Warren Buffett (Trades, Portfolio) has been active in the financial markets for well over half a century, which means that he has seen all sorts of different periods. From the perspective of someone trying to learn from history, this means that there is a lot of different source material that has been written about Buffett and his Berkshire Hathway (BRK.A, BRK.B) to analyze. This 1999 article written by Seth Klarman (Trades, Portfolio) discusses why Buffett is different to most value investors.
Good bargains become great ones in bear markets
Klarman recalls a period in the early 70s when Buffett was buying shares of The Washington Post. At the time, he believed that they were trading at a sizeable discount to intrinsic value, but was only able to accumulate a minority stake in the company, as the controlling interest was held by the Post’s founding family. This meant that Buffett had limited ability to make changes to the way the business was run (although in general he has typically stayed away from this kind of active involvement anyway). Luckily for Buffett, a bear market developed in 1973-75, causing the price of the Post’s stock to fall even further.
It’s been such a long time since a bear market was seen that many investors probably don’t even recall what that was like. As we know from the stories told by the elders, buying cheap value stocks during a bear market is not as easy as "picking up free money." Clearly there is an important psychological component that prevents the vast majority of investors from pouncing on opportunities that seem, in hindsight, to be irresistible. Klarman imagines what this period might have felt like to Buffett:
“Back in 1974 and 1975, when shares of Washington Post were declining so sweetly for Buffett, what might his daily experiences have been like? As confident as Buffett was back then, projecting out his future wealth from currently depressed point A to future point B, there were almost certainly times that a bit of fear rose in his throat too. He wouldn’t be human or risk-averse if the near-daily markdowns of his bargain purchase didn’t create room for reflection."
Risk-aversion comes in many different guises
Klarman believes that value investors must be simultaneously a little bit arrogant (to fuel their contrarian thinking) and extremely risk-averse. As noted in the quote above, he thought that Buffett must have felt at least some apprehension as the price of the Post’s shares continued to fall. But what does it mean to be risk-averse? And is Buffett risk-averse in the conventional sense? Here is how Klarman believes Buffett differs from the majority of institutional money managers when it comes to risk-aversion:
“[Short-term oriented] investors were disproportionately worried about their short-term investment results and their clients’ perception of same. In such a world, relative underperformance is a disaster and the longer-term is measured by the frequency with which investment results are evaluated. Risk for them is not being stupid, but looking stupid. Risk is not overpaying, but failing to overpay for something everyone else holds. Risk is more about standing apart from the crowd than about getting clobbered, as long as you have a lot of company."
A system that creates such perverse incentives for money managers is one that is clearly broken in an important way, but it is the one that we have. As long as there is a lot of money that plays by this script, value investors will have the ability to profit when such strategies inevitably underperform.
Disclosure: The author owns no stocks mentioned.
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- Warren Buffett on Junk Bonds, Part 1
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