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No. of Recommendations: 91
Saturday night after the annual meeting My Wife and I were sitting in the bar at “The Dover” waiting for a table. The place is always packed the night after the AGM (they have a great whiskey rib eye). Two men came in and sat down next too us at the bar and started to converse in German. My wife is Russian and speaks English with a heavy accent, and when the man next to us heard the accent he asked where she was from, so we started a conversation, and ended up sharing a table for dinner.

It turns out that both of our new acquaintances were from Germany and were in Omaha to attend the Berkshire Meeting. One was an employee of Der Spiegel, and was still living in Germany, but the other was a private equity manager living in London. This of course sparked my curiosity so I spent some time questioning him about Charlie and Warren's comments on private equity and hedge fund money. Somewhere during the course of the evening he made a statement to the effect that he knew quite a lot of people running private equity money in Europe and that they all followed Buffett's philosophy.

He explained that private equity is primarily institutional money, pension plans, education institution such as Harvard or Oxford, together with some ultra rich individuals, and that most of the managers had appeared in the last three or four years. Suddenly it became obvious to me that not only are stocks in general over valued, but there are big piles of money chasing those asset classes that are popular with value investors. The reason that Berkshire has not been able to buy much in the way of whole businesses in the last three or four years is that there are large pools of money out there bidding up the price of everything that comes down the pike.

Times have changed dramatically in the fourteen years since I attended my first Berkshire Hathaway annual meeting. In 1991 if I told people I had just been to the Berkshire Hathaway meeting I would just get this strange blank look, and the unstated question, “Who the hell is Warren Buffett?” Today it seems that everyone has heard of Warren Buffett.

My circle of competence may be limited but there is one thing I have learned through thirty eight years of investing, that the market will always do what it has to do, to prove the majority wrong. Or as Buffett says you pay a high price for a cheery consensus. This is not because the market is perverse, but because the market is a zero sum game and frictional costs mean that there will always be more losers than winners.

For most of his life Warren has been able to play on a field were all the big money was doing something else. For most of the eighties and nineties the big money was in mutual funds, and all they wanted was growth stocks. Eventually the popularity of this class drove their prices up and their risk level into the stratosphere. At first Warren was just obscure, but even as he became better known, for Wall Street he was a six sigma event, and no one was not much interested in following his philosophy. But in the last five years since the growth bubble pop things have changed some.

So what happens to us if value investing becomes the cheery consensus? Depressing as this line of thought is, it is clearly the direction that we are headed. In 1991 there were 1500 people at the annual meeting. This year it was something like 20,000. Great as this is for the hospitality industry in Omaha, I not sure that a similar benefit will accrue to people of the value investing faith. Maybe this is what Charlie is thinking about when says that they may have to lower our expectations? Maybe this is what has driven Warren to buy S&P puts, Junk Bonds and Foreign Currency?

On a more positive note this is clearly something Warren has though a lot about and his take at the annual meeting was that he may get crowded out for a while but that things can change in a hurry, and sited the junk bond market in 2002 as example were he was able to put nine billion to work in a short period of time. Still the opportunity did not last very long.

Charlie said that he does not expect to see another 1974. A careful review of Warrens comments at the meeting reveal that he may not total agree with Charlie on this point, but who can tell which one is correct. Warren the optimist believes that there will be a market crash, were as Charlie the pessimist disagrees.

For smaller investors there is always micro cap as an area where anyone managing serious money can not play, because if you are managing $100 million or more it is hard to buy a significant piece of a company with a $250 million market cap. But even this area may get difficult because if a good company gets cheep enough a private equity manager may come along and buy the whole thing and take it private.

So do I think that value investing no longer applies? Of course not. But I do think it likely that barring a real nice crash in the equity markets, the next few years will be difficult. For the last five years you had to outperform the market by 8% to get a net return of plus 4.5%. This is not my idea of easy pickings, and while it may be quite satisfactory for the true value investor, an investor paying two plus twenty is not likely to be happy with an annual return of 4.5%.

In support of Warrens optimism (that there will be a crash) is this fee structure of the hedge funds and the private capital. The twenty percent carrot offers a very strong incentive for managers to do stupid things. It is particularly interesting that while Warren has doing practically nothing for the last three years many of the private equity managers who profess to follow value investing principals are buying things that Warren would not buy or at least at prices he would not pay.

With close to a billion in equity and another billion in leverage one thing seems certain, hedge funds as a class will not be able to outperform the market. I have no idea how much money is in the hands of private equity managers but it would not surprise me that they are now in the same position as the hedge funds (to much cash in class for it to outperform the market). Perhaps what Warren sees is a huge amount of hot money with nervous feet. Hopefully enough to cause a stampede of sufficient magnitude of allow him to spend $45 billion.

On Charlie's side of the argument are the large cash positions in value funds and the large short positions by the hedge funds, for if there is a cheery contentious for a crash then it probably will not happen.

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Charlie's comments at the Wesco meeting were that there is way too much private equity and institutional competition chasing way too few goods.

He did suggest that Berkshire had an advantage-for the seller that is NOT concerned only about the price but who also cares about the future home for the business.

I thought the most important point was when Charlie said that he has never seen a period where there was LESS to do in stock, bond or real estate markets.
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Greetings,

While I agree with everything you are saying, small dislocations seem to happen more than one would think. I remember hearing once (may have been WEB or CM) that the odds of a certain market dislocation was a six sigma event but that it seemed to happen alot more often than that. In the last five years there were enormous opportunities in small cap stocks, AXP in the mid 20's, DIS at 15, MO at less than 20, Berkshire at 45 and 60 and on and on. I don't know what will cause some kind of market dislcation, an Asian Crisis, Long Term Capital Management, Dot Com bust, 9/11, Iraq, recession, currency crisis, all I know is that one will come at some point in the next few years like it always does and that will likely present an opportunity in some sectors. There may also be opportunity created in individual sectors like insurance in October and/or other areas. What I find most interesting about the AGM was when WEB said that things could get interesting if everyone tried to get out the door at the same time in currency. That may be the case in a number of asset classes. At those times, people don't care about price only selling. I remember thinking when Berkshire was trading at 1500, who is selling this to me? I do agree that most asset classes are overvalued, but they are mean reverting and often correct below the mean.

Thanks for your sharing that wonderful post.

DQ

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Obviously there is a lot of money floating around and buyers willing to bid up prices looking for a quick buck.

But it needs to be said that not all hedge fund managers are slimy fee-driven monsters. Some are actually very good at finding undervalued stocks and shorting overvalued stocks. To the extent that they run a lot of money they have the effect of pushing the market towards fair value, which it is more today than it's been in a long time.

Theoretically, if everything sold at fair value it would increase each year by the T-bill rate plus whatever risk premium was appropriate and right now we're talking 5%-6% returns.

Also, with the big money constantly looking for bargins, assets don't collapse as far as they use to and won't remain low for as long as they use to. Buffett's ability to compile a big position will be harder and harder.

Unless there is a daisy-chain collapse and a concentration of risks in the private equity/hedge fund world, I don't see huge selloffs that would create a 1974. There's too much cash waiting for 1974 for it to happen.
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Hello rclosch,

Today's WSJ discusses hedge funds, and assigns them $1 trillion in assets.

Over the past four years, the average hedge fund gained 6.4% annually, compared with an average annual gain of less than 2% for the S&P 500 and an average annual gain of less than 1% for the Dow Jones Industrial Average.

Over the same period, hedge funds have seen their assets soar to about $1 trillion from about $400 billion, thanks to the influx of new investment and the high returns.

Still, hedge funds are lagging behind bonds,...>
http://online.wsj.com/article/0,,SB111568653093328851,00.html?mod=home_whats_news_us

It has been reported that they account for 1/2 of the daily trading volume on the NYSE.

I assume, because of their huge size, they are forced into major currency market speculations. Don't see how they could buy many shares of stock without disrupting trading.

Regards,

puzzled48

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Unless there is a daisy-chain collapse and a concentration of risks in the private equity/hedge fund world, I don't see huge selloffs that would create a 1974. There's too much cash waiting for 1974 for it to happen.

For me this is the big question, and in my opinion this may be what Charlie sees. If he is right, sitting on cash and waiting for the crash may not work all that great. In the long run you may be right, but you know what Keynes said.

“In The long run we are all dead”
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rclosch-

I guess it would be interesting to know where in the equity markets these large "value" investors are buying. For example, it appears that alot of money has chased the energy, homebuilding and materials sectors of the equity market, while other sectors have languished. Certainly many stocks are trading at or below where they traded several years ago, including many "growth" stocks and Berkshire Hathaway. It may be that these stocks were way overvalued then and are simply somewhat overvalued now. However, most investors seem to be quite bearish about the stock market generally, particularly in comparison to other asset classes.

Is it possible that to the extent these hedge funds and other large value investors have been buying stocks, their buying has been limited to a narrow area of the stock market, much as investors were buying tech stocks at the height of the tech bubble to the exclusion of other stocks? If so, it may be that there are areas of opportunity in other areas of the stock market, and that Buffett's investment in BUD may be followed by other investments, even without a stock market crash.

markreisman
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I wonder if this thread (which I would summarize as, "Things might not go very low because smart value investors will scoop them up before they get low enough for us"), along with Munger's comment about having to "lower the bar", are not indicators that there is not very much fear out there. If everyone believes there's a safety net, then a lot of people, maybe even top Berkshire management, might get into stocks at prices that would have kept them away iin the past.

That could be true, or it could mean that things coult fall a lot further than we think.

gg
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If you've read OID in the past two years almost every manager other than Nygren is hoarding cash. Buffett is hoarding cash. Corporations are hoarding cash. I think there is probably too MUCH fear in the market right now, especially among the value set, despite the fact that there are serious risks ahead of us. Stocks are not screaming buys right now but they are not wildy overvalued either. In my view 15-20 times earnings for blue chips is not crazy yet Coca-Cola, McDonald's, Wal-Mart, Budweiser, Harley Davidson, Target are all near that range. There are many others, too.

I don't think value managers have loaded into homebuilding, energy, and materials because a lot of these companies are trading at single digits--hardly the height of excess. The market is building in a crash in oil and housing into these stocks which may or may not come. But it is nothing like the Tech days when people were NOT valuing in a crash and actually valuing in improvement in the future.

Are there any investors out there who are not aware of the twin deficits, unstable dollar, excess debt levels, and emergence of China? Are there any investors out there who don't know that the Great Depression was a great buying opportunity? I think perhaps this time we HAVE learned from history and we are smarter as a society and investor class.

There are risks out there to be certain, but all are fixable and Americans have shown that we can overcome our problems when we finally decide to tackle them. Buying into America has worked so well that this last crash hasn't changed people's perception that stocks are great long-term investments.

Either there will be a crash or there will be a long period of stagnation while earnings catch up to valuations. Many value managers are betting on the crash and holding cash. I think the private equity/hedge fund world thinks we're in for stagnation and that's why we're seeing record inflows into trading profit strategies.

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Warren also said at the AGM that Real Estate was probably in a bubble and that a sharp decline would present some opportunity to Berkshire. Living in San Diego and seeing firsthand what is going on, I think such a decline is inevitable in the overheated RE markets.
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gg,
I don't think Munger thinks that there's a safety net. Do other hedge funds in general think there is? Sure... but not Munger, who says of 1/2 of the things he sees that they are sewage bound to destroy our society's sense of ethics.

There are risks out there to be certain, but all are fixable and Americans have shown that we can overcome our problems when we finally decide to tackle them.

oh yeah?? so why don't we liqidate these hedge funds and use the proceeds to make a downpayment in Asia? Why are we letting the pension funds assume that the hedge funds will have a return of x? Why is the consumer buying so many cars?

Deal with our problems we will, but only when we stop over-speculation and over-consumption, and that means reduced E, and therefore, higher P/E. It also means a hedge fund disaster.

On hedge fund size: yes hedge funds have 1 trillion in assets but mutual funds still had around 7 trillion the last time I looked and they have 4.2% of assets in cash, lower than the 6% they had in 2000.
Are hedge funds holding cash? no, in aggregate they are levered. Are consumers holding cash? no. I don't see how anybody other than smart people is holding cash. Plus remember the average joe who is holding virtually no cash and is long his own mortgaged house, and has an "off-balance sheet" health care liability. When we realise this, the entire concept of buying up long-term assets will possibly be frowned upon.

vg
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There are risks out there to be certain, but all are fixable and Americans have shown that we can overcome our problems when we finally decide to tackle them.

oh yeah?? so why don't we liqidate these hedge funds and use the proceeds to make a downpayment in Asia? Why are we letting the pension funds assume that the hedge funds will have a return of x? Why is the consumer buying so many cars?

Why? It's called freedom and we don't want to stop doing it at this time. We'll wait longer until things are more obviously worse and we decide to tackle them. For now it's not that important for most people to be up in arms about. Doesn't mean it's not that important, but it's not on the forefront of people's minds.

It's like Munger said about the housewife at home preparing dinner. She's not putting the groceries away and thinking "we've got to do something about derivatives."

People won't change their behavior until things get bad enough for a critical mass of people. Until then we continue to get deeper and deeper in trouble, but not insurmountably so. It's like AIDS--when it gets to a certain point it will sharply go away because people will stop the at-risk behaviors because they are convinced those behaviors will have a 100% chance of death. Since people still believe it can't happen to them they continue with the risky behavior.

If debt gets too high for the government we'll print more dollars.

If debt gets too high for people they will start working more and start spending less. If that doesn't work they'll go to the government for relief. The government has proven to listen to people when they complain about utility bills being too high, or car insurance, or even cable bills. Don't think that if enough voters complained about high credit card bills that we wouldn't get debt relief from "Big Credit."

If we need to we can start manufacturing things here again. Will it be quick and seamless? No, but it can be done.

Our problems right now are the result of other people letting us get away with them. If they stop then we'll have to stop and we'll correct the problem. There might be unpleasantness in the process and there will most likely be a shuffling of assets from one group of people to another, but that's nothing that hasn't happened before.

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Our problems right now are the result of other people letting us get away with them.

i know, I'm defenitely not trying to go all Jimmy Carter on you

We'll wait longer until things are more obviously worse and we decide to tackle them.

If debt gets too high for people they will start working more and start spending less.


ok fine, but then there will be a dislocation because the E in the P/E goes down. Besides, the fact that the wife doesn't worry about derivatives is precisely the reason they're so dangerous, isn't it?
(at least for married hedge fund managers, it is)

vg
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Why? It's called freedom and we don't want to stop doing it at this time. We'll wait longer until things are more obviously worse and we decide to tackle them.

This ignores the fact that, like the environment probably, there are things such as non-linear systems, and many of those have unstable regions. Our financial system may be one such system: it certainly seems that way at times. Once you go beyond a certain point, there is no return. Now if we go beyond that point (and some environmentalists believe we already have in terms of global warming) before things appear obviously worse to the dim bulbs in charge, it could be a collapse in (large parts of) the financial system. We won't know until it happens. Prudence dictates one form of behavior, but tradition shows that prudence is seldom observed.
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Our problems right now are the result of other people letting us get away with them.

Sure. It is all their fault that we act imprudently.
Should we not take responsability for our own behavior? If I close my eyes or get drunk and walk across a busy street, is it really the drivers of the trucks, busses, and automobiles that I am injured or killed?
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I think that this has been an informative thread. I would however like to post one small correction to the original post. The restaurant where the meeting took place is "The DRover" not "The Dover", the original poster is right however, they do have have excellent whiskey steaks.

-Sean (who lives in the Omaha area, is long BRK, and has been to the last three meetings)
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contrary to equity mutual funds, it seems that equity hedge funds actually are holding lots of cash.

Stock funds, which account for about 30 percent of hedge fund assets, have fallen 3.1 percent on average through April 29, according to Hennessee. Equity managers are holding about 20 percent to 30 percent in cash, reflecting the difficulty of making money in today's markets, Gradante said.


http://www.bloomberg.com/apps/news?pid=10000087&sid=aPygqhDy00L8&refer=top_world_news

this is somewhat contrary to what all of the value investors have been saying - that the least appreciated asset is cash...
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If I sent you to gamble in Vegas and told you that you could make 20% of any winnings and you would not have to pay for any losses, what kind of bets would you make?

This is precisely why I would never put money in a fund with an incentive (usually 20%) based on performance.
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Then you would have missed out on the opportunity to invest with Warren Buffett when he started.

You have to factor in manager integrity into the equation.
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This is not because the market is perverse, but because the market is a zero sum game and frictional costs mean that there will always be more losers than winners.

Owning stocks is not a zero sum game. No one lost $350bn on Microsoft, for example. There is a thing called 'value creation' which KO and AXP, et al, know all about.

Naj
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>>Times have changed dramatically in the fourteen years since I attended my first Berkshire Hathaway annual meeting. In 1991 if I told people I had just been to the Berkshire Hathaway meeting I would just get this strange blank look, and the unstated question, “Who the hell is Warren Buffett?” Today it seems that everyone has heard of Warren Buffett.<<

Just a thought. Probably more out of hope than anything else. Over the years, every single widely followed market "guru" has eventially been wrong in a major way. Generally, it has happened
when they were at the height of their popularity. Granville, Abbey Cohen, Prechter and Garzarelli to name a few. Warren Buffett, for the most part, made his money out of the limelight. He made it clear he wasn't a market prognosticator. As his popularity and following has grown into near cult status he has become more talkative. He has also become much more political even advising on Arnold's run for gov. He was also very close to being drawn into the entire insurance mess. If Buffett is ever to be proven human, and by extension...wrong, then this would be as good a time as any. Unfortunately, I've proven to be even more human over the years.
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I think perhaps this time we HAVE learned from history and we are smarter as a society and investor class.<i/>

I would be very skeptical about that point of view. I don't know of any evidence or study anywhere that has shown that human beings learn from past mistakes. The reason why is because the market is a complex adaptive system -- the next time always "looks" different. Until some huge breakthrough in the field of social science demonstrates otherwise, be skeptical.

I agree with you that societies grow smarter over time but I don't think they learn from history because they have always repeated the same mistakes over and over. They are still doing it. Look at the stock prices of Apple computer and what happened to ebay a few months ago and TASER.

From social science we know that societies are self-organized and that self-organization, periodically, will reach a tipping point when different groups within the society begin to disagree with eachother. That's what creates bubbles and crashes. Right now, everybody seems to agree on the big issues that drive markets except for Energy and Real Estate. Those are the two big areas that are getting in to speculative/dangerous territory -- proceed at your own risk!

So, be very skeptical about the ability of the human mind to remember AND apply what happened 70 years ago and 30 years ago.





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I think perhaps this time we HAVE learned from history and we are smarter as a society and investor class.<i/>

I would be very skeptical about that point of view. I don't know of any evidence or study anywhere that has shown that human beings learn from past mistakes.


They certainly do not learn from the mistakes of others. Many others forget to preview their posts here before posting, for example. And the results are plain to see. Yet others fail to preview their posts before posting as well.

If we cannot learn simple things like this, where all the required data are present and the feedback is immediate, how can we expect to learn from our mistakes when the systems are complicated, the required data are not all present, and the feedback is delayed? As the pessimist observed,
"The only thing we learn from history is that we learn nothing from history." And our mistakes are all part of that history.
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Hedge funds have a TRILLION, not a billion.

And "but because the market is a zero sum game and frictional costs mean that there will always be more losers than winners."

not true.

THE economy generally grows over time, productivity, etc,
business vales grow.

Those who own, them generally win.

Losers are those who don't ? is that what you mean?
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Learning from history? Momentum types and trend followers don't even bother with fundamentals. If they do it right, moving averages are the only thing they need to make money. If a stock goes up, they pile on; if a stock goes down, they beat it down further.
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