San Francisco Financial Planner, San Francisco Financial Advisor

When you run money, you run people.  Unlike money, people make phone calls, write letters, send emails and basically toss more logs on the fire.  In the first few years of the partnership, Warren Buffet was only managing a few million dollars.  The beginning sentiment in his letters was one of a confident, yet cautious optimism.  A reading of the letters from 1963-1966 finds Warren Buffett a bit frustrated, albeit still very focused and successful.

It is refreshing to see that Mr. Buffett actually does have veins with red stuff in them.  He is not a money-making machine with total mastery of emotions at every human juncture.  At one point (and one that I appreciate more every year) he basically tells his investors, “If you don’t like the way I measure success, get out.”  Interesting that the partners question him after phenomenal year over year performances.

How Do You Keep the Music Playing?

How do you make it last?  Well, for one, pick your investors carefully.  For a stretch of about three years, the Buffett letters took a turn towards frustration.  The emotion can be felt 50 years later.  In January 1963, he acknowledges that several investors are now complaining about the long-winded nature of his writings, and how his letters are hard to follow...a year earlier they complained his letters were too short and too infrequent.

Mr. Buffett provides a bit of spice when he says, “I’d rather have 9 bored partners than 1 operating under misconception because of brevity.”  There must have been some rumblings in the camp when this letter was written because it seems rather aggressive for such a seemingly quiet man.  The next issue he covers is the absence of performance guarantees.  Many money managers find managing money for clients to be...well complicated.  This because good performance can unintentionally hint at things to come, even though “Past performance is no guarantee of future results.”

In this letter, Buffett sounds particularly unnerved, as if his prior success was causing unrealistic expectations.  He clearly articulates he cannot promise anything, but that all investments will be based on value and not popularity...and that investments will be well diversified.  Also, he clearly stated that his family will have virtually their entire net worth in the partnership, inextricably linking their destiny.

The Unruly Change the Rules

One would think the opposite would have occurred, but no matter how much he made for his investors, they became increasingly demanding.  The 1963 letter is filled with soft counterpunches to partner attitudes.

For one, he repeats himself as he attempts to explain his market approach, risk parameters, and philosophy.  He was doing this while, on a compound basis, returning close to 50% per year.  The most notable change is when he posited a slightly modified stance of how to judge his performance.  In previous letters he mentioned that looking at returns representing less than 5 years was basically irrelevant.  Here we find a new opinion; Buffett says 3 years is sufficient to judge performance.  Also, statements that the Partnership was designed to perform unrelated to the Dow Jones Industrial Average... well that changed also.  The new position was that the Dow was the ultimate judge, and their performance each year would be relative to it.  Performance based on absolute returns was dismissed.

It seems this was an attempt to bring his fold back into the general congregation of investors.  By associating with accepted benchmarks, he removed himself from autonomously living in a parallel, perfect world.  These modifiers grounded the fund and helped create context.  A wise strategy when in 5 years you turn 300k into $7 million.

“1963 Was a Good year”

This was the opening line of the January 1964 communication.  In all honesty the sentence could have been written, “Dear Partners, 1963 displayed that I am the smartest investor in the world, please appreciate me for the financial security I am supplying your third and fourth generations.”  This would have been just as, if not more accurate.  Buffett booked a total profit of $6 million or a 38% gain in the previous twelve months.  Always one to hedge enthusiasm, the letter goes on to detail that the excellence of the former year had nothing to do with profit performance, but rather the fact they did better than the Dow Jones Industrial Average.

The principal of compounding became a frequent topic in the mid-year communications.  Either we compound our money or figure out how to live longer is the sentiment.  The clear point is, your money is going to have to go ahead of you and establish your future.

Controlling How Things Generally Work Out

Even with the ability to research, make fundamental valuations, and technical observations, one is left at the mercy of market illogic.  Market forces at the hands of the general public can turn upside down excellent due diligence, and leave no clues to exactly why.

The three situations Buffett focused on were: Generals, Workouts and Control investing.  He explained that all positions held could be categorized in one of these three disciplines.  Generals were the part of his portfolio that handled undervalued securities.  General positions would closely follow the Dow.  Although there were some great profits attained via Generals, Mr. Buffett considered investing in companies with market action-based valuation as ethereal.  He made it a point to state he was not an ethereal person given to imagination.  Generals were necessary “starter” investments that held potential for more profitable situations.  “Generic” Generals that remained undistinguished were very unattractive to Mr. Buffett.

Workouts were a bit more fitting to his personality.  Workouts depended on some type of corporate action: sell-outs, mergers, reorganizations, spin-offs, etc.  This is the area that produced more steady profits year over year for the Partnership.  He had a distinct preference towards good management with identifiable, correctible inefficiencies in their business model.

The most profitable investment by far has been Controls.  This type of investing originates from the Generals category.  Controls are birthed when an undervalued or “cheap” company stays dormant long enough that opportunities to amass a controlling percentage becomes evident.  The Partnership then becomes an active or passive majority investor.  To this day, Controls are the most sought after investments for Mr. Buffett.

It’s Good to Be Wrong

After scolding his partners for their attitude, and laying out how the fund was to be judged, Mr.Buffett makes a wildly incorrect, yet fortunate statement.  While speaking about how optimistic he was for the opportunity to begin purchasing Berkshire shares he said, “Berkshire is hardly going to be as profitable as a Xerox...” the difference in market capitalization between the two companies today?  About $120 billion in favor of Berkshire Hathaway, Class A...sometimes it’s good to be wrong.

Read the original Buffett Partnership letters below, our first article entitled "Buffett Partnership Letters, Part 1"

Buffett Partnership Letter, Jan 1963

Buffett Partnership Letter, July 1963

Buffett Partnership Letter, Dec 1963

Buffett Partnership Letter, Jan 1964

Buffett Partnership Letter, July 1964

Buffett Partnership Letter, July 1965

Buffett Partnership Letter, Nov 1965

Buffett Partnership Letter, Jan 1966

Buffett Partnership Letter, July 1966