One of our directors came up with a list of qualities that any investment advisor should have. And he gave it to a future picker of professional investors, and the picker immediately fire half his picks. And I thought that was such a peculiar outcome that I’ll let Peter Kaufman share with you his ‘five aces’ system for picking an investment manager. Peter, go ahead.
Peter Kaufman: So I came up with this list in giving reference to a very exceptional money manager. And I not only wanted to give what I thought was the correct reference, I wanted the person that I was giving the reference to, to in turn be able to relate this above to the real shot-caller. So that a compelling narrative would be transferred from me directly to the ultimate shot-caller. So I came up with what I call the “five aces”. The five aces being the highest hand you can have in a wild card poker game. Ace number one is total integrity. Ace number two is actual deep deep fluency on whatever it is you say you’re going to do on behalf of the client. Ace number three is a fee structure that is actually fair in both directions. Ace number four is an uncrowded investment space. Ace number five is a long run-way. Meaning that the manager is reasonable young in age. I further add that if you ever find a money manager who possesses all five of these characteristics, there are two things you should do. One, you should put money with them immediately. And number two, put as much money as you are allowed to put. Now I know we have money managers in the room, and we have…
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Question 9: This question is for Mr. Kauffman. You mentioned about the “five aces” and aligning the interests with investors with the right fee structure to benefit both. What have you seen as a good fee structure, both from a start-up fund with say $50 million in assets, and then the larger funds with assets over billion?
Peter Kaufman: I’ll let Charlie answer that because he can describe to you what he thinks is the most fair fee formula that ever existed and that’s the formula in Warren Buffett’s original partnership.
Charlie: Yeah, Buffett copied that from Graham. And Mohnish Pabrai is probably here…is Mohnish here? Stand up and wave to them Mohnish. This man uses the Buffett formula, and always has, he just copied it. And Mohnish has just completed 10 years…where he was making up for a high water-mark. So he took nothing off the top at all for 10 years, he sucked his living out of his own capital for ten long years, because that’s what a good money manager should be cheerfully willing to do. But there aren’t many Mohnish’s. Everybody else wants to scrape it off the top in gobs. And it’s a wrong system. Why shouldn’t a man who has to manage your money whose 40 years of age be already rich? Why would you want to give your money to somebody who hasn’t accumulated anything by the time he was 40. If he has some money, why should he on the downside suffer right along with you the investor? I’m not talking about the employees under the top manager. But I like the Buffett formula. Here he is, he’s had these huge successes. Huge in Buffett’s career. But who is copying the Buffett formula? Well we got Mohnish and maybe there are a few others, probably in the room. But everybody wants to scrape it off the top, because that’s what everybody really needs, is a check every month. That’s what is comforting to human nature. And of course half the population, that’s all they have, they’re living pay check to pay check. The Buffett formula was that he took 25% of the profits over 6% per annum with a high water mark. So if the investor didn’t get 6%, Buffett would get nothing. And that’s Mohnish’s system. And I like that system, but it’s like many things that I like and I think should spread, we get like almost no successes spreading that system. It’s too hard. The people who are capable of attracting money on more lenient terms, it just seems too hard. If it were easier, I think there would be more copying of the Buffett system. But we still got Mohnish. (laughter).
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The second question was Li Lu. What was unusual about Li Lu. Li Lu is one of the most successful investors. (link) Imagine him, he just popped out of somebody’s womb and he just assaulted life the best he could and he ended up pretty good at it. But he was very good at a lot. He’s ferociously smart. It really helps to be intelligent. He’s very energetic. That also helps. And he has a good temperament. (link) And he’s very aggressive, and he’s willing to patiently wait and then aggressively pounce. (link) A very desirable temperament to have. And if the reverse comes, he takes it well. (link) Also a good quality to have. So it’s not very hard to figure out what works. But there aren’t that many Li Lu’s. In my life, I’ve given money to one outside manager, and that’s Li Lu. No others in my whole life. And I have no feelings that it would be easy to find a second. It’s not that there aren’t others out there, but they’re hard to find. It doesn’t help you if a stock is a wonderful thing to buy if you can’t figure it out.
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Question 21: In 1999, Warren Buffett said that he could return 50% if he ran $1 million. Give what you said about the investment landscape today being more difficult, what do you think that number would be today?
Charlie: Well I do think that a very smart man who’s patient and aggressive in combination, is willing to work hard, to root around in untraveled places like thinly traded stocks and other odd places. I do think a person with a lot of shrewdness, working with a small amount of capital, can probably earn high returns on capital even today. However that is not my personal problem at the moment. And for me it’s hard. And for Berkshire it’s hard. And for the Daily Journal we don’t have any cinch either. It’s disadvantageous to have securities in a corporate vehicle like the Daily Journal Corporation. It’s an accident that we have them there. We have them there because that’s where the money was. The way it’s worked out, it’s not desirable if you’re a shareholder and you have a layer of corporate taxes between you and your securities that are indirectly owned. And once you get public securities held in a public corporation taxable under sub-Chapter C of the internal revenue code, all kinds of factors, including income taxes affect your investment decisions. And it’s much easier to invest in charitable endowment or your personal pension plan. Generally speaking, I would say, if you’re shrewd enough with small sums of money, I think you can compound pretty well. The minute you get bigger sums, I think it starts getting difficult. It’s way more difficult for all you people sitting here than it was for me when I was in your position. But I’m about to die and you have a lot of years ahead. (laughter) You would not want to trade your position for mine.
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Question 26: Could you comment on whether you ever considered investments in Hershey’s or Tiffany’s over the long term and have offered attractive entry points?
Charlie: Well I’d be delighted to own either Hershey’s or Tiffany’s at the right price, wouldn’t you? It’s just a question of price. Of course they’re great companies. But that’s not enough, you have to have great companies available at a price you’re willing to pay. Hershey’s is a private company. Nobody’s offering me Hershey’s. I can buy the candy, but I can’t buy the company.
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