A glut of stored oil that helped keep prices low for years
is almost gone, thanks to production cuts by OPEC and Russia, a humming global
economy and a series of small but meaningful supply disruptions.
Excess inventories of stored oil by the world’s industrialized
economies are now at their lowest level in more than three years, based on a
five-year running average, according to data released Thursday by the Organization of the Petroleum
Exporting Countries. After months of steepening declines, the cartel
said commercial inventory levels shrunk a further 17.4 million barrels in
February, to about 2.85 billion barrels.
That represents a surplus of just 43 million barrels, based
on the five-year average. Two years ago, the storage surplus hit 400 million
barrels.
The drain on storage is partly a consequence of a concerted
effort by Saudi Arabia, its OPEC colleagues, and Russia, to throttle back
output to bolster prices.
Going, Going, GoneThe world's glut
of stored oil has quickly disappeared.Total oil inventories in OECD countries
compared with their five-year averages*
“The rebalancing process is well under way,” OPEC Secretary
General Mohammed Barkindo told an energy summit in New Delhi on Wednesday.
The quickening depletion of excess stored oil has analysts
throwing around a word they haven’t had to use that often in the past few
years: shortages. Without much cushion in storage, the threat of supply outages
can more quickly drain inventories—and boost prices.
Venezuelan crude output has been hobbled by political and
economic instability there, and rising tensions between the U.S. and Russia
over Syria have also contributed to worry over supply. President Donald Trump has threatened a missile attack against Syria, in
retaliation for an alleged chemical attack by Syria’s government, which Moscow
has backed during the country’s long civil war.
Syria doesn’t pump much oil itself, but the new tensions
have raised the specter of bigger production outages across the oil-rich Middle
East, should military action escalate. Many similar supply-shock worries have
had only muted impact on oil prices in the recent past, thanks to the glut of
oil in storage. With that cushion gone, analysts say geopolitics may again
start playing an outsize role in oil markets.
“Global oil supply and demand are quickly approaching a
balanced position after spending several years in an excessively high inventory
mode,” said Dominick Chirichella, co-president of New York-based Energy
Management Institute, in a report Wednesday. “Geopolitical risk is bubbling up
in the oil pits.”
Ministers attend the OPEC meeting in
Vienna on Sept. 22, 2017. Photo: joe klamar/Agence France-Presse/Getty Images
Saudi Arabia has indicated little appetite for opening up
the spigots. In its report Thursday, OPEC said its collective production fell
by an average 201,000 barrels a day. Part of the decline came from fresh,
voluntary cuts by Saudi Arabia. Earlier this week, the kingdom said it would
keep its overall crude-oil exports below 7 million barrels a day next month.
Saudi Oil Minister Khalid al-Falih told the New Delhi
conference this week that “we will not sit by and let another glut resurface in
the coming years and bring the market through the roller coaster that we have
seen.”
Thinning inventories isn’t just down to OPEC-led cuts. Oil
demand has been growing amid a rare, synchronized economic expansion by the
world’s biggest economies. OPEC said it now sees demand for this year growing
by about 30,000 barrels a day more than it had previously forecast. That growth
is now expected to come to an average 1.63 million barrels a day for the year.
Amid that new appetite, a series of production outages are
already sapping supply. Last month, OPEC says it lost about 100,000 barrels a
day because of the crisis in Venezuela and disputes by rival political groups
in Libya and Iraq.
All that has translated into higher oil prices. Brent, the
international oil benchmark, has been hovering above $70 a barrel—levels not
seen in three years.
The big question for markets now is whether, amid the
tightening market, North American shale producers swing back into action. These
smaller, nimbler producers have in previous periods of oil-price strength,
ramped up output to take advantage of the higher prices.
That new production typically boosts supply, and eases
prices back down again. In its report, OPEC upgraded its non-OPEC oil supply
forecast for the year, saying Canada and the U.S. will pump about 90,000
barrels a day more than expected.
Look up “permabear” in the dictionary and you might just find a
picture of Albert Edwards. Société Générale’s global strategist is
undeterred by a nine-year old bull market and argues that a new
financial Ice Age will take hold that more central-bank quantitative
easing will be unable to stop. After the huge credit boom that has
supported stock market gains, Western financial assets will experience a
downturn similar to that felt in Japan beginning in the late 1980s. In
Edwards’ scenario, U.S. Treasuries will eventually sport negative
yields, the stock market will plunge below the previous lows of 2009,
and corporate debt prices will fall. The result will be a recession.
Given the recent volatility in world stock markets, we thought it might
be a good time to chat with the 56-year-old strategist and get his
recommendations on how to play the next big chill.
Barron’s: You’re well known for your long-term bearish view based on your Ice Age thesis. Tell us about it.
Edwards:
I put together the Ice Age thesis just over 20 years ago out of
following Japan closely. In 1996, when the West was deriding Japan as
incompetent, we came to the view that what happened in Japan would visit
the West. Japan’s bubble had burst earlier, and as a result, it moved
toward outright deflation earlier than anyone else.
In Japan,
secular rerating of bonds took place with a very long journey of falling
central-bank-controlled rates in the short term and declining long-term
interest rates, with occasional strong cyclical recoveries during the
past decade and a half. As each new recession came along, the bond yield
would fall to a new low, and equities would reach new lows. From 1990,
Japanese equities embarked on a long secular bear market in valuation.
In
the West, stock valuations—not prices—reached their peak in 2000, and
the very close positive correlation between lower bond yields and rising
stock price/earnings ratios began to break down. As in Japan, bond
yields continued falling because of central-bank easing. That would
bring about an absolute and relative derating of equities versus bonds,
interrupted by cyclical recoveries. In other words, bond yields keep
falling as stock valuations drop. For that to happen in the West, the
credit bubble supporting higher stock prices would have to burst.
These
secular equity-valuation bear markets don’t occur often and take many
recessions to play out. We saw that in Japan. The U.S. has had only
three secular equity deratings in history. The shortest took four
recessions to play out; the longest, six. A secular valuation bear
market for equities is when you go from extremes of expense to extremes
of cheapness. Since the peak of the bubble in 2000, we’ve had only two
recessions. This extraordinary rally is an interruption.
U.S. and European stocks have done well. When is it going to get cold?
The
Federal Reserve managed to short-circuit this derating process. In
2011, when quantitative easing, or QE, really kicked in, equity
re-engaged with bond yields and P/Es expanded. Like an artificial
stimulant, QE inflated all asset prices away from fundamental value and
from where they would otherwise have gone.
We haven’t seen the
lows in bond yields. In the next recession, bond yields in the U.S. will
go negative and converge with those in Germany and Japan. The forward
U.S. P/E bottomed at about 10.5 times in March 2009 on trough earnings.
That was lower than the previous recession. In the next recession, I
would expect the P/E to bottom at about seven times, a lower low with
earnings about 30% lower because of the recession. That would put the
S&P lower than the 666 low of the previous crash, versus 2671
Thursday afternoon.
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If a recession unfolds, easy monetary policy won’t stop the market from collapsing. It will play itself out. When will the recession unfold?
The
Conference Board’s leading indicators look OK for now. What’s different
is that problems in the real economy aren’t being reflected in the
stock and bond markets. What we may see is the reverse: The stock market
and parts of the credit markets collapse and cause problems in the real
economy. If confidence collapses because the equity market collapses,
then a recession unfolds.
Will the next bear market be worse for the U.S. than for Japan or Europe?
It
should be. Traditionally, if the U.S. goes down 20%, the German Dax,
though it is cheaper, would tend to go down a little more. Maybe this
time it won’t. Japan is the one market we do like now on a long-term
basis, and one of the reasons is the buildup of U.S. corporate debt
during these past few years. The big bubble is U.S. corporate debt. In
contrast, Japan’s corporate debt is collapsing. Over half of its
companies have more cash than debt.
When the Fed buys U.S.
Treasuries, it pulls down all yields. There has been demand for yield,
so investors look at corporate bonds as an alternative. Companies have
been very keen to issue them, and they have used the money to buy back
stock or as a way to enrich management. This is the way QE has washed
through the system here
Corporate debt has ballooned out of
control not just with larger companies, but with smaller companies as
well. Net debt-to-Ebitda has rocketed to all-time highs.
In its
Global Financial Stability Report of April 2017, the International
Monetary Fund said that in the next recession, 20% to 22% of U.S.
corporates would default. This is where the U.S is vulnerable. It isn’t
just junk-bond issuers. It is the explosion that has taken place in
corporate debt. Companies can be put under tremendous stress by the
financial markets in an equity bear market, which means they cut
employment and investment.
There is a massive corporate credit
bubble out there waiting to be revealed in either a recession or an
equity bear market that causes a recession from the disintegration of
the corporate bond market. Normally in a bear market, if equities are
down 50%, then junk is down 50%, and investment-grade debt is down about
15% or 20%. In the next downturn, junk will probably be down more than
50%, and investment grade will be down 30% or 40%. That will be the big
surprise. In contrast, Treasury rates will rally.
We’ve got a new
president of the Federal Reserve. In the last cycle, central bankers
were lucky. They were able to blame the commercial bankers for the
financial crisis, even though it was their job to take away the punch
bowl. In the next one, the blame will stick to the Fed, and it may well
lose its independence.
What asset class do you favor in the Ice Age?
If
the U.S. 10-year Treasury goes from 3% to negative 1%, that is huge
return. In equities, it would either be Japan or, if you can invest only
in U.S., then gold miners, as gold will exceed its previous
$1,900-per-ounce high.
Is there a way to avoid this Ice Age or mitigate it? If you were the new head of the Fed what would you do?
I
would stop worshipping at the altar of the financial markets. If
pulling an economy along were the route to economic prosperity, then
Argentina would be the richest country in the world by now. This is
failed policy. What I would do is not intervene so much.
QE2 and QE3 were totally unnecessary. The leading indicators were turning up before QE1 was done.
There
is weak economic growth because you have the biggest bubble in history,
and we know from Japan there is a long unwinding period, and you are
condemned to weak growth. You need fiscal balance, which the U.S.
avoided.
This interference—even well-intentioned—causes other
problems because the policy makers used credit to drive the recovery.
You can never normalize interest rates. You try to normalize interest
rates in the next upturn, as they are doing now, and eventually you blow
things up.
Of the last 13 Fed tightening cycles since 1950, 10
have ended in recession. It tightens until something breaks, and it
breaks sooner than they expect.
What is your reaction to the Trump tariffs?
Many
thought after the election he would back away from these tariff
promises. He has delivered tax reform, which is probably the most
criminally insane piece of fiscal stimulus this late in the cycle. To
take the fiscal deficit to 6% of GDP at this stage is utterly ludicrous,
but he is delivering on his promises.
On tariffs, China will
escalate. To a person, all economists think a tariff war is catastrophic
for the global economy. This isn’t about economics; it is about
politics, about appealing to President Donald Trump’s base. If China
acts on its proposal to put on tariffs on soy exports to hit his base,
or it switches from Boeing to Airbus, then you really know things are getting nasty.
Germany
may become a target. It has the biggest dollar surplus in the world
now. If you are looking for things that will knock the market, Germany
is annoying everyone in terms of the size of its trade and account
surplus, not just the U.S. The European Commission has complained about
Germany’s trade surplus. The Germans don’t help themselves. When China
and Japan are criticized, usually they do a little something to placate
criticism. Germany’s politicians are dismissive: “We have an incredibly
large surplus. What do you expect us to do? Make crappy goods like you?”
Will Trump turn to Germany eventually on the surplus?
He
will. It is negative for stocks, with an equity market so overextended
in valuation. I compare this to 1987, when the bond market sold off
after many years of falling yields and stocks rising on the back of it.
The Fed started to raise rates. The economy was strong, just as it now.
The manufacturing ISM was over 60, just as it is now, only the second
time the ISM has gone above 60 since 1987. Oil prices recovered from a
slump the year before.
The past year and a half is very similar.
Equities were going up, ignoring the selloff in bonds, which leaves them
vulnerable. Now, central-bank liquidity stimulus is gone, leaving
financial assets vulnerable to a panic attack. And if you take out tech,
the market has been looking horrible for quite a while. Breadth is
deteriorating. We are in real trouble here.
Where might you be wrong?
The
end game for the Ice Age in the next recession is always going to be
currency wars, negative interest rates, and negative federal-funds
rates. This recovery could go on for longer. You could get inflation
that actually gets bonds sufficiently disturbed that yields break above
3% and enter a bear market. If bonds enter a bear market, I would be
wrong on bonds, but that isn’t good news for equities.
Policy
makers could always create inflation. Give everyone a check and print
money and you will create inflation. Even though I’ve been calling for
the Ice Age slipping into outright deflation, that is a signpost on the
way to total global debauchment of currencies. Policy makers look in the
rearview mirror and say easing hasn’t created inflation so far, so
we’ll do more. People look in the rearview mirror too much.
You like U.S. bonds, but then eventually the government response will make them a bad bet.
Absolutely,
people should look to hide in them as a haven over the next six, 12, 18
months. And, hopefully, if equities become cheap enough, then that is
the real opportunity. But you have got to have cash to take advantage of
those opportunities. https://www.barrons.com/articles/s-p-500-could-test-2009-low-says-longtime-bear-1522957392 On that optimistic note, thank you. Email: editors@barrons.com
Read the weekly investment strategy commentary from Chief Investment Strategist Jeff Saut.
March 26, 2018
Many of you will recall that T. Boone Pickens and I
know each other. In fact, three years ago he and I did a “fireside chat”
on stage at Raymond James’ Summer Development Conference in front of a
few thousand financial advisors. I actually met Boone years ago through
ex-CNBC anchor Consuelo Mack. Consuelo became friends with T. Boone when
she was working as a reporter in Dallas, but I digress. I bring up
Boone this morning because tomorrow we are doing a conference call with
BP Capital (Boone Pickens Capital). Details can be found in the post
scriptum of this missive. We are doing this because we believe there is a
huge disconnect between the price of crude oil and the current
valuation levels of the energy stocks. As often stated in these reports,
“The energy stocks are basically trading at the same valuation levels
that they were when crude oil was trading at $26 per barrel. Now,
however, crude oil changes hands at almost $66 per barrel.” Moreover,
our Houston-based energy analysts think the price of crude is going
higher. Also in that camp is Cornerstone Analytics’ Mike Rothman, who is
considered one of the best energy analysts around and his daily letter
is a must read. In a recent report he writes:
US inventories are continuing to decline at an impressive
rate. During the first two weeks of March, US oil storages have
decreased counter-seasonally by 11.5 million barrels; usually we see a
build in March of about 6.6 million barrels. Keep in mind that these
March declines are in addition to impressive January and February
inventory numbers. More importantly, Mike doesn’t see the draws letting
up anytime soon. [Given] tightening global supplies, and large producers
like Venezuela continuing to falter, the oil bear argument is becoming
harder and harder to swallow.
Also worth mentioning is that many oil company insiders are buying
their own stock. From the Raymond James energy research universe of
stocks that have Strong Buy ratings from our fundamental analysts, the
founder and CEO of Parsley Energy (PE/$27.32/Strong Buy) recently bought
$5 million of his company’s stock in his first ever open market
purchase. For the record, the importance of an open market purchase is
that the insider is voluntarily buying shares at the current market
price. Continental Resources’ (CLR/$58.00/Strong Buy) founder and CEO,
namely Harold Hamm, made an open market purchase of nearly $8 million
worth of his company’s stock. Evidentially, these gentlemen believe the
future looks pretty bright for their companies and our fundamental
analysts agree.
Moving on to the stock market, last week was rough with both the
S&P 500 (SPX/2588.26) and the D-J Industrial Average (INDU/23533.20)
losing more than 5%; their largest weekly loss since January 2016.
Reasons offered for the weekly decline included: Facebook’s Face-plant; a
tad more hawkish Fed; tariffs; the Whitehouse shakeup; slowing
manufacturing surveys; etc. In studying some individual stock charts, it
is quite amazing how much damage was done to select stocks in such a
short period of time. The weekly wilt saw the Industrials break below
their February 8 closing low of 23860.46, but the SPX did not breach its
February 8 closing of 2581.00, although it is close to doing so. In
fact, ALL of the major indices we follow were in the red last week, as
were ALL of the macro sectors. The only index we monitor that gained
last week was the Goldman Sachs Commodity Index (+2.37%), which is
consistent with our return to commodities theme. Along this line, gold
and crude oil are attempting to break out to the upside in the charts.
Plainly, we did not think the February lows would be retested.
Obviously, we were wrong, and in this business when you are wrong you
say you are wrong and you need to be wrong quickly for a de minimis
loss of capital. And, before we get a bunch of questions, as of yet
there is no Dow Theory “sell signal.” This week should be critical in
determining how the equity markets will do in the near term. If the 2581
level fails to contain this decline, the next “fight” should take place
at the February 9 intraday low at 2532.69. However, what we could be
setting up for is a “W,” or double bottom, formation in the charts. We
saw similar chart formations in the fall of 2015 and in February 2016
(chart 1 on page 3) and they both led to rallies. We would also note the
McClellan Oscillator is in a fully oversold condition (chart 2) and
that the S&P 500’s Advance-Decline Line did not confirm last week’s
downside (chart 3 on page 4). So we will say it again, “This week is
critical.” Longer term we continue to embrace the theme that the secular
bull market has years left to run. And our pal Leon Tuey concurs.
Recently, Leon wrote this:
As mentioned in my reports, one of the outstanding features of this
great bull market is the persistence of worries. Every week, investors
find something new to worry. This month, “trade war” is the worry du
jour. Can it happen, of course, it can. The problem is that no one knows
for sure whether it will happen and when it will happen. Also, by the
time we know about it, everyone else would have found out. Meanwhile,
what are investors to do?
No one can deal with the unknown or predict “black swans.” Available
evidence continues to support my view that the greatest bull market is
in progress and its end is nowhere near in sight. It will not end until
the Fed sees fit to tighten meaningfully. But as mentioned before, the
Fed will only do so when the economy overheats, inflation surges, and
speculation is rampant. Keep in mind what Sir John Templeton accurately
observed: “Bull markets are born from pessimism, grow on skepticism,
mature on optimism, and die on euphoria.” Where are we? You be the
judge.
The call for this week: We did not expect the SPX to
retest its February lows. In the short term we should have paid more
respect when the SPX traveled below its 20-day moving average (@ 2730)
five sessions ago. It subsequently broke below its 140-DMA (currently at
2643.49) and is in jeopardy of violating its 200-DMA at 2585.22. We
still favor the upside, believing the equity markets are setting
themselves up for a move higher, but admittedly we have been wrong for
the past five sessions. Last Friday we got a two-step decline. The first
decline ended around noon with the SPX trading around 2625 where a
rally attempt began. It fizzled out at 2648 where a deeper decline
commenced, carrying the SPX to ~2586 near the lows of the session, and
it smacked of panic selling. And don’t forget, the major market indices
are market capitalization weighted indexes; and the large caps are
leading the way down. Meanwhile, the small/mid-caps continue hang in
there pretty well.
If a move higher is in the cards it should become evident this week
with a double-bottom, or “W,” formation in the chart of the SPX. And
this morning stocks are sharply higher on the easing of trade war fears.
P.S. – March 27 at 3:00 p.m. (ET). You can register at (BP Capital call). After registering, you will receive a confirmation email containing information about joining the webinar.
Participants can use their telephone.
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In 1956, when he was just 25 years old, Warren Buffett formed Buffett Partnership, Ltd.
Buffett started with $105,100 and seven limited partners: his mother,
sister, aunt, father-in-law, brother-in-law, college roommate, and
lawyer. He charged no management fee, took 25% of any gains beyond a
cumulative 6%, and agreed to personally absorb a percentage of any
losses.
By 1962, Warren Buffett became a millionaire because of his Buffett
Partnership, which in January 1962 had a value of over $7 million (of
which over $1 million belonged to Buffett). Yet four years later,
Buffett announced that he would no longer be accepting new partners.
Following this announcement, Warren Buffett continued to run the
partnership, and he continued to crush the stock market. In 1968 the
Buffett Partnership returned 58.8% vs. 7.7% for the Dow – Buffett’s best
year ever. https://vintagevalueinvesting.com/warren-buffett-decided-to-close-his-buffett-partnership/
By 1969, $100,000 invested in the Buffett Partnership in 1957 would
have become $1,719,481! If you had invested the same amount in the Dow,
it would have only grown to $252,467. For over a decade, Buffett
achieved an annual compound return of 24.5% net of fees (29.5% before
fees). The annual return of the Dow over the same time with dividends?
Only 7.4%. Source: The Irrelevant Investor
And yet despite all of this success, Warren Buffett announced to his
limited partners in May 1969 that he would be closing down the Buffett
Partnership. Why?
Warren Buffett was young, he was having extraordinary success, and he was having to actually turn away investors.
So why did Warren Buffett decide to close down his investment partnership in 1969?
…Because of one word: Integrity.
The Buffett Partnership Letters
As Michael Batnick over at The Irrelevant Investor points out, Warren Buffett was essentially a blogger 60 years ago via typewriter – just as Buffett writes an annual letter every year for Berkshire Hathaway shareholders, he also wrote many letters to his limited partners.
In January 1967, after a decade of incredible results, Warren
Buffett warns his limited partners to dial back their expectations.
The results of the first ten years
have absolutely no chance of being duplicated or even remotely
approximated during the next decade.
In October 1967, Buffett explains why his investors why he didn’t think he’d be able to achieve the same results as before.
Such statistical bargains have tended
to disappear over the years… When the game is no longer being played
your way, it is only human to say the new approach is all wrong, bound
to lead to trouble, etc. I have been scornful of such behavior by others
in the past. I have also seen the penalties incurred by those who
evaluate conditions as they were – not as they are. Essentially I am out
of step with present conditions. On one point, however, I am
clear. I will not abandon a previous approach whose logic I understand
(although I find it difficult to apply) even though it may mean
foregoing large and apparently easy profits to embrace an approach which
I don’t fully understand, I have not practiced successfully and which,
possibly, could lead to substantial permanent loss of capital.
Buffett is saying that the easy bargains he was finding before are
now few and far between. He acknowledges that it’s easy to say that new
investing approaches are bound to lead to trouble while blindly clinging
to the past, yet he is unflinching on one point: that he will not
abandon the investing strategy that he understands
– even if it means lower profits – in favor of a new investing
strategy that he doesn’t understand which could cause him to lose his
and his investors’ money.
In July 1968, even after the Buffett Partnership’s best year ever, Buffett continues to stand his ground.
At the beginning of 1968, I felt
prospects for BPL performance looked poorer than at any time in our
history… We established a new mark at plus 58.8% versus an overall plus
7.7% for the Dow, including dividends which would have been received
through the ownership of the Average throughout the year. This result
should be treated as a freak like picking up thirteen spades in a bridge
game.
In May 1969, Warren Buffett says he’s running out of really great
ideas. Buffett says he could take some chances and gamble with his
investors’ money so that he can go out a hero, but he refuses to do so.
Quite frankly, in spite of any
factors set forth on the earlier pages, I would continue to operate the
Partnership in 1970, or even 1971, if I had some really first class
ideas. Not because I want to, but simply because I would so much rather
end with a good year than a poor one. However, I just don’t see anything
available that gives any reasonable hope of delivering such a good year
and I have no desire to grope around, hoping to “get lucky” with other
people’s money. I am not attuned to this market environment and I don’t
want to spoil a decent record by trying to play a game I don’t
understand just so I can go out a hero.
Finally, in October 1969, Warren Buffett essentially retires (briefly) from investing and closed down the Buffett Partnership. Source: The Irrelevant Investor
In his final letter, Buffett writes his partners a 10 page
explanation of why he recommended tax-free municipal bonds – even
offering to sit down with each of them individually to explain the
rationale, as well as make the actual purchases for them. But for those
who wished to continue to invest in stocks:
I feel it would be totally unfair for
me to assume a passive position and deliver you to the most persuasive
salesman who happened to contact you early in 1970.
So Buffett recommends his clients invest with his Columbia classmate, Bill Ruane – not because he was the best investor Buffett knew besides himself, but because Buffett viewed him as a man with great integrity and moral character (remember, most of Buffett’s limited partners where his family and close friends). According to Buffett,
Ruane was “the money manager within [his] knowledge who ranks the
highest when combining the factors integrity, ability and continued
availability to all partners.”
Bill Ruane, as history would have it, turned out to be a legendary investor in his own right, and his Sequoia Fund
returned 289.6% over the next decade, versus 105.1% for the S&P 500
(he’s also included as one of the superinvestors in Buffett’s The Superinvestors of Graham-and-Doddsville).
Investing with Integrity
There are several key themes from the Buffett Partnership story that have carried on throughout Warren Buffett’s career.
One of these is his focus on his investors and shareholders. Warren Buffett is a true American capitalist,
and any good capitalist knows that there are two types of people in any
capitalistic organization: principals (who own the organization) and
agents (who act on behalf of the principals) (see The Principal-Agent Problem).
For a company, the principals are the shareholders and the agents are
the managers, who are hired by the shareholders to run the company on
their behalf. For an investment fund, the principals are the limited
partners and the agents are the general partners (i.e. the fund
managers).
In all cases, it is very easy when you are the a shareholder or
limited investor (i.e. the principal) to expound on how important it is
for managers to always act in the best interest of the shareholders’
(i.e. to act in YOUR best interest). But when you’re the manager, do you
really think you’re going to put the shareholders first? Or will you
put your salary, your bonus, your job security, your perks, and your
personal ego first? I’d say in 9 times out of 10, the manager puts
himself first – it’s really only human nature.
Warren Buffett, of course, is in the 1 time out of 10 category. As
CEO of Berkshire Hathaway and as the investment manager for the Buffett
Partnership, Buffett has ALWAYS put his shareholders’ interests first.
This is clear when you read any of his letters. And it’s pretty easy to
understand why he acts this way: he has virtually all of his wealth tied
up in Berkshire Hathaway (and over 90% of his wealth was in the Buffett
Partnership), so he is also one of the largest principals as well as
the agent. Other investors also include his family and closest friends,
making it even more important to Buffett to act in their best interest.
But there is another reason why Buffett acts this way, and that’s
because of his integrity. In the whole Buffett Partnership saga, you can
see how Buffett acted with integrity toward his limited partners, and
how he acted with integrity in regards to his investment strategy – he
was unwilling to try a new, untested method just because it was becoming
harder and harder for him to continue with his tried-and-true approach.
He even closed down the partnership because he refused to gamble with
his LPs money, even though he could’ve gone on for at least several more
years. Finally, after he closes the partnership, Buffett even hand
picks a new fund manager for his partners – not based on his resume or
his IQ – but based on his moral character.
Summary
The story of the Buffett Partnership is a pretty rare one in the
world of finance. After 12 remarkable years, Buffett feels like he’s run
out of really great ideas, so he closes the partnership down. That is
like Jim Brown retiring at age 29 – at the peak of his career – after only 9 seasons.
But Buffett, of course, did not really retire, and he went on to build Berkshire Hathaway
into one of the world’s largest and most valuable companies. And as it
turns out, when Buffett closed down the Buffett Partnership, he paid his
partners in Berkshire stock. When Buffett first bought Berkshire
Hathaway stock for the Buffett Partnership in 1962-65, he
paid $7.60-$14.86 per share. Today, Berkshire Hathaway stock trades for
over $215,000 per share.
This article was inspired by Michael Batnick’s article Going Out On Top, over at The Irrelevant Investor. Michael, in turn, says that his post was inspired by Jeremy Miller’s book Warren Buffett’s Ground Rules. I haven’t read this book yet, but it’s very highly rated and I often see it recommended, so I would definitely check it out:
