Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) both cut their teeth in the investment world managing money for other investors.
Buffett set up his first investment partnership with an investment of $100,000 with family and friends after he returned from New York, where he was working with Benjamin Graham, to Omaha in the late 1950s. Munger followed several years later when Buffett convinced him that managing money was a good business to be in (in addition to his real estate development business and legal practice).
Buffett decided to close his investment partnerships in 1969. Munger didn't, but by the mid-1970s, his hand was forced. It isn't easy to imagine the billionaire quitting the market after a sudden downturn, but in some respects, that's just what he did in the mid-1970s.
In the early years, Munger's returns handsomely beat the Dow Jones. His fund earned 37.1% per annum before fees between 1962 and 1969. Then, in the three years to 1972, returns started to slip. The partnership returned 13.9% per annum during this period, only just beating the Dow's 12.2%.
In 1973 and 1974, the bottom fell out of the market. Munger's partners saw their funds' value fall 31.9% in 1973 and 31.5% in 1974. Both of these figures were worse than the broader market.
Two factors exacerbated the losses of Munger's funds. The first was the ownership of big blocks of common stock in New America Fund and Blue Chip Stamps, and second was the fact that Munger had used borrowed money to increase the firm's stake in New America.
The New America stock was acquired at close to its peak value of $9.22 in 1972. Although this was a significant discount net asset value of the time, it didn't prevent the stock from falling further, widening the discount to the asset value per share. At the end of 1974, the value of the Fund's stock held on the partnership balance sheet had fallen to $3.75. That was around 50% below its net liquidation value.
The same was true at Blue Chips. In 1972, the stock had a market price of $15.37 per share. By the end of 1974, it had fallen to $5.25.
At the end of 1974, according to Janet Lowe's book, "Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger," the net asset value of the entire partnership was $7 million. Of this, 61% was in Blue Chip and 21% in New America.
One unfortunate partner put in $350,000 before the crash and saw more than half of his funds vanish. Munger could not persuade him to stay.
Ultimately, Munger wasn't too worried about the losses in his portfolio. He had other businesses and knew the companies were worth much more than the market seemed to believe. Nevertheless, he couldn't take the pain of reporting the losses and explaining the losses to his partners. Therefore, he decided to shut down the partnership.
In some respects, this was a great decision for Munger. It allowed the investor to concentrate on his individual businesses, which included Blue Chip. This ultimately became one of the building blocks of the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) we know today.
According to Lowe's book, when the partnership was closed, Munger's family "had about $3 million" from his partnership and an additional "$2 million more from real estate." He told the author, "I owned wonderful securities, and other wonderful, bargain-priced securities were then available in the market."
And how did the partnership's investments ultimately perform? The book explained:
"New America Fund stock did fine. By the late 1980s, each share that had traded at a $3.75 market value at the low point had turned into about $100 in cash and securities...Each share of Blue Chip Stamps, then valued at $5.25 became 7.7% of one common share of Berkshire Hathaway. With Berkshire common stock selling in March 2000 at about $48,000 per share, this means a former Blue Chip Stamps share was then worth 7.7% of $48,000 or about $3,700 per share. Each dollar of 1974 market value thus became about $700 in year 2000 market value. This represents an increase of about 28.5% per annum, compounded, for 26 years."
Disclosure: The author owns no share mentioned.
Read more here:
- A Closer Look at Net Net Investment Richardson Electronics
- Charlie Munger, the Fund of Letters and Other People's Money
- Why Relying on the P/E Ratio Can Be Dangerous
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