I am fascinated by the early investment careers of Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio). I spend so much time analyzing the first few decades of these investors' careers because I think it is essential to understand how they built the foundations to get to where they are today.
It's all very well knowing which multi-billion dollar investment Buffett is making today, but these investments are going to be out of the range of most. Something I find particularly fascinating is the difference in strategies these two investors used to build the foundations of their investment careers.
Two different strategies
Buffett started his life as an investor when he was still a teenager. He made several significant investments before he went to work with Benjamin Graham in New York. When he returned home to Omaha, he set up his own investment partnerships using funds from friends and neighbors.
This was the first time the young investor was using significant sums to invest, and he built his approach around Graham's idea of buying cheap stocks. He invested in the public equity markets and didn't use much leverage, mainly because he didn't need to. Buffett was using other investors' cash, so he had more financial firepower than he would have otherwise had had.
Some of the biggest successes in these early years were Buffett's activist-style investments. He would buy up a significant interest in an undervalued company and then use his ownership to push for change. This helped crystallize value in the underlying security.
Munger's first significant investments were in real estate. He started investing later, concentrating on his career and family first. Through his contacts in the legal world, he was able to get ahold of an attractive real estate development. After the first deal, he took on several more, learning from each one and partnering up to increase his financial firepower.
Munger's strategy differed from Buffett's because not only was he using real estate rather than equities, but he was also happy to use a lot of debt. Borrowing tends to be more acceptable in the real estate space because there is a hard asset to borrow against.
Leverage and catalysts
When one compares these two strategies, there are similarities. Both investors were able to use other people's money to increase their exposure. Buffett was investing his partners' money, increasing his financial firepower and ultimately leading to attractive fees for outperformance. Meanwhile, Munger borrowed money from the bank to finance his real estate projects. This allowed him to take on projects which he might not have been able to finance himself.
The other similarity between the two strategies is the fact that both investors deployed capital into opportunities where there was the potential for a value crystallization event. This was either the sale of the real estate development (in Munger's case) or the changes he brought in as an activist (in Buffett's case).
These two strategies may have been different, but they produced the same results. These two investors were able to leverage other people's money to increase wealth and improve their returns.
Both Buffett and Munger have followed a similar approach ever since. When Munger was managing his investment partnerships, he was willing to borrow a lot of money to invest in opportunities with a set pay off date.
When Buffett wound up his investment partnerships, he started to focus on the insurance business. He could use each company's float, the money held to pay insurance liabilities, to invest in the market as a sort of investment leverage.
Other investments, such as Blue Chip Stamps, have also provided capital from other people's money for these investors.
All in all, Buffett and Munger's ability to leverage outside capital has been one of the reasons behind their success over the past seven decades.
