Manager Watch

This quarter we are focusing on the two managers we use to gain “value-oriented” exposure in domestic large capitalization stocks: Berkshire Hathaway and DFA US Large Cap Value (in tax-exempt or tax-deferred accounts) or DFA US Tax-Managed Marketwide Value (in taxable accounts). We generally allocate 40% of a client’s overall domestic large cap allocation to these two managers, with 10% going to Berkshire and 30% to one of the DFA choices. We place the other 60% in an index fund, an ETF, or a tax-managed separate account that tracks the S&P 500.

BERKSHIRE HATHAWAY

Investment Strategy and Process

Warren Buffett, the CEO of Berkshire Hathaway, remains arguably the most successful long-term investor who ever lived. Under his leadership, and that of his longtime partner Charlie Munger, Berkshire has consistently produced strong gains in shareholder value. In Berkshire’s annual report, Buffett displays the per share gain in book value as a rough proxy for gains in intrinsic value. From 1965 (almost 40!! years ago), when Buffett took over Berkshire, to 2003, per share book value has grown from $19 to $50,498, a rate of 22.2% compounded annually, and Barron’s reports that the stock price has appreciated 5,000 fold. Moreover, the consistency of performance has been remarkable. Over the last 39 years, Berkshire has returned less than the S&P 500 only five times. Curiously, the last two annual periods of underperformance (2003 and 1999) have coincided with our reporting on Berkshire in this Commentary. Be advised that we may not report on Berkshire again!

The graph below shows that since we first invested in Berkshire back in 1996 the shares have handily outperformed the S&P 500, 15.1% versus 8.3%.

Meanwhile, as we observed in our 3rd quarter Commentary back in 1999, Berkshire has evolved into a conglomerate with a heavy emphasis on insurance companies. A big benefit of these operations is “float”: cash that will eventually be paid out as claims to policyholders, but that is available, temporarily, to invest. The amount of float generated by Berkshire in 2003 was a staggering $44 billion, double the amount produced in 1998 before the acquisition of the large reinsurer, General Re. Better yet, the float was acquired without cost because the insurance operations collectively produced a $1.7 billion underwriting profit, meaning Berkshire was paid to hang on to the money. Buffet also pronounced that General Re, which in prior years experienced losses due to problems in its underwriting and reserving disciplines, ”is fixed.” The huge amount of float combined with a gusher of cash earnings from other businesses provides Berkshire with plenty of dry powder to pursue investment opportunities.

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