Warren Buffett (Trades, Portfolio) is considered to be the world's most disciplined long-term investor. But what many people do not realize is that throughout his career, Buffett has also placed a substantial number of short-term trades. These trades generally took advantage of some price dislocation that he believed could offer a quick return for minimal risk.
It's always exciting to learn about these trades when the Oracle of Omaha discusses them in letters or interviews. It gives us an insight into his way of thinking that is not usually discussed. It shows us the renowned guru is willing to take advantage of Mr. Market wherever he may offer an opportunity, even though this might mean breaking his rules about long-term trading and using derivatives.
Long-short strategy
One strategy Buffett used in the 1960s to try and make extra money for his partners was pairs trading. This involved going long one security with bright prospects and shorting another, intending to make a profit from the difference in the performance of the two.
At the 2008 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting, one shareholder asked Buffett if this is something he would ever take part in again.
He responded by saying the technique was first used by Benjamin Graham in the 1920s, when he ran one of the world's first hedge funds. "He found out it worked modestly," Buffett said. "He was right about four times out of five, but the time he was wrong tended to kill him on the other four."
The CEO of Berkshire Hathaway went on to explain that while running his partnerships, he often shorted the market, borrowing stock from significant investors such as the university pension funds of Columbia, Harvard and Chicago:
"We shorted out the general market for about five years in the partnership, to a degree. We borrowed stocks directly from some major universities. I think we were probably quite early in that.
...
We did not go short things that we thought were unattractive; we just shorted out the market generally. It was always kind of interesting to me, when I would visit the treasurer of Columbia or something like, and I'd say, "We'd like to borrow your stocks to short," and, you know, he thought his stocks were pretty good at that point. And he'd say, "Which ones do you want?" And I said, "Just give me any of them, I'm happy to short your whole damn portfolio."
Focus on quality
So it appears that Buffett was happy to short the market when he first started managing money for outside investors.
As we know, however, his investment strategy has changed drastically over the past several decades. It is highly unlikely Buffett would be shorting stocks today, and that's something he went on to add at the 2008 meeting.
After responding to the question with the above, he went on to add that "it was not a big deal, but we probably made some extra money on it in the 1960s." He continued, "Generally speaking, if you've got some very good ideas on businesses that are undervalued, it is really unnecessary to do any sorting out of the market."
To this point, Buffett's right-hand man, Charlie Munger (Trades, Portfolio), responded, "We made our money by being long some wonderful businesses. We didn't make it by a long-short strategy."
So there we have it, an interesting insight into one of the strategies the young Buffett used to produce returns for his investors in the 1960s. This is something he will not be repeating again anytime soon. I think it is worth taking note of his comment that if you can find undervalued businesses, then there is no need to short stocks at all. You can get all the profit you need from these undervalued, high-quality equities.
Disclosure: The author owns shares of Berkshire Hathaway.
Read more here:
- Warren Buffett: Why It's Important to Pay Attention to a Company's Accounting
- Walter Schloss' First 5 Tips for Making Money in the Stock Market
- Learning From Value Investing Legend Walter Schloss
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