Buffett Partnership Letter Series – 1961 (Part 1)

In this article, we will take a look at the first part of Warren Buffett’s 1961 partnership letter.

In 1961, the Dow Jones Industrial Average (“Dow”) showed “an overall gain of 22.2% including dividends received through ownership of the Dow.”

The overall gain for the Buffett partnerships operating throughout the entire year averaged 45.9%. This result is after all operating expenses, but “before payments to limited partners or accrual to the general partner.” The results of the past five years of partnership operation are shown below (on the same basis as described above: “after expenses, but before division of gains among partners or payments to partners”):



* Including dividends received through ownership of the Dow.

And here are the cumulative results on a compounded basis:



Thus, from 1957 to 1961, the partnership gain (on a compounded basis) was almost 2.4 times larger than that of the Dow.

Since there were varying limited partnership agreements in the past, Buffett used overall gain numbers above to describe the partnership’s overall performance versus the Dow. However, Buffett then shows (on a pro-forma basis) what the limited partner returns would have looked like given the “division of gains entailed in our present Buffett Partnership Ltd. agreement.” These results are shown below.



COMPOUNDED



Thus, from 1957 to 1961, the limited partner’s gain (on a compounded basis) was almost 1.5 times larger than that of the Dow.

A Word About Par

Buffett states, “The outstanding item of importance in my selection of partners, as well as in my subsequent relations with them, has been the determination that we use the same yardstick.” According to Buffett, it is critical that all partners “have the same idea of what is good and what is poor.”

Buffett goes on to say that he believes in “establishing yardsticks prior to the act; retrospectively, almost anything can be made to look good in relation to something or other.”

Buffett states that he has “continuously used the Dow-Jones Industrial Average as our measure of par. It is my feeling that three years is a very minimal test of performance, and the best test consists of a period at least that long where the terminal level of the Dow is reasonably close to the initial level.”

Buffett then describes a few of the advantages of using the Dow as an investment “yardstick”:

• The Dow “…has the advantage of being widely known, has a long period of continuity, and reflects with reasonable accuracy the experience of investors generally with the market.”
• The Dow “…has generally proven to be a reasonably tough competitor.”

Next, Buffett discusses investment company performance versus the Dow. Specifically, he compares the performance of “38 mutual funds whose method of operation I felt was such as to make a comparison with the Dow reasonable, 32 did poorer than the Dow, and 6 did better. The six doing better at the end of 1960 had assets of about $1 billion and the 32 doing poorer had assets of about $6.5 billion. None of the six that were superior beat the Dow by more than a few percentage points a year.”

Buffett then presents “the year-by-year results for our period of operation (excluding 1961 for which … [he doesn’t] have exact data, although rough figures indicate no variance from the 1957-60 figures) for the two largest common stock open-end investment companies (mutual funds) and the two largest closed-end investment companies.”



(From Moody’s Banks & Finance Manual, 1961)

COMPOUNDED



The yearly comparisons are interesting. The BPL limited partners did better than the investment companies and the Dow in 1957, 1959 and 1960; and the BPL limited partners did worse than the investment companies and the Dow in 1958 (when the investment companies and the Dow racked up large gains). This performance seems to generally coincide with Buffett’s expectation for the partnership: outperformance in relatively flat or down markets, and just trying to keep up in rapidly advancing markets.

However, even with the BPL limited partners falling behind in 1958, their compounded results were much better than those of the investment companies and the Dow (due to outperformance in the other years).

Buffett had this to say about the above return comparisons:

I do not present the above tabulations and information with the idea of indicting investment companies. My own record of investing such huge sums of money with restrictions on the degree of activity I might take in companies where we had investments, would be no better, if as good. I present this data to indicate that the Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or perhaps, even matching, its performance.

The above table of compounded results seems to support Buffett’s statement that “the Dow as an investment competitor is no pushover.” Excluding the BPL limited partner results:

• In 1957, the Dow performed better than all investment companies listed except Tri-Cont.
• From 1957-8, the Dow performed better than Mass. Inv. Trust and Lehman.
• From 1957-9, the Dow performed better than all investment companies listed (and by a decent margin).
• From 1957-60, the Dow performed better than all investment companies listed except Tri-Cont. (Note: Interestingly, Tri-Cont. seemed to achieve its outperformance of the Dow and the other investment companies in the down markets of 1957 and 1960.)

Buffett acknowledges that the partnership’s portfolio “is very different from that of the Dow” and the partnership’s “method of operation is substantially different from that of mutual funds.” But even with these differences, Buffett still feels that the Dow is a “fair test of performance” because “most partners, as an alterative to their investment in the partnership would probably have their funds invested in a media producing results comparable to the Dow.”

Thanks for reading along. Next time, we’ll examine Part 2 of the 1961 partnership letter.

Links to other articles in the Buffett Partnership Series:

Previous article: Buffett Partnership Letter Series – First Half of 1961

Introduction: Buffett Partnership Letter Series