BRK 2019 AGM Highlight: Why retirement funds should stay away from private equity

JOHANNESBURG — The Berkshire duo warm into this question from this shareholder, who is a manager at a Canadian public sector pension fund. He asked for their view on private equity investments – particularly for retirement funds like the one where he works. The Buffett and Munger response won't thrill the army of consultants selling these products. – Alec Hogg.*This is one of the highlights from the five hours of Q&A at the 2019 Berkshire Hathaway AGM in Omaha where chairman Warren Buffett and his deputy Charlie Munger field queries from shareholders..___STEADY_PAYWALL___.Please give me your thoughts on private alternative investments, the relevancy in public pension funds, and your view on long-term expectations..Yeah. If you'd leveraged up investments in just Constar and you'd figured it a way so that you would have staying power if there were any market dip, you'd obviously obtain extraordinary returns. I pointed out in my investing lifetime; if an index fund would do 11%, then imagine how you'd have done if you'd leveraged that up 50% or whatever the prevailing rates were over that time. A leveraged investment in a business is going to beat an unleveraged investment in a good business a good bit of the time. But, as you point out, the governance to protect those horrors has really degenerated in the business and of course, you've been in upmarket for businesses and you've got a period of low interest rates so it's been a very good time for it. My personal opinion is if you take unleveraged returns against unleveraged common stocks, I do not think what is being today and marketed today would work well..But, if you could borrow money in my assets, it would yield seven or eight percent and you can borrow enough money – four or five percent – and you don't have any governance to meet. You're going to have some bankruptcies but you're also going to have better results in many cases. It's not of interest to us at all. We're not going to leverage on Berkshire. If we'd leveraged on Berkshire, we'd have made a whole lot more money over the years – obviously – but both Charlie and I (probably) have seen some more high IQ people – really extraordinarily high IQ people – destroyed by leverage. We saw long-term capital management where we had people who could do (in their sleep) math that we couldn't do – at least, I couldn't do – working full time at it during the day..Really, really smart people working with their own money and with years and years of experience of what they were doing and it all turned to pumpkin and mice in 1998. It actually was a source of national concern – just a few hundred people – and then we saw some of those same people, after that happened to them once, go and do the same thing again. I would not get excited about so-called alternative investments. You can get all kinds of different figures but there is probably at least $1trn committed to in effect, buying business. You figure they're going to leverage them two for one on that. You may have $3trn of buying power, trying to buy businesses in a US market (maybe even something over $30trn now) but there are businesses not for sale so the supply/demand situation…where buying businesses privately and leveraging them up has changed dramatically from what it was 10 or 20 years ago..I'm sure it doesn't happen with your Winnipeg operation but we have seen a number of proposals from private equity funds where the returns are really not calculated in a manner that I would regard as honest. It's not something… If I were running a pension fund, I would be very careful about what was being offered to me. If you have a choice in Wall Street between being a great analyst or being a great salesperson, the salesperson is the way to make it. If you can raise $10bn in a fund and you get a one-and-a-half percent fee, and you lock people up for 10 years; you, your children and your grandchildren will never have to do a thing if you were the dumbest investor in the world. Charlie?.Well, I'd do it more safely than what he's doing but I was young..Actually, you sound like a guy that I would hope would be working for a public pension fund because frankly, most of the institutional funds…well, we had this terrible riot in Omaha and you can get a story with what happened with our public schools retirement fund. They were doing fine until the manager started going in a different direction and the trustees here – perfectly decent people – and the manager Donald came to that point…..They were smarter in Winnipeg than they were here. It was pretty bad here..It's not a fair fight, really, when a bunch of public officials are listening to people who are motivated…who really just get paid for raising the money. Everything else is gravy after that but if you run a fund and you get even one percent of $1bn, you're going to get $10m per year coming in. If you've got the money locked up for a long time, it's a very one-sided deal. I asked a guy in the past one time, "How in the world can you ask two and 20 when you really haven't got any kind of evidence that you are going to do better with the money than you're doing in the next fund??" and he said, "Well, that's because I can get 3 and 30?..What I don't like about a lot of the pension fund investment is I think they like it because they don't ever want it to rebound as much as it should be in the middle of a panic. I think that's a silly reason to buy something because you're giving leniency and marking it down..When you commit the money (often, in the case of private equity), they don't take the money but you pay a fee on the money that you have committed and of course you really have to have that money to come up with it any time. Of course, it makes their return look better if you sit there for a long time in Treasury bills, which you have to hold because they can call you up and demand the money and they don't count that. They count it in terms of getting a fee on it but they don't count it in terms of what the so-called interal rate of return is. It's not as good as it looks and I really do think that when you have a group, sitting as a state pension fund….Where all they're doing is lying a little bit to make the money come in..Yeah, that sums it up.

BRK 2019 AGM Highlight: Why retirement funds should stay away from private equity

Related Stories