Monday, April 28, 2008

Pilgrimage, Part VI: The Most Versatile Investor in the World

Note: This post, part of series on the 2007 Berkshire Hathaway annual meeting in Omaha, Nebraska, originally appeared May 22, 2007.
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Mr. Matthews, I am a fan of the blog. As a college student and investor, I generally enjoy your sharp and objective insight. That said, I recently started following the news about OSTK [Overstock.com]…... your CNBC interview did not help the cause. Byrne may tell a wild story, but he clearly carried the debate….

--PadawanCowboy


Thus began the first of what would be many comments in support of Patrick Byrne, the CEO of Overstock.com, posted on this blog in the fall and winter of 2005 by an individual identifying himself as “Padawan Cowboy.”

If you haven’t heard, Patrick Byrne is a self-styled “crusader” who’s spent the better part of two years attempting to convince the world that a coalition of short-selling hedge funds, “crooked” reporters, lax SEC regulators, Israeli mobsters and others who all take their direction from a James Bond/SPECTRE-style “Sith Lord” threaten the stock market as we know it.

You might well ask why anyone would take such stuff seriously.

The answer is that Patrick Byrne is not only the CEO of a public company, but he has an interesting pedigree: his father is Jack Byrne, the legendary insurance executive who turned around GEICO for Warren Buffett and looms large in the Berkshire pantheon of Great Managers.

Patrick himself once even ran a Berkshire apparel subsidiary.

For the record, “Naked short-selling” is a term for selling a stock short without first actually borrowing the shares being sold. Now, I have worked on Wall Street almost 30 years, and aside from a case reported in the Wall Street Journal, in which a rogue employee sold short shares of small companies in Canada without borrowing the stocks—for which he was successfully prosecuted by the SEC—I have never heard of, known of, or worked with anybody—anybody—who didn’t borrow a stock before shorting it.

Never. Not once.

But now, at the Berkshire-Hathaway shareholder’s meeting, my own 28 year’s worth of experience is being put to the test by a serious, slightly breathless, man—the kind of guy you wouldn’t want to make eye contact with at Starbucks—who is asking a question as if:

1) He is about to expose the biggest scandal since Teapot Dome, and;

2) Government agents acting in cahoots with hedge funds and Byrne’s “Sith Lord” intend to cut off his microphone before he can spill the beans.

The question he asks is, what does Buffett think of the “naked short selling” problem in this country, and what can be done to protect the companies whose stocks appear on the fail-to-deliver list “for hundreds of days.”

Now, if anybody is going to be able to contradict my own measly 28 years’ worth of experience on this and any other issue, it is Warren Buffett and Charlie Munger, whose combined investment experience exceeds 120 years.

But it’s not just a matter of age and longevity that causes 27,000 individuals to troop out to the middle of the United States and sit for five or more hours listening to Buffett and Munger answer questions of all stripes—even conspiracy-theory bunk like naked shorting.

It is to witness first-hand what am I beginning to understand is one of the less heralded secrets to Buffett’s extraordinary success: the breadth of his experience and his knowledge of pretty much everything that has happened on Wall Street since World War II (and much of what happened before he started), as well as what is happening right now.

For in seeing and hearing Buffett respond to question after question, it becomes clear he is not merely the deep-value investor with an aversion to computers (except for playing online bridge) who spends his days reading annual reports and CEO letters until one day deciding to buy 7% of Coca Cola or 11% of Burlington Northern, as he has been portrayed in some of the books.

He is in fact one of the most versatile investors in the world.

“We’re not limited,” he says, when asked about the merits of alternative investment vehicles such as managed futures funds
(which he does not care for); “we buy businesses, bonds, currencies, futures….”

And he’s not kidding.

Take derivatives. During today’s meeting Buffett will repeat his past his warnings about the risks posed by the explosion of derivatives in today’s financial markets (some day we will get “a very chaotic situation” he tells us), and he will emphasize his first-hand experience with the matter by reminding shareholders that Berkshire took a $400 million loss on a derivatives portfolio that had already been marked down to what was thought to be fair value.

Yet Buffett then goes on to say quite matter-of-factly,

“We have 60 derivatives” in the Berkshire portfolio
. “And believe me,” he says, “we’ll make money on all of them.”

We believe him.

Not only does Buffett know derivatives, he also knows currencies. In response to a question about his bearish view of the US dollar, Buffett says it will continue so long as spendthrift US policies continue, and declares:

“We think the dollar will decline and we had a $21 billion bet that way, although the carry cost made it too difficult to keep…so we’ve focused on buying companies that earn money in foreign currencies.”

He then leaves his audience hanging with a terrific teaser:

“We have one currency position that will surprise you,” he says.
“We’ll tell you about it next year.”

Now, think about that statement for a minute.

Consider it from the perspective of a nervous, coffee-buzzed, chart-addled Wall Street currency trader whose position book changes by the hour, if not the minute or the second. I know just such a currency trader who opened an office in Germany in order to save the milliseconds it took to send electronic orders across the Atlantic Ocean, giving him an advantage over certain of his U.S.-based counterparts.

Yet Buffett is talking about a currency position he quite seriously expects to hold until
some time later this year.


Buffett not only knows—and does—derivatives and currencies, he also knows commodities, and a question is asked about the Great Silver Trade of ten years past, when Buffett famously bought control of 130 million ounces of silver when the stuff was going for a little more than $7 an ounce.

Current price: $13 an ounce.

Buffett ruefully acknowledges leaving money on the table:

“I bought too early, I sold too early. Other than that it was a perfect trade,” he says, getting a laugh.

Note here that Buffett uses the nominative singular pronoun “I” and not the plural “We.” Berkshire’s silver trade was Buffett’s alone—although Munger does not distance himself from the rare mistake when he concludes the matter by saying flatly:

“I think we demonstrated what we know about silver.”

Throughout the day, questions about derivatives, currencies and commodities compete with duller and more arcane issues raised by shareholders, all of which Buffett discourses on with ease and absolute knowledge.

The topics range from recent insurance legislation in Florida (and nothing is more important to Berkshire than insurance) to those electricity-generating dams on the Klamath River causing problems for Native Americans and non-native Americans alike (Buffett claims his hands are tied by the Federal Energy Regulatory Commission, which controls what happens to the dams).

And, of course, the “naked shorting” question asked by the guy-you-don’t-want-to-make-eye-contact-with-at-Starbucks.

Buffett starts his response with a sort of amused recap of the question for Munger:

“It’s about this so-called failure-to-deliver and naked shorting.”

Note the qualifier, “so-called.” Buffett—who knows more about investing than any living American—is clearly not impressed by any supposed naked shorting crisis.

With sixty years of experience in the business, he understands what anybody with even a passing familiarity with our profession knows: no borrow, no short. Whatever is causing those stocks to appear on that list of failures-to-deliver, it is not large hedge funds shorting naked.

Buffett in fact does not even have a problem with legitimate short-selling:

“I do not see the problem with shorting stocks,” he says, noting quite correctly
, “But it’s a tough way to make a living.”

In fact, recalling that Berkshire-Hathaway made good money lending shares of US Gypsum to short-sellers when it was under seige from asbestos lawsuits, before the stock went up ten-fold, Buffett says:

“If anybody wants to naked short Berkshire-Hathaway, we’ll welcome them.”

This draws an appreciative chuckle from the audience, although not, I am sure, from the questioner, who could only have been disappointed by the frank disbelief in his cause expressed by the World’s Greatest Investor.

No doubt, too, the “college student and investor” who began posting on this blog in support of Overstock.com CEO Patrick Byrne and his naked-shorting crusade under the name “Padawan Cowboy” would likewise be disappointed, especially since the evidence suggests he was not a “college student and investor” writing about Patrick Byrne.


Like Byrne's imaginary, evil, hedge fund-commanding “Sith Lord,” a “Padawan Cowboy” is also a Star Wars figure—although a more heroic, Harrison Ford-type. And it is because of that and many other giveaways in his postings that I'd bet the Byrne-defending, naked-short obsessed “Padawan Cowboy” was Byrne himself.

We will soon break for lunch and head into the giant exhibition hall adjacent to the main arena, where the Berkshire-Hathaway companies are offering products and services ranging from Net-Jets to T-shirts to the thousands of eager, souvenir-hunting shareholders.

And it is there I will have a chance to meet members of management from one of the Berkshire companies, and finally get to find out first-hand something I have long wondered: whether working for Warren is really as trouble-free as Buffett himself would like us to think.



To be continued…



Jeff Matthews
I Am Not Making This Up

© 2007 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

4 comments:

hundredyearstorm said...

I make the point about Buffett to folks all the time. Because his most public moments have been buying large blocks of stocks and proclaiming that he will hold them "forever", people assume that his great skill is being a buy-and-hold investor. I think, like you, that his great skill is being the most flexible investor of all time. Read the partnership letters from BPL, and it's clear that he's an expert at what today would be called risk arb, he was an early "activist" (think Sanborn Maps and obviously Berkshire) and fixed income arbitrageur. Since taking the helm of BRK, he's made money every known way: stocks, bonds, currencies, derivatives, etc... And it's not just directional bets, he's as good an arbitrageur as Mayweather and Rubin, arguably the best stock picker ever, an unbelievable bond manager (made $6B in a few months in junk bonds in 2002), I mean there is no strategy that eludes him.

It's a shame that most simply know him for his long stock picking, his skills run so much deeper.

Barney V. said...

Byrne's getting worse:
http://garyweiss.blogspot.com/2007/05/tales-from-fantasyland.html

Mrk2Mrkt said...

hundredyearstorm,

You might be interested in this:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=806246
It's only been downloaded 290x, but I believe a lot more people do know of Buffett's wide-ranging strategy skills.

The most notable part of this paper, given the constraints they discuss (you should certainly read the section titled "Data Sources" first, since it'll give you an idea of the limitations of this paper), is the annualized returns on "arbitrage" (read the long-term vs. arbitrage section for that definition here) investments:

annualized mean return on arbitrage: 81.28%
annualized median return on arbitrage: 29.31%

EB said...

Buffett is simply the man. He has the courage of his convictions to buy stocks when everyone hates them. Korean stocks at 2-3x EPS. Petrochina at 10% dividend yield at 5x EPS. Silver when it is trading below manufacturing cost.