Letter to the Investment Committee
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The following is a thousand words on investing that will irritate most every investment professional. Most forms of active portfolio management incur fees, transaction costs and taxes. Whole industries exist due to these costs, and their proponents will argue that they are adding value. In aggregate they cannot; they are all costs. That I am proposing an investment that could take food from the mouths of the children of an army of accountants, brokers and investment professionals will, no doubt, cause them to find flaws in what follows.
Passive management (read: indexing) can solve much of the cost problem, but it introduces other problems. The market weighting of portfolios will overweight past winners and, by construction, underweight future ones and investments set to rebound. At best, one is settling for an average return, and at worst, one is engaging in momentum investing.
What passes for growth investing is speculation. One pays a very fancy price for investments that are believed to be the winners of the future. To be sure, investing with great managers can be a good deal, but it is very difficult to identify these people prospectively.
And while value investing has its virtues, is very hard to do. The reality is, few people have the temperament. The process requires the client and the manager periodically to underperform, do nothing or endure ridicule. That is nearly impossible when others are making money.
Especially in today’s environment, value managers are challenged (as are all managers) by the fact that the rules are changing. Regulations, taxes and monetary policy alter the landscape of winners and losers. Value managers in particular must be patient and depend on regression to the mean to create the small amount of value-add their style allows. (Like fees, the advantage may be small in the short run but can compound into a meaningful amount).
I am making no judgment here. Public policy keeps entities alive that otherwise would fail, which limits the investment opportunities for value managers and inhibits regression to the mean (that is, keeping failed companies in business hurts the profits of the successful businesses). Most value investors have not enjoyed the historic benefits of their style the last five years. It is unclear if or when the trend will reverse.
This still leaves people and institutions with the question of where to invest their money. There is, I believe, a solution that is simple and eloquent. Buy the common stock of Berkshire Hathaway.