Pilgrimage to Omaha – The Annual Confab

Going on a pilgrimage is as old as Religion. Men and Women have been for thousands of years going to the holy places of their religion in the search for peace, knowledge and enlightenment.

In the good old days before you could magically move from one corner of the earth to another in a matter of hours thanks to advances in transportation technology, this was a gruelling, time consuming and risky venture.

People didn’t go to pilgrimage of the holiest places as part of a tour package when young but as a search for something higher after having accomplished everything they desired to accomplish for there was no knowing if they would come back to the life they had.

For many years now, going to Omaha, the place of the Annual General Meeting of Berkshire Hathway has become a pilgrimage for those investors who emphasise on following the path laid down by the sage of Omaha as Warren Buffett is called.

From High Networth Individuals to Fund Managers to even Fund Distributors are now transported half way across the earth to be part of this big bash. While the meeting in itself is now web broadcasted, there is no dearth of those who wish to be part of the event physically.

While it’s one thing to believe in his principles, it’s quite another to follow and hence it’s not really surprising to see very few if any actually follow the path he walked upon.

Buffett Rule:  “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”

The thought process here is that you are not buying a ticker symbol but a business that you understand and once you buy, there should be no regrets, at least in the immediate months and years due to market / earnings volatility.

I was looking at a fund from the same fund house that took their top selling distributors to Omaha and stumbled upon something interesting. Of the top 10 stocks they were invested into 3 years back, 6 (60% of the top 10) aren’t even in the complete portfolio of today.

While 10 years maybe too long a period to hold stocks given the changing ecosystem, I was surprised to see such wide changes by a fund management house that swears by Buffett.

On the other hand, I think they were right – all six stocks are either in Industries that are for a long period of weak earnings or worse. Finally, investors reward fund houses with more assets only when performance is great, talk itself is cheap.

In his 2016 Annual Report, he wrote and I quote,

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients,”

Yet, Fund Managers regardless of size of their Assets under Management try to charge the maximum that can be charged to their investors. Warren himself has gone on record to recommend investing in low cost options such as Vanguard ETF. In India though, such views are anathema.

Warren Buffett himself gets just $100,000 as Salary for being the CEO and CIO of a company that on market is worth 488 Billion Dollars. Don’t even bother to calculate the decimal point that is the fund manager fees.

One of the reasons for higher charges being accepted has been the fact that unlike the United States where the large majority of mutual funds never beat the market consistently, here fund managers have accomplished the impossible.

The new SEBI regulations on Categorization and Rationalization of Mutual Fund Schemes shall have a large impact on fund returns and the alpha they can generate going into the future.

Fund Managers can deliver Alpha in two ways. One is to differentiate in weights compared to the Index they follow. For example, assume a Stock ABC which has a weight of 10% in the Index while having a weight of just 1% in the fund. If the stock drops 10%, the impact on the fund is much lower than it’s on the index thus providing Investors with an Alpha.

The risk though is that if the stock moves up 10%, the fund under-performs the Index  in a big way. This is a risk that most fund managers take by lightening their holdings in stocks they feel will no deliver while being overweight on stocks that they believe has a better future.

A second way to generate Alpha is by investing in stocks outside the Index. Since the stock is not part of the Index, if the stock delivers returns above that of the Index, the fund manager feels rewarded for taking the risk of being underweight Index stocks while being overweight other stocks.

SEBI’s recent circular now limits the ability of the fund manager to pick up stocks from outside the Market Cap the fund is categorized currently.  While the Alpha picking ability of fund managers were already on the way down, this should accelerate since there is little you can do to differentiate yourself from your peers or the Index.

Yet, fund managers expect that paying 2.5% for that is “sahi hai”.

When Warren Buffett started to manage other people’s money, he had an interesting way of how he will be compensated for his efforts.

Firstly, he collected no Management Fee. While we are seeing a few funds today that are following the same strategy, remember he did this in 1956.

Second, every partner would be paid 4% interest on his capital (remember, capital which could be growing or falling). Returns post that 4% were then split 50:50 between Buffett and the Partnership Investors.

In 1958, he modified it to make himself liable to pay 25% of the losses and the 4% interest if he generated a negative return on the investment during the year.

While I am no fan of Warren Buffett, its things like this that make you wonder how far ahead he was in being fair and equal when it came to outside funds. They don’t seem to make men like him anymore.

Don’t walk behind me; I may not lead.

Don’t walk in front of me; I may not follow.

Just walk beside me and be my friend.

– Albert Camus

Source on his Fees: What was the fee structure of Warren Buffett’s first investment partnership started in 1956?