle of confidence i'd say my circle of confidence is pretty small but it's big enough you know i i can find a few things and and when somebody calls me with with uh a larson jewel that is within my circle of confidence i hadn't even thought about it before but i know it's within it i mean i can evaluate a business like that and if i get called i got called the other day on a very large finance company i understand what they do but i don't understand everything that's going on within it and i don't understand that whether i can continually fund it you know on a basis independent from using berkshire's credit and so on so even though i i could understand every individual transaction they did i don't regard the whole enterprise or the operation of it necessarily as being within my circle of confidence charlie and yeah i think that if you have competence you almost automatically have a feeling of where the edge of the competence is because after all it wouldn't be much of a competence if you didn't know its boundary and so i think you've asked a question that almost answers itself and my guess is you do know what your in all kinds of areas and you do have all kinds of other areas where you know you'd be over your depth i mean you're not trying to play chess against bobby fischer or do stunts on the high trapeze if you had no training for it my guess is you know pretty well where the boundaries of your competence lies and i think you also probably know pretty well where you want to stretch the boundary and you've got to stretch the boundary by working at it including practice one of the drawbacks to berkshire of course is the charlie and i our circles largely overlap so you don't get too big complete circles at all but that's just the way it is probably why we get along so well too

Channel: The Financial Review

Views: 28,183

Keywords: investing, value investing, buffett investment, ben graham, ben graham fund, short selling, short long investing, charlie munger investing

Id: ApeLcLcrehY

Length: 14min 23sec (863 seconds)

Published: Sun Aug 15 2021