Before Charlie Munger (Trades, Portfolio) joined Warren Buffett (Trades, Portfolio) Berkshire Hathaway (BRK.A)(BRK.B), he managed his own investment partnership. Between 1962 and 1970, Munger's investment prowess helped him achieve a return for investors of 24.3% per annum, compared to a gain of 6.4% per annum for the Dow Jones Industrial Average over the same period.
The strategy employed during this period is very similar to the one he uses today: waiting patiently for high-quality, undervalued businesses and then acting with conviction to take advantage of the opportunity presented by the market.
He was even willing to borrow a significant amount of money to take advantage of attractive opportunities whenever they presented themselves.
Borrowing money to make money
For example, according to Alice Schroeder's "The Snowball: Warren Buffett (Trades, Portfolio) and the Business of Life," on one occasion, when Munger saw an attractive opportunity with British Columbia Power, he invested 100% of his liquid net wealth and borrowed and an additional significant sum to take advantage of the opportunity. As the book described:
"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."
Unfortunately, Munger's style ended up causing him significant stress in the early 1970s. His strategy of going all-in on just a few bets and using borrowed money to juice returns meant that in the market crash of 1973 to 1974, his partners suffered significantly.
Although Munger believed in the long-term outlook of the companies he owned, predominantly Blue Chip Stamps and the New America Fund at this stage, he could not rest easy with the losses his partners were taking.
"Charlie realized that some partners would suffer hard-to-bear distress. After all, an investment of $1,000 on January 1, 1973, would have shrunk to $467 by January 1, 1975, if the partner had never taken any money out during the period. In contrast, a similar $1,000 investment that performed in line with the Dow Jones Industrial Average over the same period would have shrunk much less, leaving $688. Moreover, following precedents in the Graham and Buffett partnership, all Wheeler, Munger partners drew cash from their partnership accounts at one half a percent per month on start-of-the-year value. Therefore, after regular monthly distributions were deducted, limited partners' accounts in 1973 to 1974 went down in value even more than 53%."
This whole scenario ultimately convinced Munger to stop managing money in 1974.
All value investors can learn a valuable lesson from this case study, and that is if you don't know your positions inside out, you should not be running a concentrated portfolio. I could even go so far as to say that investors who do not have the time or inclination to investigate their companies on a granular basis do not deserve to own single stocks.
Munger wasn't bothered about his own losses because he knew that he had done the research and, over time, these companies would be worth significantly more than the market was indicating.
However, outside investors did not have access to the same information he had and, as a result, were more likely to make mistakes. It is reported that one investor pulled out at the bottom after investing at the top, losing around half of his money in about two years.
So, the two lessons we can learn from Munger's early investment career are: If you want to make a lot of money, be willing to go all in on your highest conviction positions, and if you do follow this course of action, make sure you do plenty of research beforehand.
Disclosure: The author owns shares in Berkshire Hathaway.