In fine juxtaposition, Berkshire Hathaway and university endowments have reported results. Berkshire, the holding company run by Warren Buffett, and American colleges, both are quintessential long-term investors, at least in theory.
But Buffett easily outdistanced investors in Academia. And yes, there are several good lessons for the individual investor.
But first, a disclosure and an amazing fact. The disclosure is that I have an investment in Berkshire, both directly and through a mutual fund of which I’m a director.
The amazing fact is that, since May 1965, when Buffett took over what was then a struggling New Bedford, Mass., textile manufacturer trading at $18 a share, Berkshire’s book value has grown at a compounded rate of 19.1 percent a year. Over that span, the share price (through year-end) increased 20.9 percent a year.
Think about that. Over fifty-plus years, all you had to know, or very roughly predict, as an investor was the rate at which Berkshire would grow its book value. All the other stuff that investors and financial writers pay attention to — the ups and downs in the GDP, recessions, the yin and yang at the Federal Reserve, wars in Asia and in the Middle East, Presidential elections and policies, not to mention impeachments, stock market volume, Super Bowl scores, the occasional panic — ultimately, none of it mattered. Input 19.1 percent, output 20.9 percent.
Book value of course is not the only measure of corporate value, though it’s surprisingly useful. But whatever measure of corporate worth you prefer, it’s that — the intrinsic per share value — that will drive returns. The rest is noise.
This means an investor who is truly long-term can stop worrying about … just about everything that doesn’t affect corporate returns. And that, in a nutshell, is the difference between Buffett and his would-be university peers.
Over the decade through last June (when the colleges report), the S&P, including dividends, rose 7.1 percent a year; Berkshire weighed in at 8.8 percent, and universities, according to the annual Nacubo-Commonfund study of endowments, were significantly behind, at 4.6 percent. (For the decade through Dec. 31, the S&P was slightly ahead of Berkshire. Over longer periods, Berkshire is far ahead.)
Universities cannot invest their entire endowments in stocks, because they rely on a portion, typically about 5 percent, to fund their annual operations. However, endowments also trail more conservative portfolios, which are not fully invested in equities. Indeed, had the average endowment simply put a fifth of its assets in cash (enough to fund four years of operations) and the rest into stocks, their performance over the past decade would have been considerably higher.
The reason institutions with access to the biggest brains in America rack up such mediocre marks is that they suffer from an obsessive desire to avoid volatility. This makes sense over the short term. The money you will need next year shouldn’t be subject to the ups and downs of the market.
But the overwhelming portion of what universities invest is for the distant future. Indeed, no one has a longer horizon than they. Buffett likes to say he invests “forever;” Harvard, et. al has the luxury of actually being able to do so.
To dampen volatility, colleges invest in so-called alternatives, on the theory that these will not be synchronized with the market. Most alternatives — hedge funds, private equity, real estate — are illiquid (despite the colleges’ supposed emphasis on ready cash) and most charge exorbitant fees. Over time, they work like an expensive insurance policy. Volatility is less, but so are returns.
Endowments that indiscriminately follow such strategies are foregoing their singular advantage — the freedom to take a long view — for the privilege of letting their trustees sleep a little easier during periods such as now, when the market is unsettled. At last count, the average portfolio had an astonishing 52 percent in alternatives.
“Alternatives” arise from the common conceit that investing is mainly concerned with picking the right category. But the underlying premise is misplaced. All investments either participate in streams of income or seek appreciation of a capital asset. “Alternatives” may alter the packaging — generally so that more of the cream is skimmed off for insiders. But the underlying asset — which, as we saw, is what drives the return — is the same. A business is neither a better nor worse investment by virtue of being publicly or privately held. In a fundamental sense, there are no alternatives.
Whatever you call them, alternative strategies are adopted far too robotically. Alternative investing was pioneered by David Swensen at Yale in 1985, with exceptional results. But what worked for Swensen then does not work blindly for anyone at any time. As Buffett pointed out in his annual letter, endowments consistently put a portion (now about 8 percent) in bonds, as if they offered additional security. At prices that have prevailed in recent years, bonds were deceptively risky.
Let’s look at three specific “alternative” categories. Private-equity flourished in the early going, when deal prices were relatively attractive. But two generations of hungry deal-makers have driven deal prices to the stratosphere. No surprise, private-equity’s former edge over public equity (the stock market) has vanished. But endowments keep piling in.
Hedge funds, similarly, racked up impressive returns when only a handful of such funds — highly talented — existed. Those days are gone. With the universe expanded to thousands of funds, returns are mediocre — less than that when you deduct the fees. Universities invest as though hedge funds were inscribed in their charter.
Swensen had a particular edge with another alternative class, venture capital, because via the Yale faculty he tapped into a network of promising high-tech and biotech start-ups. The average faculty, alas, isn’t Yale.
To be in all these categories and more, endowments pursue a one-in-each-bucket approach, typically by owning scores of funds which trade in and out of hundreds and thousands of underlying investments. When returns falter, endowments respond by adjusting the mix, switching funds and sometimes sacking managers (Harvard did it three times in a decade) as if in search of some elusive magic combination.
The every-bucket approach left them with less than a sixth of their assets in U.S. equities and only 36 percent in global public equities. They all but missed the bull market. By contrast, Buffett invests opportunistically and puts the rest in cash and its equivalent. Most people aren’t Buffett, but by putting long-term funds in stocks and the rest in cash the ordinary investor is acting more sensibly than the highly paid, esoteric-minded endowment managers.
Their oh-so studied complexity violates two of Buffett’s cherished precepts. The first is to keep its simple. Seizing market opportunities, he wrote, “does not require great intelligence, a degree in economics, or a familiarity with Wall Street jargon.” And the second? Avoid flavor-of-the-month turnstile trading or, as Buffett put it, “Stick with big, ‘easy’ decisions and eschew activity.” But then, isn’t that the definition of long-term investing?
My recent column excoriating President Trump for imposing tariffs on washing machines and the solar cell industry asked whether David Ricardo, the apostle of free trade, wasn’t taught at Wharton. Based on Trump’s new tariffs on steel and aluminum, it appears he didn’t study even grade-school economics. The demagogue-in-chief tweeted “trade wars are good, and easy to win.” This will be news to Herbert Hoover. Trump also claimed that America is “losing many billions of dollars on trade.” Memo to the president: dollars spent on imports aren’t “lost,” any more than products shipped overseas for payments are lost. The essence of trade is that both sides gain.