Don’t live a life based on approval from others. Be authentic—act in accordance with who you are and what you believe in, or one day your mask will fall off. If Buffett was living by the standards others followed, he would not have been able to maintain the firm independence of mind that has helped him avoid many financial bubbles and the subsequent personal misery. It is a significant lesson for all investors. A contrarian isn’t one who always takes the opposite path just for the sake of it. That is simply a conformist of a different sort. A true contrarian is one who reasons independently, from the ground up, based on factual data, and resists pressure to conform.
If, in your heart, you know who you really are and that the choice you made was absolutely right, then the criticism of others should be considered and analyzed to see whether it truly has any merit, but it should not be given permission to belittle what you are trying to achieve. Let your life be guided by internal principles, not external validation. Self-respect beats social approval. Every time. We are not perfect, nor should we pretend to be, but we always should endeavor to be the best version of ourselves.
Buffett’s operating principles during the Buffett Partnership years provide many lessons for fund managers—and all those who should always occupy the high ground in the interest of their clients.
The Buffett Partnership Years
In 1956, when he was just twenty-five years old, Warren Buffett formed Buffett Partnership Ltd. with $105,100 in capital and seven limited partners: his mother, sister, aunt, father-in-law, brother-in-law, college roommate, and lawyer. He charged no management fee, took 25 percent of any gains beyond a cumulative 6 percent, and agreed to personally absorb a percentage of any losses. You will rarely find such an equitable fee structure in the investment management industry today.
By 1969, $100,000 invested in the Buffett Partnership in 1957 would have become $1,719,481. If you had invested the same amount in the Dow, it would have grown to only $252,467. For more than a decade, Buffett achieved a compound annual return of 24.5 percent, net of fees (29.5 percent before fees). The compound annual return of the Dow over the same time, with dividends, was 7.4 percent.
And yet, despite all this success, Warren Buffett announced to his limited partners, in May 1969, that he would be closing down the Buffett Partnership.
Buffett was young, he was having extraordinary success, and he was having to actually turn away investors.
Why did Warren Buffett decide to close down his investment partnership in 1969?
Because he possessed certain virtues. Honesty. Sincerity. Integrity. Authenticity.
In January 1967, after a decade of incredible results, Buffett warned his limited partners to temper their expectations: “The results of the first ten years have absolutely no chance of being duplicated or even remotely approximated during the next decade.”2
In October 1967, Buffett explained to his investors why he didn’t think he would be able to achieve the same results:
Such statistical bargains have tended to disappear over the years….
…When the game is no longer being played your way, it is only human to say the new approach is all wrong, bound to lead to trouble, etc. I have been scornful of such behavior by others in the past. I have also seen the penalties incurred by those who evaluate conditions as they were—not as they are. Essentially I am out of step with present conditions. On one point, however, I am clear. I will not abandon a previous approach whose logic I understand (although I find it difficult to apply) even though it may mean foregoing [sic] large and apparently easy profits to embrace an approach which I don’t fully understand, have not practiced successfully and which, possibly, could lead to substantial permanent loss of capital [emphasis added].3
In January 1969, even after the Buffett Partnership’s best year ever, Warren Buffett continued to stand his ground: “At the beginning of 1968, I felt prospects for BPL performance looked poorer than at any time in our history…. We established a new mark at plus 58.8 percent versus an overall plus 7.7 percent for the Dow, including dividends which would have been received through the ownership of the Average throughout the year. This result should be treated as a freak like picking up thirteen spades in a bridge game.”4
In May 1969, Buffett said he was running out of good investment ideas. He said he could take some chances and gamble with his investors’ money so that he could go out a hero, but he refused to do so.
Finally, in October 1969, Warren Buffett closed the Buffett Partnership.
In his final letter, Buffett wrote his partners a ten-page explanation of why he recommended tax-free municipal bonds—even offering to sit down with each of them individually to explain the rationale, as well as to make the actual purchases for them. For those who wished to continue to invest in stocks, he said, “I feel it would be totally unfair for me to assume a passive position and deliver you to the most persuasive salesman who happened to contact you early in 1970.”5
Buffett recommended his clients invest with his Columbia classmate Bill Ruane, not because he was the best investor Buffett knew other than himself, but because Buffett viewed him as a person with high integrity and moral character. (Remember, most of Buffett’s limited partners were his relatives and close friends.) According to Buffett, Ruane was “the money manager within my knowledge who ranks the highest when combining the factors of integrity, ability and continued availability to all partners.”
Bill Ruane turned out to be a legendary investor in his own right, and his Sequoia Fund returned 289.6 percent over the next decade, versus 105.1 percent for the S&P 500. Later on, Ruane would be included as one of the superinvestors in Buffett’s speech titled “The Superinvestors of Graham-and-Doddsville,” delivered in May 1984 at Columbia Business School.
Throughout his early partnership years, Buffett embodied what Peter Kaufmann referred to during the 2018 Daily Journal Corporation meeting as the “five aces” of money management (figure 10.1).
FIGURE 10.1 “Five Qualities of Investment Advisors” by Peter Kaufman.
Source: “Charlie Munger on Bitcoins, Banking, AI, and Life,” Safal Niveshak (blog), February 17, 2018, https://www.safalniveshak.com/charlie-munger-bitcoins-banking-life/.
Fund managers (who, in essence, are operating in a fiduciary role for their clients) should view themselves first and foremost as risk managers. As such, they should follow the key principles of prudent insurance underwriting, outlined in Buffett’s 2001 shareholder letter:
They accept only those risks that they are able to properly evaluate (staying within their circle of competence) and that, after they have evaluated all relevant factors including remote loss scenarios, carry the expectancy of profit….
They limit the business they accept in a manner that guarantees they will suffer no aggregation of losses from a single event or from related events that will threaten their solvency. They ceaselessly search for possible correlation among seemingly-unrelated risks.6
Charlie Munger has always admired his protégé Li Lu for his work ethic and high integrity as a trusted steward of capital. To understand why, one needs only to listen to what Lu told the students at the Guanghua School of Management in China, in October 2015:
Establish an awareness of fiduciary duty. What are fiduciary duties? You must treat every dollar of client money as though it were the fruit of your own parents’ labor, saved up piece by piece over a lifetime of diligence and thrift. Even if it’s not much, it took years of struggle and sacrifice to accumulate. If you can understand the responsibility this entails, then you can start to understand the meaning of fiduciary duty.