Monday, September 26, 2016

Comments on investment philosophy - part one of hopefully a few...

This is the first of several investment think pieces I have in my head dealing with investment philosophy, where markets are now and maybe even a stock or two... They are surprisingly hard to write so these posts might come slowly...


When I was starting out in the investment game I read Warren Buffett's letters from inception, Ben Graham, Phil Fisher, anything I could on Charlie Munger and the rest of the standard investing canon. 

One thing that had a profound effect on me was Warren Buffett's twenty punch card. (Quoted here...)

Buffett has often said, "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches - representing all the investments that you got to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do so much better."

Buffett is right. That would be a really good way to run your private investments - you would, I think, be very rich by the time you were old. And indeed Charlie Munger has run his career close to that way (though I suspect he is closer to 100 investments by now...) 

Charlie Munger has quoted Blaise Pascal approvingly: "all of humanity's problems stem from man's inability to sit quietly in a room alone."

There are plenty of people out there who call themselves Buffett acolytes - and as far as I can see they are all phoneys. Every last one of them. 

Find any investor who models themselves off Warren Buffett and look at what they do.

And look at their investments against a twenty punch card test. 

They fail. They don't even come close. Several big-name so-called Buffett acolytes have made more than three to five large investments in the last three years and at prices that can't possibly meet the twenty punch card test. Most phoney Buffett acolytes have been turning stock over faster than that.

Warren Buffett's two juniors (Todd Combs and Ted Weschler) have turned over many stocks in the past few years too - and at prices that don't reconcile with any twenty-punch-card philosophy. They are phoneys too. Just a little less egregious than many other so-called Buffett acolytes.  

I used to profess myself a Buffett acolyte too. But somewhere along the line I realised I was a phoney too. I just wasn't close to that selective and when the situation was right I wasn't anywhere near willing enough to pull the trigger and go really large in a position

There are psychological feedback mechanisms that stop you meeting the twenty punch-card test. Firstly it is really hard to be that patient. I did not find a new stock that met that test this year. Or last year. Or the year before. Or the year before that. I found one in 2012. And prior to that I had not found a new one since the crisis (when there were many available most of which I missed). 

But I am incapable of sitting idle since 2012 (even though the local beach is very good) and so I do stuff. Inferior stuff. Stuff that may produce inferior results. 

And some of it (thankfully not much) did produce inferior results. [I was long Sun Edison for example.]

And when you are wrong like that it is scarring. It makes you less willing to pull the trigger in quantity when something does meet the twenty punch-card test. Indeed perhaps the main advantage of the twenty punch card test is the avoidance of mistakes so you can (both psychologically and from a risk-management perspective) take much bigger positions when they come along.

Phoney Buffett-style value-investing is dangerous

A twenty punch card investment portfolio is - by its nature - a concentrated investment portfolio. If I had run my portfolio like that I would have come out of the crisis with maybe six stocks, turfed one or two by now and added a single stock in 2012. 

The rest of the time I would have spent reading, talking to management of companies I was never going to invest in, and otherwise tried to work out how the world actually works. (And the world is always more complicated than you imagine so the work is endless even if the activity is muted.) 

Many so-called Buffett acolytes (phoneys, all of them) have imbibed that a concentrated portfolio is a good idea. And so they present as having five to twelve stock portfolios and are prepared to take 30 percent positions. 

But the stocks often don't meet the twenty punch-card test. And so these investors wind up with large positions in second rate investments. When one goes wrong it is deeply painful. When three go wrong simultaneously it is devastating. 

The lesson here is easily stated: "if you are going to fill your portfolio with crap, it better be diversified crap". 

Several of my favourite phoney Buffett acolytes have been posting catastrophic losses. It was due. The phoney Buffett acolytes still here are just waiting for their turn to have catastrophic losses. 

Real twenty-punch-card investing is impossible to sell to clients

Just imagine if I had run a twenty-punch-card style portfolio and sold it to clients. We would have made a bunch of decision in 2008 and 2009 and our numbers would have been stunning to 2012. (Our returns on our longs were very good in those years. Way ahead of market.)

We would have turfed one or two of these. (Some businesses just change, others go up seven fold and are just not worth holding.) 

I would have bought a single big position in 2012.  

And since about mid-way through 2013 my cash holdings would be going up and up. Partly from dividends, partly from asset sales. 

And I would be underperforming now. Quite badly, even though returns would be positive. Come to think of it, my longs mostly are underperforming now. So are the longs of many fund managers I admire.

But mostly I would have been just idle. So in the midst of underperformance a client might ask me what I did last year and I would say something like
a) I read 57 books
b) I read about 200 sets of financial accounts
c) I talked to about 70 management teams and 
d) I visited Italy, the UK, Germany, France, Japan, the USA and Canada 

but most importantly I did not buy a single share and I sold down a few positions I had.

And I underperformed an index fund.

That is kind of hard to justify. I don't have a clue how you would ever sell it to clients. I can't imagine any clients buying it.

And so to my knowledge there is absolutely nobody who is true to the formula and who really runs a concentrated 20 punch-card formula fund. 

They are all phoneys because (a) the truth is so difficult it hurts and (b) the clients can't handle the truth.

What I did when I realised I was a phoney Buffett acolyte

Somewhere along the line I realised that did not have the temperament to be a true 20 punch-card investor. So I did two things.

a). Rather than accumulate cash and just sit there for very long time periods (five to ten years) I tried to find shorts. The shorts have two benefits (i) they turn into cash when the market goes down and twenty-punch-card opportunities arise and (ii) they attempt to make some money on their own.

b) I run a portfolio that is more divesified than I desire. I desire to be 15 stocks in 15 industries and seven countries, though in reality my desire should be to be more concentrated than that. [I would/should be happy with five 20 percent positions as long as they all meet the 20 punch-card test.] Alas (justified) lack of conviction means my portfolio is about 45 long positions - many of which are for sale when a better idea comes along. In other words when I hold crap at least I diversify it.

This is not entirely satisfactory. I get some longs wrong and lose money on those. And the shorts can be difficult to make money on even when you are right. A stock that goes from 10 to zero might look like a great short but if it goes via 50 then you are likely to be forced to cover some on the way up and its unlikely you will ever recover your losses.

We have strategies to manage both those problems and the results have been and will remain satisfactory although they will not always glow. There can be sustained periods of dull performance. And whist this is not as hard to sell to clients (or yourself) as a true 20 punch-card portfolio after a couple of years dull performance can become exhausting. Clients who haven't lost any real money will leave - because there is always someone else who is making money - and the grass is always greener - and because clients see performance more than inherent risk in any portfolio - and low risk portfolios can be dull.

Portfolio managers I admire

I still admire Buffett's portfolio management more than I can say. He really is astonishingly good at what I have chosen to do for a living.

But I can't emulate Buffett and nor can anyone else I know. And if someone uses his name to describe their investment philosophy my (likely accurate) presumption is that they are a phoney.

There are other managers I admire. I still think Kerr Neilson at Platinum is a freak but it is awful hard to emulate him though in at least part of my portfolio I try. I worked for him for seven years and have some idea how he does it. [He is unbelievably good at cyclical stocks for instance - something Buffett professes no desire to do and which I lack some of the skills necessary to do.]

But almost every other portfolio manager I admire is a long-short manager who has come to an investing compromise like mine. They aspire to be world-class long investors but irregularly fill their portfolio with more diversified second-class stock picks. And they run short books.

And the short books hopefully make money on their own - but mostly make money at the right times - delivering their profits in down years like 2008, and stripping them of profits in super-strong markets.

The problem is that almost every one of these managers is having a dull patch at the moment. These are people I think are amongst the best in the world. And I think (without naming names) that they are having the dull patch the same way as I am. In particular it is devastatingly hard to find things that meet the 20 punch card test. [If you have one please email me. I am prepared to listen to almost anything.]

So instead they have been buying things which are "ownable" rather than "buyable". In other words things that are sort-of-okay in that if you owned them for a decade you would probably be happy enough but not thrilled with the result. And the results from doing this have - at least over the past year - been dull. [Exception: if you bought pure bond sensitives as an alternative to bonds you did really well - but alas I did not do that...]

And the good long-short managers have found it easy to find egregious crap to short. Stuff where the story has more resemblance to fantasy than reality. The typical tell is massive differences between "the story" and the GAAP accounts". 

Some of these fantasy stocks have blown up (Valeant, Concordia) but many are alive and well and when I describe them as fantasy stocks I just get back hostility. And as a rule long "ownable", short "fantasy" has not worked that well. Truth be told it has produced results that somewhere between 5% positive and 5% negative. It has been hard work to go nowhere. 

And there are fund managers who are doing better. Some of them have tricks I do not understand (I put David Tepper in this camp - I simply don't get how he does it and hence can't emulate it*). But the ones I do understand I don't like. Their chance of a plus 20 is clearly better than mine. And their chance of a minus 40 is alas even better than that, and that is something I find abhorrent even if the clients are seduced.

Its really hard out there. I don't think it is a time to be greedy, but low to negative yields make it a difficult time to be safe/fearful as well. 


*The Tepper trade that most impressed me this cycle was long the airlines. I had enough knowledge to know this cycle would be good if I put the pieces together. But I did not put the pieces together and my allergy to capital intensive competitive businesses overwhelmed common sense. Tepper made a great trade that almost any Buffett acolyte would have ignored.


CrocodileChuck said...

If Buffett is so smart, why in the world did he buy [& then double down on] IBM?

John Hempton said...

Why did Buffett buy IBM?

I have heard one theory on that. Which is that it involved his excess regard for an attractive younger woman...

This theory was told to me by a New York Billionaire who knows Warren quite well.

But more likely he just made a thumb-sucking dumb mistake.

Andy said...

Really great. I run a very small investment partnership and my clients are leaving me because I have made like two trades in three years and ma 50% in cash... You can make alot of money quickly though if you have balls when things turn to shit.

Jason K said...

So Buffett himself is a phony? He has not adhered to a 20 hole punch-card philosophy... He was presenting an idea to help the ordinary investor, not a blueprint for a professional.

You don't need to follow every piece of advice he has ever given down to the last letter in order to practice his principles. In fact, one of the most important things you can learn from Buffett and Munger is to think for yourself and develop a system that suits your own unique characteristics and circumstances.

Bonus points if you can can do that and fund it with enormous amounts of free of money...

J Marsh said...

Great post. It is rare to read anything as frank, even from an Australian.
Capitulation (if one could call your mood that) often comes just before the turn.

obelix said...

Without having thought about it very long, isn't it enough to know when you've stumbled on one of those twenty ideas of your lifetime?

I've had two that I knew at the time were special. Both I implemented with as many securities as I could, so they don't map neatly into a concentrated portfolio.

Is the problem with betting on so-so ideas that it distracts you from working in finding more of those big and best ideas? I'm thinking automating the so-so ideas or having someone else manage them might be a solution to that.

CrocodileChuck said...

Manhattan, KS -> Harvard, eh?

I'm impressed [I was born 25 miles from Manhattan]

The rest is 'who she knows', and it all sounds pretty inbred.

[Last point: she should have read your two part-er on IT five years back]

Or Rob't X. Cringely:

We all love Gero said...

The real point is that you are not a 'Buffett acolyte' unless you have permanent capital (as holding onto the Berkshire Hathaway business in the 70's granted him, for those in the partnership that wanted to continue the ride). It's hard not to admire how far ahead he and Charlie were. This is the only way you could run a 20 punch card fund.

HS said...

It's pretty obvious that Buffett does not follow the 20 punch card rule. And if Munger follows something similar, he only started following it once he had stopped managing money for other people. But let us work backwards to figure out why Warren says this. I think there are three main ideas here. The first one I will suggest is that lots of terrible investment mistakes have been made in second-rate businesses. Ones where you would struggle to find a moat but sometimes if you try real hard you might convince yourself that you see one. Said another way, if you could only make 20 investments you would want to make sure the barriers to entry were super strong because you don't want to think about selling anytime soon, and the longer your holding period, the more likely your returns will resemble the returns of the underlying business. The second set of mistakes is not thinking enough about an investment like you would a business that you own. It's the prism of a 20 year holding period. Is chewing gum a declining business because people are not smoking any more? Will there be broad adoption of electric cars in 20 years? Will Visa/MasterCard get dislodged by some online payment platform (developed by say Amazon once it has a 50 share of retail). It's disruption risk and business owners think about that all the time (the smart ones). Note that once you go down this road so many things are excluded that what remains will generally be very expensive. By default this generally means waiting for market corrections before making investments because you're not going to make one of your 20 investment during a normal market. The final one is in doing enough work before pulling the trigger that you're sure about your research. We've all been there. In other words the punch card is a mental model for avoiding investment mistakes, not a model for investing. Despite this powerful mental model, Buffett did not steer clear of IBM, which clearly doesn't fit (whether it works or not). Despite Wells Fargo's recent issues I think it's much closer to punch card investment. The return are much lower but so is the disruption risk IMO. So Hempton stop being so hard on yourself and others. It's a useful model that we should all think about. Nothing more.

rs55 said...

Its possible Buffet was simply hyper-adapted to the environment. I mean - if you are pig headed, bullish and do rudimentary "fundamental"analysis - and you find yourself in 1960 at the beginning of your career - well, you are likely to have done very well. You had faith , you never sold during the declines etc. And we had the greatest boom in human history.
In a different environment, those same pig-headed, bullish characteristics might spell your doom.
In an abundant jungle of greenery, those large elephants may do very well, look magnificent , the envy of all. . In a prolonged drought - not so well. Being hyper - adapted is not a good survival strategy , even if people point to those amazingly large animals that did so well. Better to be small and adaptable. No medals will be won , but your odds of survival are vastly greater.

Anonymous said...

Don't take Buffet literally.
He has done his fair amount of arbitrage and also mistakes.

There have been plenty of opportunities in the market around February 2016 and
then around BREXIT. So patience pays.

You cannot allow only 20 punches. There will be plenty of opportunities in
any given year.

Overall you see which companies treat you well and you reinvest. The ones
that don't you weed them out. Eventually you will have a pretty clean portfolio.

rs55 said...

The Fed is in the process of changing the structure of our economic system. central banks buying equities, corporate bonds etc.With no political push-back whatsoever. We'll talk about how to prosper financially, after we have figured out what kind of system we actually have.
The actual challenge right now is to figure out what "money" is. In what form one should have one's wealth. And whether that form of wealth is defensible and whether one can have any confidence whatsoever that that the wealth will still be there in 20 years.

Trung said...

Hi John,

I really enjoy this post as I just realised I am one of those phoney Buffett acolytes myself. I was way too active and do not adhere to the 20 punch card test.

I look forward to more of your posts in this topic.

Anyway, regarding IBM, what does Tracy have anything to do with IBM? I thought Mr Buffett just looked at IBM with a different lense after reading that IBM's 2010 annual report (after reading IBM annual reports for 50 years).

Jason said...

Hi John! Love your blog and appreciate your CTA. I emailed a potential "Punch Card" idea to your investor relations email. If interested, I've also included a link here:

Anonymous said...

I've managed institutional money in both long short and long only strategies over the last decade + and concur with > 99% of your comments in this post.

My only point of disagreement is I personally found the long/short product design amplified under performance in periods like today or 2009/10 or conversely out performance in periods like 2007/8. My feeling is that markets tend to go through a cycle of varying degrees of discernment / skepticism. The reason you get paid in terms of alpha by the market for fundamental analysis (at least in part) is that it becomes rational for people to ignore it for certain periods of time. This opens up risk vs reward mismatches provided you can be relatively relaxed on time to maturity. Quant models will tend to observe a period of divergent performance as adding to aggregate risk and penalize you for it, so you are testing client patience by double leveraging your fundamental view.

I also think the rise of passive investment via ETF's is elongating the periods of market apathy. In theory this would mean your total alpha may increase, but the consistency of its delivery may decrease, which makes it all a much harder sell.

Sorry to sound like such a pessimist!

Sartaj Hans said...

Thanks John. Great post.

I forwarded your mail to a friend with the header
"Insight + truthfulness + no posturing = THREE HEADED rare beast in the fund management industry"

Martin said...

I do not belive he meant the punchcard literally. Keep in mind Buffett used to invest in work outs. You have higher turnover with special situations.

D said...

Sounds like a narrow description of Buffett. According to this definition of what it means to be a Buffett acolyte, even Buffett himself wouldn't qualify, looking at the number of investments he has made in the past 5 years. Not sure if all of them fit the 20 punch car test.

Besides, Buffett just said that he could improve your performance if you applied the 20 punch card test, he didn't say that he would do it himself.

Rahul Deodhar said...

Super stuff.

Buffet, Graham Fisher and "Value investing" are buzz words that clients love in the ppts on slide Just before the chart that tells them how much they made (post fees).

Please write more...

Anonymous said...

WEB himself can be considered a phoney if the apply the rule strictly. There is a difference between guidelines and rules. Nonetheless, i would agree that the cottage industry of invoking WEB and Munger at every instance that a lot of folks have got running is deeply objectionable.

Stephanovic said...

Hey John,

I face this question as follows:

1. I want to buy high quality long-term stuff for good prices
2. I know I can probably only do this a few times a decade
3. So in the meantime I will not sit in cash, I will speculate using a strict rules based systems
4. Risk management program triggers when markets start to decline putting me in cash ready to look for those mythical keepers.

Sandymount said...

Arguably there have been a few 20 punch card events in last few years... Irish property, Russian stocks, mining more recently, maybe shipping now, extreme distress/joke valuations but most investors dont have mandates that allow them to go near some of these areas due to volatility and/or legal/jurisdiction ... David Iben to his credit does seem to be this kind of a guy. Lives through unpopular periods but needs clients who will hold on. Chandler brothers most have never heard of became billionaires investing this way and gave back client money in early days as too hard to hold clients hands through inevitable volatility.

Hohe said...

I really enjoyed this post and am very glad you wrote it. Thank you. I've wrestled with this concept in my own business and PA investing.

In a fund I manage I once owned a 30% position in a stock that was an incredible bargain. Indeed, I had a target price of 10-fold our entry price (the entry price was a P/E of around 2x for a 60% ROIC business, with no debt and strong growth prospects with a world class business). Here was a stock akin to the case studies of Buffett = like his "greatest hits" investments - P/E of 2-3x for Wells Fargo, ad agencies at similar multiples etc. We actually submitted a write-up of the idea to a popular stock write-up site (it was rejected). The stock in question ended up appreciating 20-fold. Although new money had come into the fund which diluted down the impact of a 30% position appreciating by 20x over 5 years, there were some interesting points worth sharing to add to your observations:

- once a large position appreciated by a lot in a short space of time - your fund is close to being a one-stock fund. Any risk management style consultant/new investors doing DD etc will not like this at all. New potential clients will feel that they have missed the boat - they will not believe an explanation that although a stock is up, say, 5 fold, it will still double. Also, they can just buy the stock themselves.

- your fund is now very volatile - this will scare everyone.

- you look lucky - "well if you take out that stock, what is your performance?".

- new clients will feel they can replicate your portfolio. A large fund of funds once came up with an idea to replicate the positions of ESL Partners - the formerly high performing (IRRs of 30% for decades - until, approx - 2008 - with poor returns to date), as he tended to own a punch card like portfolio. They failed at this - doing so just as his positions didn't go well. They also under-appreciated a key point:

- it is VERY hard to keep a position so that you don't sell it before it goes up 10x or more. Doing nothing is very hard. Very hard. At the same time, maintaining conviction in a position over say the necessary 5-10 years to enjoy an outsize return is so difficult. There will be bad news during this time - prices will jump around, business results will vary. Someone replicating the holding will not have developed the emotional muscles necessary to have the conviction level to hold for the long term. I find the only way to have such a level of conviction is that you personally must have done all of the research and feel you know everything about the position you possibly can.

- Another problem of this situation is - like the man with hammer to whom everything is a nail - you want to find the next low-risk, no brainer 20-bagger. Such ideas come along rarely. It is hard to not jump at the next thing - and there is a high chance you will make a horrible investment - and must be careful not to over-concentrate in it. Jim Rogers would often say people who make a large return usually part with the proceeds shortly thereafter due to greed at jumping too soon at a poorer quality idea.

- To cope with potentially long periods of no great results, you need a very understanding investor base. This may not exist in reality. Fast money will go out of the fund as fast as it enters. ESL like fund terms would help but it is hard to lock in investors for 5 years or do a well-timed Ackman-style closed end fund (where would he sit without this!).

Stay black,


Hohe said...

Comment cut off: - I have quarters where we don't buy anything (that is actually good long term) - the reporting way around this is a lot of discussion on existing positions - which I assume is what PE firms do. After a few do no trade quarters, there can be invisible pressure.

- From memory Buffett went 3 years without buying a single stock in the 70s.

- One great thing about a large winning position is that it stops you making dumb investments you would have otherwise made.

There are guys that do this style of investing - we do it less now in the fund (biggest position is say 18%) so but I'm debating re-concentrating but the key is the idea has to match the intention. The process must be: 1. how good is the idea 2. question 1 determines the portfolio sizing issue. I think I copied that from Greenlight/Einhorn's book and it is broadly sensible provided the execution matches the intent.

One other point of the concentrated portfolio is the possibility of genuinely impossible to foresee bad luck - we once had a 15% position which was partly-nationalised by the government. If it had been 5% position this would not have been the disaster it was from an IR point of view. This is a pretty good point against very large position sizing.

We have a current position that is a no-brainer: monopoly business, 3x p/e, modest leverage pays a 20% dividend yield. Long-term we should own as much as possible. Will we? I'm not sure given the business hassle this entails. (ps no one shares decent ideas in my experience - why would you?)

In terms of folks who stick to this - you have to be pretty confident in your ability to ignore the concerns of your investors. I would say Berkowitz is a punchcard like guy. Other names are: ESL Eddie Lampert - he held Autozone, one of the great investments of the past few decades, but is a good cautionary tale given the Sears mess (good trade held too long?). Punchcard Capital of Florida follow - as their name suggests - this strategy. They will buy one stock a year and the biggest holding is say 40% of the book. They have a special investor base though - including a certain fellow who works for Buffett.

The ultimate exponents of this style of investing is of course the Chandler brothers - the greatest value/portfolio investors of the past 30 years however you qualify it (better IRRs than Buffett/Soros etc). 7 odd investments caused a 10m fortune to grow to $25b in 25 years - despite the public mess of SinoForest (although the loss was only $400m so not a huge amount relative to the overall personal fortune). Interestingly, they do NOT run outside money - it is just the money of family. I think that is your solution - the fund will be more diversified and your family office concentrated and not super active.

One of the tidbits I found interesting studying the Chandlers is that after they had built up the family fortune of $10m to $1b, they invested nearly all of it into one stock - Gazprom. It then went down 90%! They held on and it came back to slightly above their purchase price. To have the control to not panic sell at least some during that period is a rare feat. Not many folks worth $1b will risk all of that (Elon Musk?) to do it again. They went all in on Japanese banks during the Asian financial crisis and made large returns (and still own 5% of these large companies). That is a case study (like most Tepper investments) that I couldn't work out - it just seemed that there was a very real chance the banks would be nationalised.

Again, thanks for articulating such an interesting issue.

ps run away from any Buffett-name dropping investment manager. I recall listening to a growth obsessed fund manager lady tell an audience that she invested just like Buffett whom she then used to defend the concept of paying no heed to price! The anti-thesis of Buffett's message! Many sins are committed in the name of Buffett!

Lionel said...

Great note. Especially the Tepper comments - to get those returns without the 20 punch card is a big deal. Buying debt at a discount is his real strength I think and has been a great place to be through the past few cycles.

Cheryl Frances said...

Enjoy your writing John, Look forward to more
Still true a hundred years later...circa 1900 Livermore states hardest thing to do is sit on your hands. One piddles around for small amount, affects pysch and then when the time does come unable to act due to fear (or lack of funds)

Thoreau Devotee said...

Don't be so impressed with the old Buffett. Not only did he buy IBM he didn't buy Amazon he never sold his coca cola. And his insurance business is not as attractive when the float earns close to zero. His best deals were long ago or in a crisis when his connections allowed him access and great terms

Anonymous said...

What about Thomas Russo, John?

Sandymount said...

Whilst on Buffett, I think before managers beat themselves up too much he has not made 20% a year on an apples to apples basis. Unlevered his investment record has been about 12% versus 9% for the S+P. BRK compounded at 20%, i.e. another 8% due to structural set up/ 'free' leverage of the float... and he charged effectively no fees.

This is not to take away from his record as all those factors (there were others, eg deferred taxes etc) were conscious decisions on his part but to compare BRK annualised return to an unlevered fund is misleading, or for that matter to a long short 2 and 20 hedgie but it does make you have to think very hard before paying those fees when you can just click BRK on your broker app.

Anonymous said...


Buffett's MTM is probably just as bad as anyone else's. The key is to have permanent capital - freed from redemption - and control. From there, you need skill to grow the capital. Because Buffett has long-term capital he can distract investors with book value until MTM rebounds.

To me, this is the beauty of closed end funds. Permanent capital without having to own a particular operating company. Too bad this seems to be a dying breed of investing vehicle in the age of passive indexing and ETFs. More spoils for those remaining and willing to work hard, I suppose.


Zheng Yuan said...

Idea: CMG. Even though you don't seem to see eye to eye with Ackman doesn't mean this is a potential great investment. Highest ROIC in the industry with long growth path. Trading at 20x normalized EPS. It doesn't strike as cheap but consider the stock has average P/E multiple of 40x in the last 10 years with annualized 40% CAGR return. Historical 40x P/E is simply wrong (too low), otherwise where does the 40% CAGR return coming from?

NotATeabagger said...

Every Buffett disciple is a phoney, can imagine your favorite phoneys were long Horsehead...

That said, Long Short is pretty worthless from an investing standpoint. You never back just one great manager so you end up with ultimately 2/20 fee structure, tax inefficient low beta that you can get with a 60/40 portfolio.

20 stock works when you consider taxes too. I am a Buffett disciple but road the airplane trrade before tepper. Remmeber being at vegas bach party in alte july when US Airways (LCC at the time) had some great results, stock was up 20% from like $2/share. I still own HA to this day. That trade is available circa 2009 in other parts of the world.

You take what WEB says but have to ultimately adapt to who you are. It's like Stevie Ray Vaughn was inspired by his blues but wasn't some carbon copy, he became his own person. What I appreciate from WEB and really mroe so Munger is buy good stuff, even at fair prices, you'll be ok. Then I pepper in the cyclicals, which is all about abouting low multiples and crappy op earnings and seeing how to safely bridge to better op earnings that drive multiple expansion. a lot of value guys dont look to that bridge, they just own cheap crap and then get smoked. they also have a blind spot to credit, bad idea for highly levered op cos w/significant debt..

look up fayez sarofim, another ultra long term holder.

Kevin said...

Well said Jason

David Merkel said...

The twenty punches concept is a limiting concept. Even Buffett himself does not follow it.

On the bright side, it encourages managers to not over-diversify. Most managers who follow that idea tend to do better because they focus on the strongest ideas.

Anonymous said...

A few comments:

1. I think WEB mentioned the rule as a guid for the lay investor, not really somebody running a hedge fund. It was sort of the idea from Keynes to "put all your eggs in one basket...and watch the basket very closely".

2. I don't think WEB was including arbitrage / workouts, which is an entirely separate category of investing from long investing (if you look at WEB's partnership letters, he uses this dichotomy). Notice that when WEB was running a partnership and the market was high, he focussed on arbitrage. Arbitrage by definition is supposed to be more diversified than long investing.

3. There is a fund that has practiced the 20 Punch methodology successfully (whether this was their intent or not starting out, I don't know, but it has been the result in practice). This is H Partners, run by Rehan Jaffer (ex-Third Point PM). They consistently own only 3-5 stocks. See filings here:

Gloeschi said...

We mortals cannot emulate Buffet. Because he has a huge information advantage. He get to do due dilligence and a deep dive into the books (customer lists etc) before he buys a company. You can never do that as an institutional investor. Furthermore, the BAC convertible deal during the GFC was not available for ordinary investors.
His market timing sucked, as he was writing naked puts on major stock markets months before the 2008/9 crash.

John Huber said...

It's a great post John. I made some additional comments in a follow up piece on my site here:

My main question: it seems that you imply that the punch card approach is best. But yet you don't practice it. As I said in my post, I think most of the battle is recognizing the bias we have toward activity (and the built-in constraints we have toward inactivity). But most people don't consciously think about this, so they have no chance to guard against the bias. You are fully aware of it, as you articulated here very well. So I'm wondering why not try to implement the approach? Is it that you don't think you could grow your business effectively this way? Or maybe I'm misreading it and you don't think it is in fact the best approach?

Kevin Thompson said...

This article really got me thinking, John. On a personal level, I've had equivalent thoughts about using a 20 punch card approach with clients. When I look at my numbers, 70% of my business comes from a smaller population of clients. The "less is more" mindset can work in law, in my opinion. There's a lot to be said for cutting out the 80% that suck out time, energy and ego.

Regarding Buffet, here's the theory that came to my mind: He's unique because he was forged in a different era. He had already earned respect long before the 24/7 news cycle. He's always been "above the fray" where other managers need to be seen on TV espousing deep thoughts on interesting stuff to keep their investors interested. I remember Buffet wrote in one of his letters, something like "If I own a piece of property, and somebody was on my fence yelling at me everyday about my property's value, I might be more inclined to sell it." He was referring to the constantly-on financial news that puts pressure on analysts to pay attention and make decisions. I think there's more pressure on managers like yourself to constantly stay ahead of the curve to provide your investors some action. And investors are also drinking the kool-aid, watching CNBC and expecting managers to work miracles.

It's a different era today. Personally, I subscribe to the Billy Beane approach to a lot of things....I'm not looking for home runs, I'm just looking to get on base as much as possible. Investors these days....they want home runs, and that leads them down dark paths.

Thanks for sharing a very open and candid article.

MLee Hypotenuse Cap said...

Trying to emulate WEB without permanent capital is like trying to farm corn in the Sahara. It might be theoretically feasible but you might be better off moving to Indiana.

Denis Brassard said...

Warren has so much buying power , that back in 2008 he bought Citycorp below market value. not too many money managers can pull this off.

thanks for the great post, very humbling , as it is not easy to stay ahead.

Anonymous said...

Buffet is a great Investor - Every one knows that. Buffet is an acolyte of Ben Graham, but he deviated a lot from Ben graham's approach to investing ( though he followed those principles, and started with that approach) over the years. Buffet often said that his approach is 85% Graham & 15% fisher, but over the years it's moved more towards fisher and less of Graham. ( Jeff Matthews book & blog have detailed & very good description of this, and also about buffet's post rationalization & do as i say not as I do ethos.) Even the 20 punch card approach to investing is more of Fisher's than Graham's. Only a few like Walter Schloss & Irving Kahn stuck to Grahams approach. Max Heine created a path of his own, while still following Grahams Principles.

Just being an acolyte does not mean that you have follow the same approach. As you've clearly described with Kerr Nielsen, being well versed with an approach does not mean that they anyone can do it as well and expect the same results. As Graham detailed, temperament ( what many call Psychology & emotional intelligence now a days) is an essential aspect of investing.Most investors alter an approach to some extent to suit their temperaments.

While there are many phoneys who the buzzwords for marketing and promotional purposes, many fund managers have tailored their approach while adhering to the principles as best as they can given the circumstances while still being acolytes of Buffet. You've described that very well as to why fund managers can't sit idly by waiting for the fat pitch every few years.

Bill Gross has a great write up on Epoch's and how it affects investing, and his own investing record. By 1970's even Ben Graham believed that his approach may not be as effective as it used to be when he outlined it 3-4 decades ago, Walter Schloss closed his fund citing that as a reason. One approach may work for while & under certain circumstances may not work as well with different time, country & circumstances.

Dmitry Kozlov said...

Dear John,

I do not understand your Tepper comment.
Maybe it came consequentally to your own lack of understanding in explanation, or maybe it's really a mistake in judgement.

Highly competitive, capital intensive industries ARE "meh". It's hardly just your personal allergy.
Is there any systemic indicators to when they perform well, which you think Tepper get and you didn't?
Or it's a hindsight regret over "not knowing the ante" despite the play being strategically correct?

Jake M. said...

Interesting post, John. Thanks.

I agree with Jason K. The 20 punch card test wasn't meant to be taken literally. Buffett has failed this test himself many times over. Many investors do silly things out of boredom or lack of patience.

I think the more egregious error made by the Buffett acolytes is running a concentrated portfolio of mediocre businesses, specifically concentrated investments in the retail industry which Buffett has warned us about for decades. I agree with Klarman and others that every business despite its quality has a price at which is becomes attractive. However, retailing is so fickle that it is hard to determine fair value and have any confidence in such an investment. Certainly not enough confidence to make a 20% position in a JCP or Sears.

Anonymous said...

"Unlevered his investment record has been about 12% versus 9% for the S+P. BRK compounded at 20%, i.e. another 8% due to structural set up/ 'free' leverage of the float... and he charged effectively no fees."

He made 30% (vs 10% for the Dow) when he was running his partnership over 12 years, with basically no benefit from float (didn't buy National Indemnity until 1967). So he did way better than BRK has done. Anyone who says Buffett isn't the greatest of all time by a wide margin is utterly delusional.

Anonymous said...

...not only is Buffett the greatest investor ever, he's also proven himself to be a great business executive. How many other insurance executives are you aware of who have managed to gather tens of billions of float, yet show an underwriting profit over many decades? The answer is zero. People act like, Well hey he's done great b/c he's had free leverage - well, if it's so easy to obtain such leverage, why can't anyone else seem to do it? When I look at other insurance companies, they all seem to have pretty consistent underwriting losses.

Anonymous said...

He probably meant 20 BIG TIME punches dancing around a bunch of small experimental positions and special situations. But willing to sell any of those for a big fish.

Trader Joe said...

Fantastic post John, thank you so much for your thoughts and openness.

I've always felt the Buffett adulation is warranted but there's a fair amount below the surface that Buffett haters mostly miss, even those on Wall Street. First, he was building the base on which to compound very early on without the same competition as we have now. Then as Sandymount mentions, factoring in leverage vs the S&P it's a much smaller outperformance gap. I've seen studies that attribute most PE firm excess returns to leverage; there's a reason Steve Schwarzman once said Buffett has the best capital structure. And lastly, there's no doubt he's been one of the single biggest beneficiaries of the structural fall in interest rates and increase in asset prices since the early 80s. That capital base came from the partnership years, sitting in cash in the GoGo early 70s, and then punching one of his 20 punches in the huge 73-74 bear market.

But ultimately, you can't argue with uninterrupted compounding for 50 years at 20%. And that's uninterrupted compounding using higher leverage than the S&P through thick and thin. And he is a wonderful teacher who, along with Munger, cultivates a system of thought and shares it. What bigger meeting of the minds was there in the 20th century than Buffett and Munger at the Omaha Club in 1959? Churchill and Roosevelt? Jobs and Wozniak? Lenin and Stalin?

It's heartening to hear some here are at a similar juncture in their investment outlook. As someone who tries to incorporate the best of many different investor styles/philosophies, I too have seen very little since 2012-13 that has made me feel like this could be one of the 20. Try as central banks might, cycles haven't been eliminated and keep the faith that like Buffett in 1973-74, Tepper in 2009, or most P/E heads in the early 90s, the big money will be made in bear markets.

Anonymous said...

Bronte has -1.2% performance over the last 12 months.
What is your expected returns going forward?
Are you focused on your business?

MTH Investments said...

2016 has taught me plenty, and I thank you for having some of those points to remind me. In particular, let go of all the notion of being in a specific category and focus on logical intelligent investing. Value, Events, Long term or Short term, GARP classifications only serve to hamper returns. One must be optimistic yet pessimistic, humble yet confident with the flexibility to adapt. Its important to find a style that suits one's personality and temperament.

In terms of approach, I find the punch card approach logical yet challenging in practice. It takes time to experiment and shift into that mode. No normal man can sit still and do nothing 9waiting for a potential jugular) while getting tempted daily by the market's siren songs or losing consistently in the short term. Its what I term mega-delayed, non-certain gratification.

It is by no coincidence that most institutional investors are the mainstream, and eschew this non-mainstream approach. Tepper has has done incredibly well with consistently huge swings in volatility. He questions the basics and bets the farm on ideas he has confirmed. This is something most institutional investors would have cringed at, but logically makes the most sense. Hence most of his assets are largely employee owned or close friends/family including ex colleagues. One would have ended up on the streets if he or she used this approach and relied on mainstream capital.

Lastly, there was an evolution in WEB's strategies through the years. Earlier on, while he was concentrated, he was intensely into event-driven stuff and did not mind holding them for short term gains. There were clearer opportunities and less land mines unlike today. With the advent of the internet, technology and a lot more institutions, investors need to work harder to find stuff. Not impossible, just harder..and different.

Special Situations Investments said...

Great post! Over the last week I was distilling my thoughts on what value does short-selling brings to portfolio besides occasionally making money (need to make presentation for students in my alma mater). Fully agree with you that being occupied on the short-side (instead of doing something dumb with the long side of the portfolio) and getting cash on market pull-backs are the most important things why it is worthwhile keeping at least a small short position.

Anonymous said...

One needs to be able to withstand the psychological impact of taking huge concentrated bets

1. Source of capital should match you investment strategy. If your investors bug you every year or every 6 month, just be honest with yourself and figure out that works for you
2. Ability to filter out news. IMHO, no one is good at that. Its like being kid in a room with cake and being asked to not eat it. Best way is to just not look at it.
3. Confidence and ability to not listen to people or market and just stick to your plan. This means all work has to be done upfront and need to have ultra confidence in your ability.
Even Buffet won't style wont perfectly match up to what he preaches.

John, but you are not even close.
1. I remember you that you once wrote "position went much against us and we had to cut down". Look, Buffet won't do it even it years. You did it in a matter of months.
2. You are validating your ideas on a blog, common man ! :)
You are a trader and you are doing good. Just stick to it. You don't have to be a legend. James Simons, Steve Cohen .. guys have done well in their own way.
* I know everyone will say the Steve Cohen traded on insider information and blah blah, but he was done really well over a long period of time and even now with his family office so you have to give it to that guy that he's got some substance.

Anonymous said...

Hi John,

amongst the investors who follow a "punchcard" investing philosophy and actually stick to that, you should be aware of Andy Brown, who runs Cedar Rock capital. Sticks to a few industries he knows, does not trade and has a stellar track record.

MrContrarian said...

The Zeroth Rule of Investing

If a beginning investor literally followed the 20 punch limit it would very likely end in failure. Very likely.

It's impossible to achieve mastery without study and practice. And if you don't have mastery you will keep buying crap (as well as some good stuff) and not even know it at the time.

It's like carpentry. You buy cheap wood while you learn and make a lot of mistakes. After a while you start to get cocky and think the next cabinet you make is going to be perfect, with no wasted materials. It isn't. You are pissed off at ruining the expensive oak you used. Round and round you go, gradually improving.

A beginner needs to buy many cheap (as in sum invested) holdings to practice on. His skill will rise much more rapidly and more importantly so will his awareness of his skill level. After 10 or 20 years he may be ready for serious concentration.

Buffett was a very fast learner. He was unique.

Perhaps it's time for the Zeroth Rule of Investing, to preface Buffett's First and Second rules:
Zeroth Rule of Investing: You are not Buffett.

Anonymous said...

FYI, blog post is referenced heavily in this Morningstar piece:

Anonymous said...

Robert Mercer is another enigmatic - yet very, very successful investor

Anonymous said...

I speculate in a very unique type of real estate. If I am patient Im usually able to cover the entire purchase price and any/all applicable taxes ( state/fed) from an unrealized ( or undervalued) asset present.
How many of these do I get a year: If Im very lucky - 2.
However the wait is worth it. The last one I did generated a six figure return ( pre tax) .

Anonymous said...

ok for disclosure i run just one of these concentrated investment partnerships you would describe as phoney, and i used to work at a long/short fund but found myself temperamentally unsuited for shorting. i appreciate this post as there is a lot of good food for thought even though i would disagree with quite a few points in it.

but here is my real question, what you said about long/short sounds great that it provides cash in declining markets to cycle into cheaper longs. but how many long/short managers really do that, and wouldn't anyone who tried this have a similar client problem to the inactive long only? in other words when the market is down and they are panicking and so happy to have their short exposure and then they call you up and you say actually our short exposure is declining as we aren't adding any new ones and are increasing our long exposure. and also as you add longs you are exposing yourself to a sharp snapback as many of those low quality companies you are short are likely to rally by more than your longs in a market recovery. i just don't see clients accepting that you usually run with say 80/50 long vs short but here right when they are worried your short exposure falls to 25? i personally know quite a few long/short managers who got whipsawed in 2009 in just this manner, and they felt they just had to be short something due to client pressures.

Michael Seeley said...

Mr. Hempton,

Excellent article. It is extremely informative to obtain insight into the methodologies and investment philosophies of fund managers.

You are right that the 20 Punch Card Test is more conducive to private investments than to professional investment management. I am in no way a Warren Buffett expert, but I note that over the bulk of his investing career, not even Warrant Buffett would have met the requirements of the 20 Punch Card Test. I cite as one example his 1961 Buffett Partnership Ltd. letter in which he acknowledges the Partnerships' ownership of "probably 40 or so securities". In this regard, perhaps we may all take comfort that we are in good company.

In your experience, how does the portfolio management described in the 1961 letter work today in avoiding 100% market correlation and delivering Alpha? Namely, 50% of the cigar-butt value stocks (5-10 positions), with the remainder comprised of special situation work outs (5-10 positions), and if the fund is large enough, activist-oriented control positions? The market correlation of the work-outs, when paired with a modest short-book, may serve the purpose.

I expect these hypotheses are only fascinating until one is managing money for others. ;)

Best Regards,


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