How Buffett Is Different From Most Investors, Part II

Includes: BRK.A, BRK.B
by: David Merkel, CFA

Click here for Part 1

Before I begin this evening, let me simply say that where I find intelligence, I appreciate it, whether I agree with all the ethics of the situation or not. Buffett is a bright guy, brighter than most. I have not been shy to criticize Buffett when I thought there were ethical lapses — whether it was retroactive reinsurance, life settlements, David Sokol, or anything else.

The fifth way that Buffett is different is that Buffett was comfortable managing a company, rather than a pass-through vehicle like a mutual fund or a hedge fund. That may sound trivial, but it is significant, because few investors do that. The advantages are considerable. You have permanent capital to work with, so you can focus on the distant future when times are bad.

The article that prompted this piece talked about how Buffett would "bet against beta," and would invest in quality stocks. These are the strategies that one can take advantage of if one has sufficiently long-term capital. But I differ from the article, because value, betting against beta, and an emphasis on quality are not risk factors if you have a sufficiently long time horizon. They are sources of alpha. I disdain everything from MPT. Real investing is finding companies that can compound free cash flow at above average rates.

I think that is a part of the problem with academic consideration of investing. Typically they embed an idea that the investment horizon is short, which makes their ideas useless for long-term investors.

The sixth way that Buffett is different is that Buffett uses leverage ("float") from the insurance companies to fund much of his assets. The float has grown, but in an era of low interest rates, P&C insurance companies focus hard on making an underwriting profit. In one sense, the low interest rate environment has made the P&C insurers and reinsurers to not be financials; they compete on underwriting, not investing.

The seventh way that Buffett is different, is that he doesn't care what form the investment takes. Buffett might say: "Stocks, great. Convertible preferreds, even better. Convertible bonds, yes. Credit default swaps, only if I get to structure it, and same for selling options. Private equity is fine; I will leave them alone, and capture the private equity niche of those who care about their corporate culture." And more… he is a flexible guy, because he has a strong balance sheet behind him.

As for the robo-Buffett the academics create, well, hindsight is 20/20. Who could have seen the relatively placid economics of the past 30+ years? With that much foreknowledge, some private equity investors could have gone wild and done far, far better than that.

But Buffett had no roadmap. He faced the same fog that we all do, but made robust choices that would do well against a fuzzy future. As such, he deserves attention for his clever investing, because Buffett is different from the rest of us.