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Rupert Hargreaves
Rupert Hargreaves
Articles (491)  | Author's Website |

Charlie Munger: Loading Up on Leverage

Guru isn’t afraid to use gearing to boost returns

April 21, 2017 | About:

Charlie Munger (Trades, Portfolio) is well known today as the vice chairman of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) and Warren Buffett (Trades, Portfolio)’s right-hand man. He’s also earned a reputation in his own right for his intellect, investing prowess and desire to speak his mind.

But while most writing on Munger today concentrates on recent history, there is little discussion about Munger’s early days even though a lot can be gleaned from his early investing career.

Charlie Munger: Beginnings

Even though Munger is almost a household name today, five decades ago he was relatively unheard of, and it’s here where Munger’s career began. In 1960, Munger owned his own law firm after graduating from Harvard Law. After running into Buffett, who was an old friend, Munger set up his own partnership in 1962, and this is where his investing career began. In 1985, Buffett penned the now-famous essay on the super investors of Graham-Doddsville and wrote the following about Munger’s early career:

“I ran into him in about 1960 and told him that law was fine as a hobby, but he could do better. He set up a partnership quite the opposite of Walter’s. His portfolio was concentrated in very few securities and therefore, his record was much more volatile, but it was based on the same discount-from-value approach. He was willing to accept greater peaks and valleys of performance, and he happens to be a fellow whose whole psyche goes toward concentration with the results shown.”

Between 1960 and 1975, Munger achieved a compound annual return of 19.8% overall for his partnership, a total return of 1,156.7%. And rather than following a strict value strategy, as Buffett did at the time, he employed an entirely different strategy altogether.

As detailed in the highly informative Buffett encyclopedia, "The Snowball: Warren Buffett and the Business of Life":

“He said to Ed Anderson, 'I just like the great businesses.' He told Anderson to write up companies like Allergan (NYSE:AGN), the contact-lens-solution maker. Anderson misunderstood and wrote a Grahamian report emphasizing the company’s balance sheet. Munger dressed him down for it; he wanted to hear about the intangible qualities of Allergan: the strength of its management, the durability of its brand, what it would take for someone else to compete with it.

“Munger had invested in a Caterpillar (NYSE:CAT) tractor dealership and saw how it gobbled up money, which sat in the yard in the form of slow-selling tractors. Munger wanted to own a business that did not require continual investment, and spat out more cash than it consumed. Munger was always asking people, 'What’s the best business you’ve ever heard of?'”

Munger was also happy to borrow money to accelerate his returns, a highly risky strategy but one that seems to have paid off:

He wanted to get really rich, really fast. He and Roy Tolles made bets on whose portfolio would be up more than 100% in a year. And he was willing to borrow money to make money, whereas Buffett had never borrowed a significant sum in his life.”

“Munger did enormous trades [with borrowed money] like British Columbia Power, which was selling at around $19 and being taken over by the Canadian government at a little more than $22. Munger put not just his whole partnership, but all the money he had and all that he could borrow into an arbitrage on this single stock – but only because there was almost no chance that this deal would fall apart.”

This shows how different the strategies of Munger and Buffett were in the early days. It also poses an interesting question of whether Buffett would have been able to build the empire he has today without Munger at his side. Munger was clearly concentrated on quality and willing to make high conviction, highly concentrated bets to accelerate returns, unlike Buffett.

But at the same time, it should be said that this strategy is hazardous and the fact that Munger did not blow up in his early career is quite surprising. There are probably thousands of investors who have tried to follow a similar strategy but have failed. Munger’s success is either a result of his extreme genius or just pure luck.

Disclosure: The author owns no stock mentioned.

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About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. Prior to his investing and writing career, Rupert was as a proprietary currency trader. Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

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