Berkshire AGM: Succession and tucking into the new Heinz cheesecake

This portion of the Berkshire Hathaway AGM starts with the investment case for USG and sees Warren Buffett and Charlie Munger tucking into some Heinz cheesecake.

Thank you, Mr Buffett and Mr Munger, for all you’ve done and the opportunity to learn even more from your approach to investing in life. My name is Harry Hung and my respirable is just from Vancouver/British Columbia. The question goes back to 2001, you made an initial investment in USG, shortly before the company declared bankruptcy, due to the amounting asbestos and liability. You held those shares through the bankruptcy process, even though standard wisdom says that the equity in Chapter 11 is usually worthless. Can you explain why USG’s equity was a safe investment?

Well, I don’t really remember all the details then.

It was very cheap…Very cheap.

Yes but I would say this. USG, we own, I’m not sure what percentage but it’s a very significant percentage on them.

20% or something.

Or 30%, something like that.

Yeah.

But USG overall has just been disappointing because the Gypsum business has been disappointing and I think, and I may be wrong, they went bankrupt twice. Firstly, asbestos going back and then subsequently because they just had too much debt. So it has not been a brilliant investment. Now, if Gypsum prices were at levels that they were in some years in the past it would have worked out a lot better.

But it hasn’t been terrible.

No, it hasn’t been terrible but if Gypsum took…It’s taken a real dive several times and there has been too much Gypsum capacity and then, when it comes back the management has not necessarily been  at USG but including USG perhaps. They got more optimistic, they got more optimistic about future demands than they should have and they like, going back historically, where they like to build new plants. It’s a business where the suppliers have been significantly, potential suppliers have been significantly greater than demand in a lot of years. You’ve seen housing starts since 2008/2009, and not come back anywhere near as much as people anticipated, so Gypsum prices have moved up and not dramatically, so just that one down as not one of our great ideas. It’s not one of my great ideas, Charlie wasn’t involved in that. It’s no disaster though.

No, it isn’t.

Becky?

This question comes from Axel Meyers in Germany, who writes if Ajit Jain were to retire, or God forbid, be promoted, what would the impact be on the insurance operations, both with regards to underwriting profit as well as the development of flow?

Well nobody could possibly replace Ajit Jain, I mean you can’t come close but we have a terrific operation in insurance, we really do, outside of Jain and it’s terrific squared with Jain. There are things that only he can do but there are a lot of things that are institutionalised, a lot of things in our insurance business where we’ve had extraordinary been able to manage too, so Ajit, for example, bought a company that nobody here has heard of, probably, called Guard Insurance a few years ago. They’re a Workers’ Comp primarily, it’s based improperly in Wilkes-Barre, Pennsylvania, and it’s expanding like crazy in Wilkes-Barre. It’s been a gem and Jain overseas, we’ve got a terrific person running it. We bought Medical Protective some years ago. Tim Kenesey runs that and he’s overseas but Tim Kenesey can run a terrific insurance company with or without Ajit, but he’s smart enough to realise that if he’s got someone like Ajit, then he needs someone to oversee it, to a degree. That’s great, but Tim is a great insurance manager all by himself and Medical Protective has been a wonderful business for us. Most people don’t know we own it. The company goes back into the 19th Century actually. We’ve got a lot of good operations. If you look at that section in the ‘end report’ called ‘Other Insurance Company.’ That is, in aggregate that is a wonderful insurance company and there’s very few like it. Geico is a terrific company, so Ajit has made more money for Berkshire than I probably have. We’ve still got, what I would consider, the world’s best propetly casualty insurance operation, even without them and with them, nobody can…I don’t think anybody comes close…Charlie?

Well, a few years ago California made a little change in the Workman’s Compensation Law, and Ajit saw instantly that it would cause the underwriting results to change drastically and it went from a tiny percent of the market, to like 10% of the market, which is big and he just grasped a couple of billion Dollars, at least out of the air. Like he was snapping his fingers, and when it got tough he pulled back. We don’t have a lot of people like Ajit. It’s hard to just snap your fingers and grab a couple of billion Dollars out of the air.

The California Worker’s Comp though Guard has moved into it. We have got a lot of terrific insurance managers. I mean, I don’t know of a better collection any place, and Ajit has found some of those. I’ve gotten lucky a few times. I mean Tom Nerney, at US Liability that goes back 15 to 16 years.

Yes.

It is a terrific operation, and it’s huge but it’s so well managed and people don’t even know we own these things but you look at that last line, and now we’ve added Peter Eastwood with Berkshire Hathaway especially, and these are really good businesses, I’ve got to tell you. When you can produce underwriting profits and on top of that have more float. We don’t have many businesses like that. Those are great businesses. We’ve got $100bn plus of money that we get to earn on, while at the same time, overall on balance we’re likely to make some additional money for holding them. If you can get somebody to hand you $104bn and pay you to hold it, while you get to invest and get the proceeds, it’s a good business. Now,most people don’t do well at it and the problem is that, well I’ve just described attempts for lots of people to get into it and recently people have gotten into it really just for the investment management. It’s a way to earn money offshore and we don’t do that but it can be done for smaller companies with investment managers. So, there’s a lot of competition there but we have some fundamental advantages, plus we have, and certainly we have absolutely terrific managers to maximise those asset managers, and we’re going to make the most of it. I’ve just been handed something Kraft Heinz came out with, they just came out with a commercial a few days ago, maybe a few weeks ago. At the Berkshire’s meeting they had this. I had three of these, I’m sure that there’s a few members of the audience who may not approve of it but I’ve got to tell you folks, it’s good. It’s a cheesecake arrangement with topping, and I don’t know if you’re a cream cheese specialist, so you can create your own cheesecake and I thought that I could eat it while Charlie is talking and you’ll be able to get it at halftime. It’s selling very well and I think…

Just so you don’t feel too guilty, it’s 170 calories for this cherry. Like I said, I had three of these.

I don’t mind having 500 to 600 calories for desert. I’ll let somebody else eat the broccoli and I’ll have the desert. So, we’ll be eating this, but you too at half-time. I think they brought 8 or 9 thousand of these. I’ll be disappointed if we don’t run out. Actually, I’ll be disappointed at you and not them. Okay, Jay?

This question is on the topic of succession planning. Warren, there seems to be fewer mentions by name of top performing Berkshire managers in this year’s annual letter. Does this mean you’re changing your message regarding the succession plan for Berkshire’s next CEO?

The answer to that is no and I didn’t realise there were fewer mentions by name either. I write that thing out and send it to Carol, and she tells me to go back to work. I don’t actually think that much about how many personally get named. I would say this, and this is absolutely true. We have never had more good managers than now, because we’ve got more good companies, but we have never had more good managers than we have now but it has nothing to do with succession. Charlie?

Well, I certainly agree with that. We don’t seem to have a whole lot of 20-year-olds.

Certainly not at the front table.

No.

We’ve got an extraordinary group of good managers, which is why we can manage by application. It wouldn’t work if we had a whole bunch of people who had come with the idea of getting my job. If we had 50 people out there all of who wanted to be running Berkshire Hathaway, it would not work very well but they have the jobs they wanted. Tony Nicely loves running Geico, and you could have a line. They have jobs they love and that’s a lot better, in my view than having a whole bunch of them out there that are kind of doing their job there of kind of hoping that the guy whose competing with him will fail, so that when I’m not around they’ll get the nod. It’s a much different system that exists at most large, American corporations. Charlie, do you want to come in?

No.

Well, we’ll go to station A.

Buffett on Kraft-Heinz bid for Unilever: We would have contributed an additional $15 billion if a friendly agreement had been reached.

— Julia Horowitz (@juliakhorowitz) May 6, 2017

Hi, Warren and Charlie. My name is Vicki, I’m a MBA student from the Wharton School of Business. This is my first time to be in this meeting and I’m really exciting about it. Thanks for having us here.

You’re welcome.

My question is where do you want to go fishing for the next 3 to 5 years, which sectors are you most bullish on and which sectors are you most bearish on?

Yes, Charlie and I do not really discuss sectors much. Nor do we let the macro environment or thoughts about it enter into our decisions. We’re really opportunistic and we’re obviously, looking at all kinds of businesses all of the time, it’s a hobby with us almost, probably more with me than Charlie. But we’re hoping we get a call and we’ve got a bunch of feelers and I would say this for the both of us. We probably know within the first 4 to 5 minutes, or less whether something is likely to, or has a reasonable chance of happening. It’s just about going  through there and the first question is, can we really ever know enough about this, and come to a decision? That knocks out a whole bunch things and there’s a few, and then if it makes it through there there’s a pretty good or reasonable chance we may do something but it’s not sector specific. We do love the companies obviously, with the moats around the product where consumer behaviour can be perhaps predicted further out but I would say it’s getting harder for us anyway, to anticipate consumer behaviour than we might have thought 20 or 30 years ago. I think that it’s just a tougher game now but we’ll measure it, and look at it in terms of returns on present capital, returns on prospective capital. A lot of people give me some signals as to what kind of people they are, even in talking in the first 5 minutes and whether you’re likely to actually have a satisfactory arrangement with them over time. So, a lot of things go on past. We know the kind of sectors we kind of like or the type of business we’d kind of like to end up in but we don’t really say ‘we’re going to go after companies in this field or that field or another field.’ Charlie, do you want to…?

Yes, some of our subsidiaries do a little bold-on acquisitions that make sense and that’s going on all the time. Of course, we like it but I would say the general feel of buying whole companies, it’s gotten very competitive. There’s a huge industry of doing these leverage buyouts (that’s what I still call them). The people who do them think that’s a bad marker, so they say they do private equity. It’s like making a janitor calling himself the chief of engineering or something. But at any rate, the people who do the leverage buyouts, they can finance practically anything in about a week or so, through shadow banking and they can pay very high prices and get very good terms and so on. So it’s very hard to buy businesses and we’ve done well because there’s a certain small group of people that don’t want to sell to private equity. They love the business so much, they don’t want it just dressed-up for resale.

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We had a guy some years ago who came to see me and he was 61 at the time, and he said look, I’ve got to buy a business. I’ve got all the money I could possibly need but there’s only one thing that worries me when I drive to work. Actually, there’s more than one guy who has told me that, they used the same term. The only one thing about it, is when they go to work if something happens to me today my wife is left. I’ve seen these cases where executives in the company try to buy them out cheap, or they sell to a competitor and other people. He says, “I don’t want to leave her with a business.” I want to decide where it goes but I want to keep running it and I love it. He said, I thought about selling it to a competitor but if I sell it to a competitor their CFO is going to become the CFO of the new company and I’m down the line, and all these people who’ve helped me build the business, a lot of them are going to get dumped and I’ll walk away with a ton of money and some of them will lose their jobs. He said, “I don’t want to do that.” Then he said that he could sell it to a leverage buyout firm, where they prefer to call themselves private equity, but they’re going to leverage it to the hilt and they’re going to resell it. They’re going to dress it up some but in the end, it’s not going to be in the same place. I don’t know where it’s going to go. He said, “I don’t want to do that, so, he said it isn’t because you’re so special, he said there just isn’t anyone else.” If you’re ever proposing to a potential spouse don’t use that line. But that’s what he told me and I took it well and we made a deal. So, logically, unless somebody has that attitude, we should lose in this market. I mean you can borrow so much money, so cheap, and we’re looking at the money as pretty much all equity capital and we’re not competitive with somebody that’s going to have a very significant portion of the purchase price, carry the debt, and maybe averaging 4% or something.

And he won’t take the losses, so if it goes down he gets part of the profit if it goes up.

Yes, his calculus is just so different than ours and he’s got the money to make the deal, so if all you care about is getting the highest price for your business, we are not a good call. We will get some calls, in any event, and we can offer something that, I wouldn’t call it unique but it’s unusual. The person that sold us that business and a couple of others, actually it’s almost word-for-word, the same thing they say. They are all happy with the sale they make, very happy, and they have lots and lots of money and they’re doing what they love doing, which is still running the business and they know that they made the decision that will leave their family and the people who’ve worked with them all their lives, in the best possible position and that’s, in their equation, they have done what’s best but that is not the equation of many people and it certainly isn’t the equation of somebody who buys and borrows every dime they can, with the idea of reselling it after they maybe dress up the accounting and do some other things. But they want prosperity to get so wide between what a heavily finesse purchase will bring as against an equity type purchase. It gets tougher, there’s just no question about it, and it will stay that way.

But it’s been tough for a long time and we’ve bought some good businesses.

Yes, okay Andrew?

Warren, this comes from Cheryl, who I think is here who asked to remain anonymous, she writes three years ago you were asked at the meeting about how you thought we should compensate your successor? You said it was a good question and you would address it in the next annual letter. We’ve been patiently waiting. Can you tell us now, at least philosophically, how you’ve been thinking about the way the company should compensate your successor, so we don’t have to worry when the pay consultants arrive on the scene?

Well, unfortunately, at my age I don’t have to worry about things I say three-years ago, but this guy is obviously much younger and remembers. I’m not, well I’ll accept his word that I said that. There’s a couple of possibilities actually and I don’t want to get into details on them but you may have, and I actually would hope that we would have somebody, A) that is already very rich, which they should be and have been working a long time and have got that kind ability that’s very rich, and really is not motivated by whether they have ten-times as much money that they and their families can need or a 100 times as much. They might even wish to perhaps set an example by engaging for something far lower than actually, you can say what their true market value is. That could or could not happen but I think it would be terrific if it did but I can’t blame anybody for wanting their market value. If they didn’t elect to go in that direction, I would say that you would probably pay them a very modest amount and then have an option, which increased in value or increased in striking price annually, nobody does this hardly. Graham Holdings have done it, the Washington Post Company did it a little bit but it would increase because and assuming that there was a substantial retainer, and I don’t think it’s every year because why should somebody retain a bunch of earnings and then claim they’ve actually improved the value. Simply because they withheld the money from shareholders, so it’s very easy to design that. In private companies people do design it that way. They just don’t want to do it in public companies because they get more money the other way. But they might have a very substantial one that could be exercised about whether shares had to be hold for a couple of years after retirement, so that they really got the result overtime that the majority of the stockholders would be able to get in and not be able to pick their spots as to when they exercised and sold a lot of stock. It’s not hard to design and it really depends who you’re dealing with, in terms of actually, how much they care about money and having money beyond what they can possibly use, and most people do have an interest in that. I don’t blame them but what do you think, Charlie?

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Well, one thing I think is that I’ve avoided all my life is compensation consultants. To me, I hardly can find the words to express my contempt.

I will say this, if the board hires a compensation consultant after I go, I will come back.

Mad, so I think there’s a lot of mumbo-jumbo in this field and I don’t see it going away.

Oh, it isn’t going to go away. No, it’s going to get worse and I mean if you look at the way compensation gets handled. Everybody looks at everybody else’s proxy statements and we can’t possibly hire a guy that hasn’t been…

I know, it’s ridiculous.

And so on, and the Human Relations Department work for the CEO, come in and suggest a consultant. What consultant is ever going to get another assignment that says you should pay your CEO below the, down in the fourth quarter, because you’re going to get a fourth quarter result. It just…  It isn’t that the people are evil or anything. It’s just the nature of the situation, it just produces the results that is not consistent with how representatives of the owner should behave.

It’s even worse than that. Capitalism is the golden goose that we all live on and if people generally have contempt for it because they don’t like the pay arrangements and the system. Your capitalism may not last as well and that’s like killing the golden goose, so I think the existing system has a lot wrong with it.

I think there is something coming in pretty soon, I may be wrong about this, where companies are going to have to put in their proxy statement the CEO is paid at the average pay or something like that. That isn’t going to change anything.

It won’t change a thing.

It won’t change a thing and it will cost us at Berkshire…

By the way, it won’t get any headlines either. It will be tucked away.

It will cost us a lot of money with 367 thousand people employed around the world and I mean we’ll hope to get something that makes us somewhat [inaudible 0:25:49.3]. We can use estimates or something of the sort but to get the medium income or lean income, or whatever the powers of the rules may read.

That’s what consultants are for, Warren.

It’s human nature that produces this and the most… I write in this letter to the managers every two years. I say, “The only excuse I won’t take on something is that everybody else is doing it.” But of course, everybody else is doing it, is exactly the rational for why people did not want to count the cost of stock options as a cost. It was ridiculous, all these CEOs they went to Washington and they got the Senate, I think to vote 88 to 9, to say the stock options aren’t a cost. Then a few years later it became so obvious that they finally put an end to what was a cost. It reminded me of Galileo or something.

Worst, it was way worse. The Pope behaved better to Galileo – he was…

Anyway, I would hope, like I say, somebody and it doesn’t even have to be… I’m not talking about the current successor or anybody else. These successors down the line would probably have gotten very wealthy by the time they’re running Berkshire. The incremental value of wealth gets very close to zero at some point and there is a chance to use it as a different sort of model but I don’t have any problem. If a system is devised that recognises retained earnings. I’ve never heard anybody talk about it on the 20 boards I’ve been on or anything. If you and I were partners in a business, and we kept retaining earnings in the business and I kept having to add the value to buy a portion of you out at a constant price. You’d say this is idiocy but of course, that’s the way that all the option systems are designed and it’s better for the CEO and for the consultants’ and of course, usually if there’s some correlation between what CEO’s are paid and what boards are paid. If CEO’s were getting paid at the rate that they got paid 50 years ago, adapted to present Dollars. Their interest rate would be lower, so it’s got all these billing things that, to some extent, sort of kindle the…

No Berkshire director is in it for the money.

Well, they are. They own a lot of stock and they bought it on the market.

Yes, it’s a very old-fashioned system.

I looked at one company the other day and seven of the directors had never bought a share of stock with their own money. They’ve been given stock but not one, well I can’t say not one, seven of the directors had never actually bought the share stock and there they are, making decisions on who should be CEO and how they should be paid and all that sort of thing. But they never felt like shelling out a Dollar themselves, now they’ve been given a lot of stock. We’re dealing with human nature here, folks. What you want is to have a system that works well, in spite of how human nature is going to drive it, and we’ve done awfully well in this country in that respect. I mean American businesses, overall, has done very well for America, generally. But not every aspect of it is exactly what you want to teach your kids. Okay, Greg.

Warren, between 2010 and 2015, Intermodal Rail Traffic enjoyed double digit rates of revenue growth, and showed how freight converted from truck to rail. During the past year or so though, cheaper diesel prices and more readily available truckload capacity had made trucking more competitive Leading to a decline in the Intermodal Rail Traffic. While car load growth is expected to be solid, longer term, helping to offset weakness in other segments, like coal. What impact do you expect the widening of the Panama Canal, which was completed last year, to have on the West Coast port shipments that BNSF have traditionally carried through to exchange points for the Eastern-US Railroads? As shippers elect to have goods unloaded at ports in the Gulf of Mexico or up to the Eastern Seaboard. While lots of volumes is never a good thing, could there be a small trade off here, as the bottleneck in Chicago, where most of these West cargo is handed off, ease a bit over time as some of the current traffic gets rerouted?

Chicago has got lots of problems and it’s going to continue for a while. That requires a big solution. When you think of how the railroads developed, Chicago was the centre and they laid the rails and there were a whole bunch of different railroads 100 years ago, and the city grows up around them and everything, so Chicago can be a huge problem. But getting to Intermodal, I think Intermodal can do very well but you were correct that Car Loadings actually hit a peak in 2006, so here we are, 11 years later, and the investment of the five-big class-one railroads, four of the biggest. If you look at their investment, beyond appreciation, it’s 10’s and 10’s of billions’ of Dollars and we’re carrying less freight, the four in aggregate than we were in 2006. Coal continued to increase. It’s a good business that has big advantages over truck in many respects. Truck gets much more of a free ride, in terms of the fact that their right of way, which is the highway system, is subsidised to a much greater degree, beyond the gas tax than the Railroad Industry. But it has not been a growth business in physical volume to any great degree. I think it is unlikely to be. I think it’s likely to be a good business. I think we’ve got a great territory. I like the West better than the East and, as you mentioned, there will be some Intermodal traffic that gets diverted to Eastern ports perhaps or so on. Overall, we’ve had terrific system in that respect and we will do well. It would be more fun if we had something where you could expect aggregate car loadings to increase, 2%, 3% or 4% a year but I don’t think that’s going to happen. I do think our fundamental position is terrific, however. I think we are on decent returns on capital but I think that’s the limit of it. Charlie?

Nothing to add.

Okay, station 9?

I’m from llinois. Thank you for doing everything you do for us. I have a question. The two of you have largely awarded capital allocation stakes by bouncing ideas off of one another. Will this continue long into Berkshire’s future and I would like, just having both at the headquarters and at subsidiaries?  

It can’t continue very long.

Don’t get defeated, Charlie. Any successor that’s put into Berkshire, capital allocation abilities and proven capital allocation abilities are certain to be uppermost in the boards’ minds, or in the current case, in terms of my recommendation and Charlie’s recommendation for what happens after we’re not around. Capital allocation is incredibly important at Berkshire. Right now we have $280 or $90 billion of whatever, maybe of shareholder’s equity. If you take the next decade alone nobody can make accurate predictions on this but in the next 10 years, if you just take, and depreciation right now is another $7b a year, something around that order. The next manager in the decade is going to have to allocate maybe $400bn or something like that or maybe more, and it’s more than what has already been put in, so 10 years from now, Berkshire will be an aggregation of businesses where more money has been put in on that decade than everything that took place ahead of time. So, you need a very sensible capital allocator in the job of being CEO of Berkshire, and we will have one. It would be a terrible mistake to have someone in this job who really capital allocation might even be their main talent. It probably should be very close to their main talent. Of course, we have an advantage at Berkshire in that we do know how important that is and there is that focus on it and in a great, many companies people get to the top through ability and sales, sometimes they come from the legal side, from all different sides, and they then have the capital allocation, sort of in their hands. Now, they may not have [inaudible 0:36:23.4] strategic thinking divisions or they may listen to investment bankers and everything but they better be able to do it themselves. If they come from a different background or haven’t done it, it’s a little bit, as I put in one of my letters I think. It’s like getting to Carnegie Hall, playing the violin and then you walk out on the stage and they hand you a piano. It is something that Berkshire would do well if somebody was put in, who had a lot of skills in other areas but really did not have an ability of capital allocation. I’ve talked about it as being something I call a money mind. People can have 120 IQs or 140 IQs or whatever it maybe, very similar scoring abilities, in terms of intelligence tests. And some of them have minds that are good at one type of thing and some of them in another. I’ve known very bright people that do not have money minds and they can make very unintelligent decisions. They can do all kinds of other things that most mortals can’t do but it isn’t the way their wiring works and I’ve dealt with other people that really would not do that brilliantly. They do fine on a SAT test or something like that but they’ve never made a dumb money decision in their life, and I’m sure Charlie has seen the same thing. We do want somebody, and hopefully they’ve got a lot of talent but we certainly do not want somebody that, if they lack a money mind. Charlie?

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Well, there’s also the option of buying in-stock, which, so it isn’t like it’s some hopeless problem. One way or another, something intelligent will be done.

And a money mind will recognise when it makes to buy in-stock and does it. In fact, it’s a pretty good test for some people, in terms of managements and how they think about something like buying in-stock. It’s not a very complicated equation if you sort of think straight about that sort of a subject but some people think that way and some don’t and they’ll probably be miles better at something else but they say some very silly things when you get to something that seems so clear, as whether and say buying in-stock makes sense. Anything further, Charlie?

No.

Okay, Carol?

This question comes from Connecticut. Warren, you’ve made it very clear in your annual letter that you think the hedge fund compensation scheme of 2 and 20, generally does not work well for the funds investors. In the past you have questioned whether investors should pay “financial helpers” as much as they can. Butt financial helpers can create tremendous value for those they help. Take Charlie Munger for instance. In nearly every annual letter, and on the movie this morning you describe how valuable Charlie’s advice and counsel has been to you, and in turn, to the incredible rise in Berkshire’s value over time. Given that, would you be willing to pay the industry standard “financial helper’s fee” of 1% on assets to Charlie or would you perhaps even consider 2 and 20 for him? What is your judgement about this matter?

Yes, well I’ve said in the annual report that I’ve known maybe a dozen people in my life and I said there are undoubtedly 100’s or maybe 1000’s out there but I’ve said that I’ve known personally, a dozen where I would have predicted or did predict in a fair number of those 12 cases. I did predict that the person involved would do better than average in investing over a long period of time. Obviously, Charlie is one of those people, so would I pay him? Sure, but would I take financial advisors as a group, and pay them 1% with the idea that they would deliver results to me that were better than the S&P 500 by 1%, therefore leave me breaking even against what I could have done on my own? There’s very few, so it’s just not a good question to ask, whether I’d pay Charlie 1%. That’s like asking whether I’d pay Babe Ruth $100 thousand or whatever it was, to come over from the Red Socks to the Yankees. Sure, I would have but there wasn’t very many people I would have paid $100 thousand to in 1919, or whenever it was, to come over to the Yankees. It’s a fascinating situation because the problem isn’t that the advisors are going to something terrible. It’s just that you have an option available that doesn’t cost you anything that’s going to do better than they are in aggregate. It’s an interesting question. If you hire an obstetrician, assuming you need one, they’re going to do a better job of delivering the baby than if the spouse comes in to do it or if they just pick somebody up off the street. If you go to a dentist or if you hire a plumber and all the professions – there is value added by the professionals, as a group, compared to doing it yourself or just randomly picking layman. In the investment it isn’t true. The active group, the people that are professionals, in aggregate, are not, cannot do better than the aggregate of the people who just sit tight. If you say well, in the active there’s some person that’s terrific I will agree with you but the passive people can’t all pick that person and they don’t know how to identify them.

It’s even worse than passing the expert, whose really good, when he gets more and more money, and he suffers just terrible performance problems. So, you’ll find the person who has a long career at 2 and 20 and if you analyse that, net, all the people that have lost money because some of the early people have had a good record but more money coming in later and they lose it. The investing world is just a morass of wrong incentives, crazy reporting, and I’d say a fair amount of delusion.

Yes, if you asked me whether those 12 people I picked would do better than the S&P working with $100bn, I would answer that probably none of them would. That would not be their perspective performance but when I was talking of them or reference them, and when they actually worked and practiced, they dealt generally with pretty moderate sums. As the sums grew, their relative advantage diminished. It’s so obvious from history, the example I used in the report. I mean the guy who made the bet with me, and incidentally all kinds of people didn’t make the bet with me, because they knew better than to make the bet with me. There were 100’s, at least a couple of 100 underlying hedge funds, these guys were incented to do well, the fund-to-fund manager was incented to pick the best ones he could pick. The guy who made the bet with me was incented to pick the best fund-to-funds. Tons of money, just with those five funds, a lot of money went to pay managers for what was sub-normal performance over a long period of time. It can’t be anything but that and it’s an interesting profession when you’ll have 10’s of thousands or 100’s of thousands of people, who are compensated, based on selling something that in aggregate can’t be true, superior performance, so it will continue and the best sales people will tend to attract the most money and because it’s such a big game, people will make huge sums of money, far beyond what they’re going to make in medicine, or you name it. I mean, repairing the country’s infrastructure, I think the big money, the huge money is in selling people the idea that you can do something magical for him. If you even have a $1bn fund and get 2% of it for terrible performance, that’s $20m. In any other field it will just blow your mind but people get so used to it in the field of investment that it just sort of passes along. $10bn I mean $200m fees, we’ve got two guys in the office, they’re managing $11bn, sorry they’re managing $20bn between the two of them, $21bn maybe, and we pay them $1m a year, plus the amount by which they beat the S&P. They have to actually do something to get contingent compensation, which is much more reasonable than 20%. How many hedge fund managers in the last 40 years have said ‘I only want to get paid if I do something for you?’ Unless I actually deliver something beyond what you can get yourself. I don’t want to get paid and that just doesn’t happen. It gets back to that line that I’ve used but when I asked a guy how can you, in good conscious, charge 2 and 20 and he said because I can’t get 3 and 30.  Anymore Charlie, or have we used up our…?

I think you’ve beaten up on them enough.

Yeah, Jonathan?