Berkshire Hathaway
Buffett Partnership Letters

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By gdefelice
August 2, 2001

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I've had the chance to read the Buffett Partnership letters -- they are extraordinarily fascinating. One gets a wonderful sense of how Buffett's mind works, especially from the perspective of odds and math in general.

His basic strategy was to outperform the Dow by beating it in down markets. (Of course, he kicked the hell out of it in every market. As an aside, however, I humbly point out that owning Berkshire, today, in a declining market -- they DO happen -- might turn out to be an enriching experience.) One can sense how carefully he thought about achieving his goal -- he never directly explains how he intends to do this, but I think one can guess based on the types of investments he chose and the fact that we know he won't buy things when they're selling for more than he thinks they are worth.

He bought undervalued stocks but, importantly, he also did workouts -- events such as mergers, liquidations, reorganizations, spin-offs, etc. The important point about workouts (as it relates to beating the market by outperforming during down years) is that the financial results obtained by owning securities in this group are determined by actions of the managements rather than by the supply and demand created by buyers and sellers of securities. The final group is called control situations. As the name implies, these are situations where the partnership owned a controlling stake or a large enough stake to influence management actions and I think that he intended the returns to reflect similar patterns to those from most "workouts" -- namely, returns were not dependent on the market reappraising the investment and pushing the price up to its "true" value. Rather, the outcome was in the hands of a very few people and the returns, assuming he had his facts straight, could be realized on a more predictable schedule. Moreover, in modern parlance, the returns were not "correlated" with the market.

Buffett said that in a rapidly advancing market for blue chips, he would expect that the Partnership might keep pace, but more likely would underperform. Of course, such a market is typically overvalued and, as Graham has explained, it is very difficult to outperform with his techniques when little or nothing is "undervalued." In any case, I think that Buffett's basic goal was to outperform during down markets precisely because of his use of workouts and control situations -- situations where returns were not affected as much as for those investments whose fortunes were tied more closely to the market, where the emotions of mass psychology so often distort reality.

In cases where the market was going hog wild, he foresaw that he would have had to play the greater fool game in order to keep pace. Workouts and controls provided for ballast in an emotionally-driven down market just as he expected them to be anchors in an emotionally-driven up market. Ultimately, when things became more and more speculative on the upside, he simply disbanded the Partnership and made Berkshire (to the benefit of us all) his investment vehicle. His pessimism about the market at that time (late '69) was palpable. It is clear from the letters that things were ideal for a Grahamite circa 1950 -- while it isn't clear he knew that conditions were ideal at the time, he was clearly able to discern the time when conditions were no longer ideal for his investment style.

The letters are especially useful if one is trying to be a manager of OTHER people's money -- as opposed to managing for one's self, where I think the tenets expressed by Buffett in the Annual Letters are more useful. I think this is an important distinction. I will say that managing other people's money, using the techniques we all believe as gospel, makes it very, very, very difficult in such a market as has just passed (most believe, though not on this board, it hasn't passed yet) -- where the Wilshire 5000 was compounding at 25% a year from '95 - '99. As those of you who manage money for others know, just try telling your investors that making 25% a year doesn't make "sense." By the time you turn out to be right, they've taken their money and lost it somewhere else.

Most people expect their money manager to outpace rising markets; they simply do not want to consider down markets. Yet Buffett set out to do the opposite. He said that he expected that, in rising markets, he might underperform while in down markets he should outperform. This type of thinking is not music to most people's ears. He said, in 1961, "I would consider a year in which we declined 15% and the Average (Dow) 30% much superior to a year when both we and the Average advanced 20%. Over a period of time there are going to be good and bad years; there is nothing to be gained by getting enthused or depressed about the sequence in which they occur. The important thing is to be beating par; a four on a par three hole is not as good as a five on a par five hole and it is unrealistic to assume we are not going to have our share of both par threes and par fives."

Personally, I think much more can be learned about investing by reading the Annual letters for Berkshire. But, it is clear that even from the beginning, when I would guess Buffett was about 27 or 28, he was something special. His writing was so clear and confident -- it had (and still has) that special quality of undeniability. It is that quality, I think, which attracts to many of us to him today. In a word, he is RIGHT. I have no doubt, NONE, that he will be proven right again and that ultimately his stake in Berkshire Hathaway will make him the wealthiest man in the world (God willing age is not an impediment). I believe that for him, the goal is to be that person not because it will "feel good" to have the most but because it will prove, beyond a shadow of a doubt (beyond six or seven or eight sigmas), that Graham and Buffett and Munger (with Buffett providing the link between the two) are the only ones to ever figure out a way to win (where winning is defined as beating the market) over the very, very long-term.

I hope someday that Buffett feels that it is a good idea for everyone to share in the BP letters. It would be nice if he provided a reason that they shouldn't be shared. But, I will respect his wishes.

On this subject, does anyone know how to get ahold of the Berkshire annual letters from 1970 - 1976? Can anyone speculate as to why they are not on the website?