What Warren Buffett Is Leaving His Successors

(Bloomberg Opinion) -- I'm starting to suspect that Warren Buffett doesn't think he's immortal. This is from the new Berkshire Hathaway Inc. shareholder letter:

We continue … to hope for an elephant-sized acquisition. Even at our ages of 88 and 95 — I'm the young one — that prospect is what causes my heart and Charlie's to beat faster. (Just writing about the possibility of a huge purchase has caused my pulse rate to soar.)

Charlie is, of course, Charlie Munger, Berkshire's vice chairman and Buffett's longtime partner in investing. Maybe it's too much to read that as “just let us do one more big deal before we go,” but I can't help it given how the rest of the letter seemed to make the case that Berkshire is built to last regardless of whether any elephants are acquired soon.

Most of the letter is a discussion of how the conglomerate should be evaluated not as individual businesses but as a “forest” of investments arranged in large “groves” with complementary characteristics. Along the way, there are occasional digressions intended to illustrate how Berkshire's approach differs from those of other corporations and investors — less comfortable with debt, more comfortable with big piles of cash, better at accounting, more long-term oriented. Finally, there are a couple of pages extolling what Buffett calls “The American Tailwind,” the tendency of the U.S. economy to keep growing and enriching those who invest in it.

Buffett's own investing career began 77 years ago (yes, he was 11), with the purchase of three shares of Cities Service preferred stock. Cities Services is now Citgo Petroleum Corp. and is owned by Venezuela's national oil company; it has been having a very interesting week. The investing world is a lot more complicated, and internationalized, than it was in 1942. As Buffett concludes:

There are also many other countries around the world that have bright futures. About that, we should rejoice: Americans will be both more prosperous and safer if all nations thrive. At Berkshire, we hope to invest significant sums across borders.

Over the next 77 years, however, the major source of our gains will almost certainly be provided by The American Tailwind. We are lucky — gloriously lucky — to have that force at our back.

My Bloomberg Opinion colleague Tara Lachapelle, who follows Berkshire a lot more closely than I do, proposed this week that it would be nice if Buffett used the letter to answer two questions:

1. Should anything be gleaned about the future of Berkshire from its relatively new, and recently erratic, interest in technology investments?
2. If Buffett didn't find a significant acquisition in December's market swoon, then when will he?

As noted above, Buffett did sort of address the second question but didn't answer it. And there was nothing at all about those tech investments and barely anything about the troubles at Kraft Heinz Inc., in which Berkshire owns a 26.7 percent stake. Those troubles, of course,  intensified greatly Thursday and Friday with a $15.4 billion asset writedown and a 27 percent share price drop — which Buffett couldn't be expected to address in a letter that was most likely finalized a while ago. There was a line in his forest discussion to the effect that “a few of our trees are diseased and unlikely to be around a decade from now,” but again the overall message was that Berkshire shareholders shouldn't get too worked up about the occasional investment decision that doesn't work out.

Buffett is an advocate of index funds, the low-cost investment vehicles that effectively outsource decision-making to the market. Berkshire combines a couple of the best attributes of index funds — low overhead and low turnover — with the freedom to occasionally ignore the volatile moods of what Buffett's mentor, Benjamin Graham, called “Mr. Market.” Buffett has, of course, been exceptionally astute over the decades at choosing what and when to buy and sell. But his greatest call of all may have been choosing to build his second investment vehicle (in the 1950s and 1960s, he ran what would now be called a hedge fund) in a way that preserved his independence to make those choices.

Those who manage other people's money often struggle with the skittishness of the other people. A mutual fund manager usually has to buy when the market is rising (because that's when investors move cash into mutual funds) and sell when it is falling. Hedge funds try to restrain those tendencies by closing to new investors and imposing lockups, but it's a struggle. Berkshire is far less dependent on the whims of outsiders. The cash it uses to make investments comes in the form of float from its insurance operations and retained earnings from the businesses it owns. Berkshire is thus exempt from some of the dynamics that make it so hard for professional investors to consistently beat the market.

That's the gift that Buffett and Munger will be bestowing on their successors at Berkshire. It's not a guarantee of success, and the now gargantuan size of the enterprise adds challenges that Berkshire didn't face in its early years. But I think what Buffett is arguing between the lines in this year's shareholder letter is that it's a good model for doing a bit better than an index fund, in a country where index funds will probably continue to thrive. And I wouldn't bet against that.

Disclosure: the longtime editor of Buffett's shareholder letter, Carol Loomis, was a colleague of mine at Fortune magazine.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”

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