Full Transcript: Robert Hagstrom on Business-Driven Investing
Why Buffett’s Lens Still Beats Modern Portfolio Theory
Matt: You’re watching Excess Returns, the channel that makes complex investing ideas simple enough to actually use, where better questions lead to better decisions. Bogumil Baranowski is here with me. It can only mean one thing. This is 100-Year Thinkers and another extra special episode. Robert Hagstrom’s here.
We’re talking about business-driven investing, a presentation that you gave, Robert, about how investing’s drifted away from business analysis into portfolio math. Berkshire found a way to preserve the owner’s lens. First off, just tell us where you gave this presentation most recently. This is where the idea came from.
Robert: Yeah, this was... You know, I actually did this a couple years ago at Guy Spier’s ValueX at Berkshire, and the reception on it was really quite good. And this past year at the Berkshire — you know, you know, it’s a whole week of Berkshire festivities, not just the Saturday shareholder meeting. The week prior to that are lots of conferences.
And Bob Miles does a value conference, but he also was doing a kind of a tribute to Charlie Munger. And Charlie has this really great quote that I’ve used from time to time, and we riffed on that. And Charlie basically was saying, “You know, if Berkshire is so right,”, “You know, if Berkshire is so right, and it’s done such a great job over time investing money — why is it that there are not more eminent, reputationally great places, money management firms, universities and stuff like that, that aren’t teaching or applying the same methods?”
And he says, “If we’re so right, why are so many eminent places so wrong?” And I always thought that that was a very interesting question. And the more I thought about it, that’s what really motivated me to drill down into first principles. Let’s, let’s just start at the very beginning to try to figure out how we got started, and then this path that we took subsequently called Modern Portfolio Theory — why did we go down that path? How did it happen? And why has it still got its tender hooks into everybody’s thinking?
Matt: Well, let’s start with those beautiful little tender hooks there. When you look at Modern Portfolio Theory, you call it the first mistake. What’s the first mistake?
Robert: Well, listen, none of this is personal. You know, I have the highest regard for Harry Markowitz and Bill Sharpe and Eugene Fama, who I call the high priest of modern finance. I mean, these were the first disciples that came out of the gates. And, and it’s so interesting, Matt and Bogumil — if you go back in time, you know, we go back to the 1950s. Here’s this brand new young student, 18, 19 years old, who applies to the University of Chicago. It’s the only school that he ever applied to. You know, he played the violin. He loved reading. By all marks he was a great young man, and he takes a liberal arts education, decides to stick around and do his master’s in economics.
And, and basically starts to think and ponder about the relationship between risk and return, and it drives his thinking, and he wants to do his master’s thesis on the whole concept of risk and return. So, okay, I’ve got no problem with that. I have no problem with, you know, young students — undergraduate, graduate, new people coming into the field — saying, “Hey, I’ve got ideas. I wanna share those ideas with you.” But, you know, what was interesting is he had never invested in the stock market, never owned a business, and basically had a theory that it would be best if we understood the trade-off between risk and return, which was the whole basis of his paper, that kind of led to the advent of Modern Portfolio Theory.
Bogumil: Can you set the time when it was happening? Because initially that paper didn’t really get as much attention, but the market was going through a hard time. And I think people were looking for answers and maybe a direction — where do we go from here?
Robert: Well, I don’t think the publicity of investing was anywhere near, certainly not anywhere near what we are today. There was the Journal of Finance, which was about the only periodical out there that would look at academic research at that time. Now we’ve got multiples of them. There was no CNBC. There was a Barron’s, there was a Wall Street Journal and stuff like that.
But this was an academic paper that really never saw the light of day for decades. He wrote it and he finally got it published in, I guess it was ‘52, and nobody paid any attention. It got no press whatsoever. In the stock market world, in the economic world, in the finance world, nobody talked about it, nobody had anything to do with it. He went, he left the university and went to work for Rand Corporation doing Fortran programming and stuff like that. So he was out of the loop completely.
So he writes this paper, and basically — 14 pages, I think it had three citations in the whole thing. And he basically said, you know, that risk and return is something we ought to think about, and return is the expected yield of the investment. I’ve got no problem with that, whether it’s the coupon of a bond or the earnings of a stock, whatever you get out of it, that’s your return.
He says, “Well, if we use that as our return, the yield of that investment over time.” And risk, he said, though, was the variance of return. And that’s what stopped me cold in my tracks, because this was the very first time anybody had ever said anything about... Well, let me put it this way. He said that risk was the variance of return, and already Graham was saying variance of return has nothing to do with risk.
It has everything to do with margin of safety. If you buy something for less than what it’s worth, you’re acting with low risk. If you buy something above its intrinsic value, you’re operating with high risk. And then Graham goes on to say, you know, what stock prices do in the interim time is not a risky proposition to someone who doesn’t have to sell immediately in a market that has that kind of volatility. So Graham had already said, “No, that’s not what risk is.” And even in the book that he cites, John Burr Williams in The Theory of Investment Value, John Burr Williams says, you know, risk is everything to do with buying these coupons above stated intrinsic value — that’s very risky. Or if you buy them below the stated intrinsic value, you’re acting with less risk. So these two paramount people, Benjamin Graham and John Burr Williams, were saying, “No, risk is not variance of return. It is margin of safety.” But Markowitz plowed ahead. He said, “I don’t care. I’m just gonna run with this. This is my thesis, my theory.”
And he did the infamous, you know, efficient frontier line — and it was, you know, a graph line from bottom left to top right. The more risk that you take, the more return you would expect to have; or said differently, the more return that you take, the greater risk that you would have to take. That was the efficient market line.
And once again, if you think about it, Security Analysis had been written in ‘34. By 1951, we’re already in the third edition. The Intelligent Investor that Graham wrote in ‘49 was a very, very popular book. So you had all this material that basically said, “Hey, this guy Ben Graham is saying something differently.”
Now, what I took issue with was that the dissertation committee at the University of Chicago did not make him address what would’ve been the alternative theory. Today, if you walked in with a brand-new theory about how the world works, your dissertation committee would say, “All right, what are the other theories out there? What are the alternative theories, and what is the difference between your theory and the alternative theories?” Well, the dissertation committee never forced him to make that judgment. So he never mentioned Graham, he never mentioned margin of safety. He never mentioned any of that. He just solely said risk was the bounciness of a stock price.
And so, nobody cared. Nobody published on it. Nobody did anything until Sharpe showed up in the early ‘60s. He was a student out at UCLA. He was looking for a dissertation. Once again, number two is a college student, never invested in the market, never owned a business, looking for a dissertation topic. He tracks down Markowitz. And what Markowitz was doing was doing all these mathematical computations of correlations between stocks. Can you imagine without computers — I mean, it’s graph paper, right?
Matt: The paperwork here.
Robert: You know — the reams of calculations. Can you imagine going back day to day or week to week or month to month doing all these correlations for all those stocks? And Sharpe says, “Hey, what if we do something different? Why don’t we look at not the correlations of stocks to themselves back and forth — the thousands of them that you have to do all the time. What if we just say all stocks to something that has an impact on their behavior?” Was it the economy? Was it the industry settings, or was it the market as a whole? They agreed that it would be the market as a whole, so they basically could take the variance of the stock market and the variance of an individual stock and plot its relationship.
If it had the same variance of the stock market, it had a 1.0 beta factor. If it was 20% more variant than the market, its beta was 1.2. If it was .8% of the market’s volatility, it had a beta of .8. And so he said, “Hey, I just simplified your entire life.” Basically, now we can tell you exactly what is the variance of every single stock without doing hundreds of thousands of correlations between stocks. We can just say each stock to the market itself. And then Sharpe signs off by saying that which has a beta greater than 1.0 has more variance than the market, therefore it is more risky than the market. And that which has a beta less than 1.0 has less variance than the market, therefore it’s less risky.
Okay, that’s 1962. Nobody cares. Great, you got your PhD, good for you. Go and teach it in the academic halls. Well, and then Fama shows up, you know, mid-’60s and he gets some press. And Fama’s at Chicago. And he kind of gets into this efficient market theory and it’s, you know, how come people can’t beat the market? It’s because it’s rationally priced all the time. These profit maximizers get in there and reset prices and stuff like that. And so he runs with that for a while, and, and, and it gets some press, but not a whole lot. But once again, nobody cares. No — I mean, it didn’t change anybody’s life, not the inve — you know, Warren Buffett, let’s think about Warren.
When Markowitz was writing his paper, he was sitting for the spring seminar for Ben Graham at Columbia University, and Ben Graham’s saying, “Hey, you buy something for less than it’s worth, you’re gonna get a high return with low risk,” right? And, you know, of course, Markowitz saying anything with higher return has higher risk, and Graham saying it’s not. And then, you know, you get into the ‘60s and when, Bill Sharpe shows up, you know, Warren’s like in the sixth or seventh year of managing the investment partnership, the Buffett Investment Partnership. He’s killing it, you know? He’s making tons of money, concentrated low turnover investing. Never thinks about, you know, risk being variability. It’s all about buying things for less than what they’re worth.
So life goes on. It just goes on and nobody gives a damn about it. And it wasn’t until the ‘73, ‘74 bear market, which was the worst bear market since the 1929 stock market crash, and people were really, really devastated. I mean, people had pension plans and things. This was before IRAs and stuff like that. But they had pension plans. Their pension plans had gotten cut in half. They were totally, totally devastated. Things were terrible — we cut the market in half and people were bewildered.
That then set the, the, the table for somebody to step in and say, “Is there a better way to manage money?” Now remember, the ‘73, ‘74 bear market was caused by, you know, massive speculation in the Nifty Fifty stocks. I mean, this was, you know, Avon Products, IBM, Xerox, all these things were trading 50, 60, 70 times earnings, and people were buying them based upon momentum. And so speculation had run rampant, and when they pulled the rug out from underneath it, that’s when the stocks cratered.
So there we are. We’ve got all these papers written back 20 years ago. We blow up the market in ‘73, ‘74. The dust settles. You start to put back the pieces of the puzzle. We get through the late ‘70s — hyperinflation, double-digit interest rates. But, you know, the market starts to recover in 1982. We get to the peak of interest rates and inflation, and we start to, start to get a new bull market. And investors are coming back to the stock market, as they always do after some time, and they say, “Well, okay, what are we gonna do? How are we gonna do it?”
And, you know, these professors kind of raised their hand and said, “Hey, you know, I kinda wrote this paper a long time ago,” and it talked about, you know, you gotta have broad diversification and non-correlative strategies, and you want things that are less bouncy than the market. And we’re gonna work on performance presentation standards. We’re gonna measure your performance on a short-term basis. We’re never gonna let this stuff get out of control, so you know exactly what’s going on.
And, you know, they basically did risk tolerance questionnaires and stuff like that. It all had to do with bounciness. And they said, “How does that sound?” So then they said, “Well, wait a minute. So you’re gonna check the performance more often, and you’re gonna basically make it so my portfolio doesn’t bounce around a lot, and you’re gonna give me a nice smooth ride. None of this ‘73, ‘74 nonsense. I’ll vote for that.” And they voted for that and, and there came the tsunami. And there came the tsunami. We created Leviathan in the early 1980s, and it scaled, and everybody adopted it. And it became what is called standard investment portfolio management, which is at its root the beginning of Modern Portfolio Theory.
Matt: Take me... So it becomes a standard, and I love, love, love the history on this because we actually see the direction from academia — from thinking less like a business owner, which is something you care very, very much about — into the way that this gets institutionalized because it’s safe.
Robert: Yeah.
Matt: Spend another minute on this. So now that MPT is institutionalized, it’s brought into the system.
Robert: Yep.
Matt: And we create this, we create SPIVA, basically.
Robert: Yeah. Yeah.
Matt: And it doesn’t exactly show... All the academic research doesn’t say like, “This is the right way to do things,” or, “These are — no — stellar results.” And we... it’s like we didn’t invent a perpetual motion machine.
Robert: No.
Matt: We actually found out — all the flaws are here in the
Robert: math itself. Yeah. I love the way that you frame this, Matt. Even, you know, when Modern Portfolio Theory takes off, there really wasn’t that, you know... We can, there were, you know, the Peter Lynches were starting to come around and stuff like that, but you weren’t writing papers on the brilliance of modern portfolio theory to generate outstanding investment performance. There weren’t these great books going, “If you wanna beat the market, if you wanna outperform the market, if you wanna have, you know, top 10% performance, this is what you should do. You should own 100 stocks, all of them being non-correlative. Own every sector. Have high turnover so you keep your correlations, and we’ll do short-term performance.”
No papers — they weren’t writing papers saying that because that’s not what was happening. You weren’t getting really outsized investment results from following the dictates of Modern Portfolio Theory. It was just left to continue to motor through as it had been. But nobody was writing papers saying this was the second coming. These guys solved the big puzzle of how to manage money, and based upon their theories, all these people are generating outstanding investment results better than the market. Nothing was being written like that. Nothing.
Now, the problem that we ran into, and this is where you move into Kuhnian philosophy, Thomas Kuhn’s theories of scientific revolutions. Basically, you, you, you built up an industry. I mean, there was a, this massive industry that was built upon the concepts of Modern Portfolio Theory. On top of that, there were academicians that were getting their PhDs in Modern Portfolio Theory, and so this was the dominant model, right? This is the dominant model.
So you got Buffett over here doing his thing. You got Charlie Munger doing his thing. We got John Maynard Keynes. We could go back to Chess Fund, who was the very first concentrated low turnover portfolio manager. You had guys like Lou Simpson. So, you know, there were people that were basically doing the antithesis of Modern Portfolio Theory and generating outstanding investment results.
So here they were, right? Now, they weren’t writing papers either, except Warren was writing annual reports and talking about it, you know, from his perspective at Berkshire. But here were these guys that were killing it. Now, the problem is their behavior of their portfolios was everything that Modern Portfolio Theory was supposed to solve or was trying to solve, which is, “I don’t like volatility. I don’t like prices going up and down.” We’re solving for that. And if you looked at everybody except Warren back in the early days, their standard deviation was twice the market. Their drawdowns were significant, which we’re trying to avoid. That was ‘73, ‘74 — let’s not have drawdowns. So all these people were generating outsized returns, but they were violating the precepts of Modern Portfolio Theory, which says you don’t want a bumpy ride, you don’t want big drawdowns, and that’s really bad because that can be very harmful to your financial worth, much less your psychological and emotional well-being.
So don’t do any of that. And these guys over here are doing something different, but you don’t wanna do that because that’s very, very dangerous and not gonna be good for you. So you had these two camps, right? And then as Charlie says, you know, when, you know, this is Kuhn’s paradigms in collision. You know, you had Modern Portfolio Theory here — and you had, you know, these, these intrinsic value, concentrated value investors doing this, and they’re starting to come into collision. They’re basically, there’s two ways to manage money and they’re coming into collision.
And if you go back to Thomas Kuhn’s theories of scientific revolutions, he said, you know, you would think that this would all be solved, you know, respectfully. You know, someone would say, “I see how your theory is better than my theory,” or “I see how your theory beats the market and mine doesn’t.” But nothing was farther from the truth back then. So what do you do if you had invested all of your time, net worth, and intellectual capital into Modern Portfolio Theory? You basically try to destroy the competing paradigm. You basically say, “I don’t care that they’re beating the market, they’re doing it all the wrong way.”
So you had these two paradigms in collision like that. So imagine this, Matt and Bogumil. I’ve got a, you know, $20 billion business run on Modern Portfolio Theory. My performance is spotty. You know, I win some, I lose some. But, you know, overall it’s not that great. But I’m making a lot of money managing this money, and I’ve, you know, I’ve built up a lot of net worth, and I’ve got a lot of employees, and I’ve got all these clients and these portfolio strategies and stuff by the Modern Port — am I gonna just one day say, “All that stuff that I’ve basically been selling you for the last 10 to 20 years — that’s a bunch of bunk. Okay, we’re not gonna do that anymore. We’re gonna go over here and do what Warren and Charlie do, which is concentrated business-driven investing, because that gives you higher returns.” There’s no chance they’re gonna do that, right? Because you would give up your business. You’d give up your paychecks, you’d give up your employees, you’d give up your clients.
So they basically were in a war, have been in a war for the last, jeez, what now, 50 years, arguing about it, going back and forth. But the results, as you mentioned, Matt, are, are, you know, undeniable. The SPIVA record basically says anybody that follows Modern Portfolio Theory, you know, overwhelmingly underperforms the market one year, three year, five year, seven year, 10 year, since inception. And when you look at the data, you go, “Well, that doesn’t appear to be a very good way in which to manage money,” but it’s still perpetuated to this day.
Bogumil: The point that you’re making, and I think it’s really profound, is that if you choose to manage money in the Buffett way, just to simplify it — yeah — it’s a huge business and career risk because you will have volatility, you will have a tracking error. And to maintain any asset base when somebody else is trying to hug the index, it becomes even more difficult had we not written those papers you talked about, had we not had this theory at all.
Which takes me back all the way to what investing was about — owning businesses. And we talked, on this show before how these happen to be businesses that are listed on the stock exchange and have a price tag. But let’s not flip the two. It’s a business that has a price tag that moves every day. So what’s it like to be a business-owner-like investor and pick stocks?
Robert: It, it, you know, it took a while because, you know, I, I, you know, I got my CFA, and I kind of was on two tracks at the same time, but eventually came to the Warren Buffett methodology and, and basically embraced it enthusiastically and wrote “The Warren Buffett Way.”
But you basically have to... I think it’s almost you have to — not only emotionally just, separate yourself from the market. Intellectually you have to separate... I loved, I loved, you know, just to take a sidebar, I love this analogy that Warren gave a couple years ago — not this past year but two years ago — about the cathedral and the casino. Do you remember that? Just brilliant. So good.
All right, so the business-driven investor, Warren says, you know, we stay in the cathedral. We’re studying businesses. We look at the annual reports and the financial statements, and we think about how companies are run and the management. Everything as if there was no Modern Portfolio Theory ever invented. We’re just only interested in the businesses that we own. But because, you know, to make a transaction to become an owner of that business, we’ve got to step across the street and go into the casino. And the casino — is the stock exchange, right? Whether New York, NASDAQ, whatever you wanna say. You gotta go in there and make a transaction. I’m going to buy shares in the business. You go across the street, you walk into the casino, you give them your money, you get shares for the business.
Now, what was great about Warren and Charlie and all the rest of the great fraternity is that they went into the casino and they immediately went back to the cathedral. And they stayed in the cathedral, right? And they studied businesses and they studied management and stuff like that. But 99.9% of the people stayed in the casino. And they basically lived out the majority of their hours investing in a casino. So they ended up buying and selling, buying and selling, buying and selling, and the whistles are going off, and the bells are ringing, and the champagne is flowing.
You really have to psychological and emotionally tell yourself, “That’s a casino on the screen that I’m looking at. That’s a casino. And not everybody’s playing the same game that I’m playing. I’m a business owner. I, you know, I have certain things that I look at and... But there are a lot of other things that people look at, at a casino, and they make buys and sells based upon a lot of other things that don’t make sense to intrinsic value, but that’s the way they play their game.”
You really just have to, to, to emotionally and intellectually detach yourself from the casino. And once you do that, life gets much, much better. Much, much better. Until, and I think, you know, Bogumil, you guys were both saying it, until you get clients involved. I’m a portfolio manager. I’m running my money, but I wanna run money for other people, too, and build a business. And so that’s when you bring in the clients. And the clients are not yet quite strong emotionally, intellectually, or psychologically to putting up the blinders on the casino as we are or as we had become. And so you’re doing a lot of hand-holding. A lot of hand-holding on, “I know the price is down, but the intrinsic value is not that compromised. We’re in a volatile situation, but our business is just fine.” It takes them a while to get that figured out.
Matt: You know, there’s a lot of value in that separation of church and state. Those charitable contributions. I mean, I saw season two of The Wire, I know what happens.
Robert: Yeah. Get, get... Go ahead. No, I, I was gonna tell you my Bill Ruane story. When, right after I wrote “The Warren Buffett Way,” it was at the annual meeting, and this was the days that the annual meetings were on Mondays, right? Both in the old days, they were on Mondays, and it was gonna be at the Holiday Inn Convention Center.
It was right after the book came out. On Saturdays, they’d have a baseball game, and Warren would dress up. The farm team was the Omaha Royals, after the Kansas City Royals. He would dress up in a baseball uniform. He’d go out on the pitcher’s mound, he’d throw the first pitch. And all the shareholders are screaming and yelling and it’s a real great time.
And I’m sitting on the first baseline, there’s a fence there, a metal fence, and eating some popcorn, and up next to me walks Bill Ruane. Now, Bill Ruane was a classmate of Warren Buffett, and he was also the guy who was the recipient, along with Rick Knuth, to take on some of the Buffett partnership money when Warren shut the partnership and put it all into Berkshire Hathaway. Some of the people went into what was then launched as the Sequoia Fund, which was the repository for some of the Buffett partnership money.
And I recognized him. He didn’t know me from Adam, and I said, “Mr. Ruane,” I said, “It’s such an honor to meet you. Congratulations on all your success, and Sequoia Fund is just quite amazing.” I said, “I’m Robert Hagstrom.” And he goes, “Oh, Robert, that’s so nice. Oh, well, congratulations on your book.” And I said, “Oh, that’s, you know, I really appreciate it.” And he goes, “Well, what are you up to?” And I said, “Well, I’m trying to manage money like Warren taught us to do.” And he goes, “Oh, good. All right, so you’re gonna put together a fund or portfolio?” And I said, “You know, something like that. I don’t know.” But he goes, “Listen, can I give you some advice?” I said, “Absolutely, Mr. Ruane. Absolutely.” He goes, “Well, you’re not gonna take my advice.” I said, “Well, wait a minute.” I said, “Mr. Ruane, I assure you, any advice that you give me, I will take it very seriously and I will incorporate.” He goes, “No, you won’t.” I said, “No, yes, I will.” And he goes, “No, you...” I said, “Just tell me, what is your advice?”
He says, “Well, you know, you’ve got this book and you’re a disciple of Buffett and, you know, great for you. And, and you’re gonna get some people that wanna manage money, you know, like Warren, and they’re gonna be very hyped up about that, but there are gonna be a lot that are gonna really be a problem for you, and they’re gonna be yelling and arguing about why don’t you own this and why did you buy that and that.”
And he goes, “I want you to fire all of them. Just fire them.” And I said, “Okay, Mr. Ruane, I’ll fire everyone.” He goes, “No, you won’t.” I said, “You’re a young man. You’re starting out in business. You know, you’re trying to build a practice. You’ve got a family, you’ve got kids, you’ve got a mortgage, you’ve got education.” He goes, “You’re not gonna fire them. You’re gonna try to convert them.” And I said, “Well, maybe I’ll try to...” He goes, “Don’t waste your time. It’s just too hard. Either they get it or they don’t get it. And the people that don’t get it, you’re gonna spend 90% of your time exhausting yourself trying to convert them.”
Mm. But some people just don’t get it. And I think that is largely true, but it’s also a defeatist mentality, and I hate defeat. And so I still feel that, you know, I, I wanna, I, I wanna go out and try to save some souls. If I can save one or two souls, then maybe I can get into heaven, you know?
Matt: Well, here’s to trying to get into heaven. At least trying.
Robert: Yeah. At least trying to get in there.
Matt: I wanna talk about these two courses. How do you think about a business? How do you think about the price of that business, the stock price? And I think this is just a fundamental piece that the academics took in another direction and almost forgot.
Robert: Yeah, absolutely. Well, you know, Buffett said, you know, he says, “I’m not a, I’m not a market analyst.” And you know, he doesn’t judge markets. He goes, “I’m not a macroeconomic analyst.” And he goes, “I’m not even a security analyst in how that term is defined today.” And when you think about the security analyst as defined under whether you’re a chartered financial analyst or you follow Modern Portfolio Theory, you’re coming up with all of these mathematical factors like beta, correlation, standard deviation, drawdown, information ratio.
Matt: That sounds very fancy, sir.
Robert: I know. I’m very,
Matt: I’m already
Robert: impressed — just to highlight. I, I, you know, and people are mesmerized by this, you know, and stuff like... And, and Warren goes, “Man, I don’t understand any of that. It doesn’t make any sense to me. I don’t pay any attention to it.”
So he says, “I’m a business analyst,” right? “That’s who I am.” So just imagine that there’s no Modern Portfolio Theory. There’s no beta. There’s no information ratios. There’s no, none of this stuff that causes you to put portfolios together in such a way. There’s none of that. So if you had none of that, what are you left with?
And put it this way — if it was before Modern Portfolio Theory, what would you have had to rely on other than speculation to make a decision about your portfolio? It would’ve been the same thing as a business owner. Ask a business owner what the most important thing is for them in operating the business. The first thing that comes out of their mouth is, “How much cash do I get? How much cash is my business generating?” That’s all they worry about. You know — I’m running a business, what, how much money is in the cash register, right? Because they have bills. They’ve gotta pay their mortgage. They’ve gotta fund their retirement. They’ve got expenses. So the first thing they say is, “What is my cash?” And I go, “Well, that’s what we look at — owner’s earnings. How much cash?” You start with GAAP accounting, you subtract the non-cash charges, but you gotta add back the capital expenditures, which GAAP does not do, and so we get to owner’s earnings yield.
So that’s my first measuring stick. And then someone might say, if they’re really thoughtful, “Well, I borrowed money from the bank to start this business, and the bank’s charging me 8% on my loan, so I better at least generate an 8% return on my investment, because if I don’t, I don’t have enough money to pay back the bank.”
Matt: Mm-hmm.
Robert: So they already know they better generate a pretty good return on their investment — they’re talking about earning a return above the cost of capital. So two things jump out at you. I gotta have cash, and I gotta earn above the cost of capital. And those are the things that business owners focus on. They don’t focus on correlations and betas and information ratios and all that other stuff. A business owner wouldn’t think about that, so why would I?
And so when you take on the business owner’s robes and you put them on, that’s what you’re looking at. That’s all you’re thinking about. It’s backward induction. You know, this is what the cash is. This is what the cash is. This is return on invested capital. John Burr Williams taught me how to do a dividend discount model. This is what I think this business is worth. I will buy the business for what it’s worth, or try to get it even for less than what it’s worth. That’s how I spend my whole day. That’s it.
Now, compare that to everybody else that’s doing Modern Portfolio Theory, and it’s just — it’s Greek. It’s Chinese. I don’t know what it is, but it’s not what a business owner does.
Bogumil: Robert, I manage money for families — long-term patient capital. And a lot of them had a business, sold a business, or have a story of a business that was sold in the family. They think the simplest way, like Buffett. They wanna have a handful of businesses. They wanna hold them for a long period of time. They wanna be in industries they understand. Sometimes it’s something close to what they knew. They have low-turnover, concentrated portfolios. They have no idea how the index is doing. Most of the time, they don’t know what’s in the index. Is that how you build a portfolio?
Robert: Yeah, I mean, you do think about diversification. I mean, you know, you, you don’t — you wouldn’t want... You know, if you liked energy, you know, you wouldn’t — and you own 20 companies, you wouldn’t want all 20 of them to be gasoline stations. I mean, you’d have to have some level of diversification. You might have two or three or four. But yeah, I mean, in my mind, I’m just trying to put together these businesses, and I have some level of understanding of diversification, but not how it relates to the market or the S&P and stuff like that.
So, you know, when you were talking, Bogumil, it was saying to me, you know, I would love to have — you know, your clients as, as, as my clients, because I will tell you 100%, the best clients that I’ve ever had in my 30 years, 40 years of doing this now, have always been business owners.
Bogumil: Yes.
Robert: Always. Because they — we talk the same language, right? Yeah. We’re — You know, I’m saying... And they say, “Well, how do you think about stocks?” And I go, “Well, you know, how much cash? How do you think about your business? How much cash,” right? You know, we, we just, we, we — we, we’re like soul brothers immediately. We, we connect, right? And so I always say to my client events and when I’m doing meetings, I say, “You know, my, my very best, best clients have always been business owners.” And I might do a client event, And I might do a client event with 100 people in the room, and I say, “Just a show of hands — how many of you either currently own or had owned a business in the past?”
Bogumil: Mm-hmm.
Robert: And out of 100 people, maybe 15 or 20 raise their hand. And I go, “Congratulations. That’s just terrific.” And then I said, “Okay, for everybody else in the room — how many of you own common stocks, either in a separately managed account, individual stocks, or a mutual fund? How many of you own common stocks?”
All the hands in the room go up. Which then begs me to ask, “What is it you think you own?”
Bogumil: Mm-hmm.
Robert: And the room goes quiet. So — basically, the disconnect I feel, Matt, in Bogumil, is that people own stocks, but they don’t perceive them as businesses. They don’t make that instantaneous connection.
Bogumil: No.
Robert: And because they don’t make that instantaneous connection, that’s where the challenge begins. That’s where the problems begin. That’s where the casinos move in and stuff like that. But to what degree people equate a common stock to a business or think about common stocks in a business way, life for me gets much, much easier. But a lot of people don’t think about common stocks as individual businesses. They just don’t.
Matt: I wanna talk, and this is on the portfolio side — very sympathetic to Bogumil’s view, my own experience with this as well. The concept of once you have the portfolio, once you’ve told yourself, “I’m going to think of these as businesses I own” — this idea of look-through earnings. This idea of actually thinking about the economic returns as they’re accruing in your portfolio. And it ties back to our very good friend and normal co-conspirator in these, Chris Mayer, and the way he thinks about it.
Talk to us about look-through earnings.
Robert: Well, so when I run my portfolio, the Global Leaders Portfolio, it’s a mini Berkshire. I tell people, what, do you wanna run your own Berkshire Hathaway, right? So, you know, Berkshire Hathaway is both public common stocks and private businesses, but Warren looks at them at the same, both the private businesses and public common stocks have earnings or what he calls owning, owner earnings yields. Both the private businesses and public common stocks have earnings, or what he calls owner earnings yields.
Buffett basically thinks about it in aggregate, and he’s trying to move that aggregation of owner earnings yields — whether it be private businesses or public businesses — and get them to move forward. So in my portfolio, every month we’re running what our weighted average operating cash flow yield is, which is owner earnings. We’re at 4.4, 4.5% operating cash flow yield for my little mini Berkshire Hathaway. My return on invested capital on a weighted average sales basis is about 32%. So our companies earn very high rates of return on invested capital. I like that a lot. When I’m earning high returns on invested capital, particularly in excess of capital expenditures, I can put the money back into the business, which creates that compounding effect.
We understand sales growth. We have an idea of what our forward sales growth is, and then we have an idea of what our intrinsic discount to intrinsic value is. So I can take my 21 stocks and make it a mini Berkshire Hathaway by simply just following the economic variables that are most important to the long-term growth of a stock price, which is the long-term growth of its economic variables.
So we know owner earnings yields, we know return on invested capital, we know sales growth, and we have an idea of what our intrinsic value discounts are, and that’s all I think about. When I put a stock into the portfolio, unless it’s a really good diversifier, Charlie Munger said to us a long time ago, “Is it better than what you currently own?” It’s an interesting idea. If my benchmark is 4.5% operating cash flow yield, 32% return on invested capital, 17% forward sales growth, and I’ve got a discount to intrinsic value — why would I put something into my Berkshire Hathaway that has economic attributes less than that?
Bogumil: No good reason.
Robert: No good reason. Why? No good reason, right? You’re — if I’m lowering, I’m lowering my economic benchmark, right? I’m lowering my economic benchmark, therefore I’m lowering my future economic rate of returns. So basically, what we’re trying to do is not only keep our economic benchmarks high — when we add something to the portfolio, the idea is that we’re increasing the economic returns of our Berkshire Hathaway. Why else would I do that? I’m not gonna put a stock in there because it doesn’t correlate to everything else I own, or because I think there’s a short-term opportunity in the Middle East because of energy this or fertilizer that. I’m saying, “What are the economics of these businesses, and is it better than what I own?”
If it’s better than what I own, I’m very interested in adding it to the portfolio if I can buy it at a discount to intrinsic value. So everything, everything is seen through, first, the economics of the business. So everything is seen through, first, the economics of the business that we own, then we look at how it fits into the portfolio. That’s it.
And even Bill Ruane said, “My business card says ‘research analyst.’” Everybody wants to be a portfolio manager. At Ruane Cunniff, at Sequoia Fund, the four-star admirals, five-star generals are research analysts. That’s all we wanna be. We just wanna figure out businesses, and that’s what we try to do here.
Bogumil: It’s very thoughtful, very deliberate in the way you say it. There shouldn’t be any other way to do it.
Robert, I wanna ask you about this idea of outperformance versus making money, and I wanna highlight that because at some point we invented an index, then we were able to invest in an index, and now there’s so much money passively invested. So you could participate in the success of those businesses, do really no work, and do it at a low cost. So in my mind, the families I mentioned — their goal is to continue to make money with their money. Their goal is not to outperform the benchmark. If they do, that’s great, but the benchmark itself, even in my professional lifetime — some 20-some years — has changed so much. It’s a very different index than I started with. Can you talk about the difference? Are we trying to outperform the market? Are we trying to make money? Can we do both?
Robert: Well, well, good point. I mean, I think in family offices — and you would educate me, Bogumil — I don’t have that many people that have sold their businesses. There has to be something in which to measure your progress. And you, you know, as the client says, “Look, I think it’s important for you to know whether we’re making positive progress.”
Bogumil: Yeah.
Robert: It, you know, somehow or another, how would we judge that? Or, you know, some people would say —
Bogumil: Yeah.
Robert: Grow capital at above the inflation rate after tax, you know? That’s a bogey. Okay, that’s fine. Other people might say this, that, and another. Other people might...
Even Warren back then, his benchmark was the Dow Jones Industrial Average, right? Yeah. So he even said, “Look, the Dow Jones is my benchmark, therefore that’s my bogey. That’s what I’m gonna try to do.” There has to be something that you can measure yourself against that would, give information to the client who is hiring you, paying you money, that you are in fact achieving their goals or the goals in which you have, have all decided upon, collectively decided upon.
So there has to be a benchmark. Now, how you treat that benchmark and how frequently you look at it and how frequently you test yourself against it — that may get into that gray area, Bogumil. Are we making money here? Are we trying to grow the intrinsic value of our investments over time? But somehow or another, we’ve got to measure against something.
I do think there’s a lot of discussion — and we could have a separate episode on the structure of markets one day. Just how significantly the structure of markets has changed, not only in indices. There are more ETFs today than there are common stocks. The options market, I mean, I... It just blows me away that today the notional value of options today traded on a daily basis is greater than the entire market capitalization of US stocks. How can that be? How can you basically have options that are trading every single day, every single day, the notional value of which is greater than the market value of what you’re trading against or trading with?
So we’ve created — the casino’s gotten really big. The casino’s put on several decks. It’s got a couple more stories. You know, it’s getting bigger and bigger and bigger, and the cathedral is just the cathedral, right? It’s just, it’s always the same. But the casino’s gotten really big, and so those lines blur, Bogumil, they blur. And, and it’s very hard for people, I think, to distinguish between making money in the short run — yeah — and growing your intrinsic value at a, at a good rate, however you describe that, over the long term. And, and those two parts are different for a lot of people’s mentality. They wanna be making money. Most people wanna be making money in the short run. “I wanna be making money now. You can talk to me until you’re blue in the face about intrinsic value and owner’s earnings yields, but if I am not seeing that I’m making money” — that’s a problem for a lot of people.
Bogumil: It could be a whole episode on its own, but just to sharpen the image here for a second — I like that question. I asked it before, and I think you and I spoke about it before. If the benchmarks were never invented — Dow Jones never invented, we never thought of organizing a group of 30 stocks with some strange rule to weigh them or all the other ones that followed. By the way, they say market cap weighted, but they’re all adjusted. They’re not really true market. We know that. Never happened. Never invented. Would you manage your money the way you manage it now, or would you be absolutely lost because you don’t have a benchmark?
Robert: No, I would manage money the way I’m doing now.
Bogumil: So you don’t need the benchmark. You don’t need the benchmark to do a good job, right?
Robert: Yeah. I would, I would think the benchmark probably does more harm than good, you know?
Bogumil: Than, than be a guide. Because you start watching... Yeah, you start watching — with one eye — what is the benchmark doing, right? And then you realize, oh my God, there’s, you know, 30% in five stocks. I have none of them. Am I okay? Right? Yeah. Right. And then you start looking —
Robert: I absolutely do not disagree with you.
If there was no stock market, and there were no public prices, and you owned businesses, how would you be able to judge your progress? And I guess it is, I made more money this year than I did last year. There you go. Right?
Matt: Yeah.
Robert: Yeah. That, that, you know, and that, that’d be 101. I have more owner’s earnings yield this year than I did last year, or my returns on my invested capital are higher this year than they were last year. That would be progress. We spend a lot of time on return on incremental capital. I mean, you know, which is — I think it’s the canary in the coal mine in trying to figure out — I wish Chris was on here, he’d correct me. But, you know, I think return on incremental capital is the canary in the coal mine to tell you whether you still have a compounder left in this business — or you’re, you know, you’re in the final innings of it. And so, you know, there... Once again, we’re looking at the economic, we’re looking at economic data.
And lo and behold, you know, you have to, I guess if we would have a saving grace — that no matter how big the casino is getting, the weighing machine still seems to work.
Matt: Mm-hmm.
Robert: It does — it works erratically. It has fits and starts. It sometimes looks like it doesn’t work. But the weighing machine does work over time. It seems to get it right over time, which is a miracle, you know, in my mind when you think about all the noise in the system. And this goes back to the wisdom of crowds and all that. But, you know, the economics does — at the end of the day, economics will carry the day. Now, whether that day is 24 hours or, you know, 24 months, in the end, economics carries the day.
Bogumil: There are many qualities that are unique about Buffett, but to me, one of them is that he owns publicly traded companies that we all follow and know, and he owns a lot more privately held businesses — some of them entirely. And there’s no price tag on these. He has not asked for an appraisal, as far as I know, of any of those in a long time or ever.
Robert: And I’ve always said that I thought the essence of Buffett’s success was the fact that he owned both at the same time.
Bogumil: Yeah.
Robert: And that was the trick, right? So even if you go back to the partnership years, and, we looked at that and stuff like that. He owned, you know, Dexter Hill Manufacturing, he had these stupid, department stores and stuff like that. But he owned them both at the same time in the same portfolio. Can you imagine the 1950s and ‘60s? He had private companies, he had public companies. Yeah. And he didn’t treat them differently. He treated them both the same, and that carried on.
So that experience that he had, that education that he had, that way of managing money that he had, was so deeply ingrained in its earliest years. When he was in his 20s, he believed in that. That’s the way he managed money in his 20s. So when this crap showed up, you know, 30 years later, you know, he was like, “No, I’ve been doing this for 20 years. Makes perfect sense to me. I’m making billions doing this. Why should I do this over here?”
Bogumil: Mm-hmm.
Robert: And of course, you know, everybody else went over to the Modern Portfolio Theory side because it was gonna give you an emotionally satisfying, you know, easy... You know, Modern portfolio can’t beat the market because it doesn’t have the paramount objective of making money. It has the paramount objective of giving you an emotionally comfortable ride. If your paramount objective is an emotionally comfortable ride, you’re never gonna beat the market. That just doesn’t happen that way.
Matt: Nor will you necessarily be emotionally comfortable, but —
Robert: That’s true.
Matt: I want you to think from the perspective of — straw man this however you like — somebody’s watching this, they’ve operated this way. They drank the Markowitz Kool-Aid. They got a little Fama under their nose there. They’ve operated this way, they’ve thought this way. But they’re listening to you talk through this and they’re going, “You know, I’ve felt this way.” Or maybe it’s a 35-year-old who just got their CFA and they’re working somewhere and they’re going, “I don’t know if I believe this the way I do.” What would the first baby step be to embracing this, understanding this new path you’re embarking on if you go there? What does that first step look like?
Robert: Well, I think it, it’s a great question, Matt. I think it, it, we’ll take it on two levels. One is if you’re an individual investor and you just can’t give up your, your broadly diversified portfolios because it’s gonna give you that smooth ride, I tell people take, take 5 cents, take 10 cents, take 20 cents on the dollar and go manage it the Buffett way, right? Just put it over there, and you can keep the other 80 cents here in the Modern Portfolio Theory world, and that’s your warm, fuzzy blanket that helps you sleep at night. That’s fine. Just promise me you’ll take 5, 10, 20 cents on the dollar and let’s go do Buffett. But manage it according to the Buffett principles. Don’t conflict them, don’t get them all messed up. And that’s one way to do it at the individual level.
If you’re in the money management business, that’s a little bit harder. If you’re running a money management business with broadly diversified, high-turnover, non-correlative strategies, it’s very hard to do a one-off. You could try. Most people just run and start hedge funds and try to do it under the secrecy of hedge funds so they don’t have to report.
Matt: Mm.
Robert: You know, that’s one of the great things. You don’t necessarily have to report, you know, daily, weekly, monthly, and that’s why private equity has taken off so well, although that’s a subject for another day as well. But private equity... But if you look at it, private equity is basically doing the Warren Buffett way without having to deal with prices. Yeah. Their problem is they don’t have very good businesses to work with. I mean, if you think about the public markets, these are really outstandingly great economic-returning businesses. I mean, I just told you what our economics were. The problem is most of the best performing economic attributes are in the public markets, if not soon to be in the private market. So I don’t know where I get off on that, but it’s harder to do that in a money management business where everybody’s doing it the same way, rowing in the same direction.
I’m not recommending anybody leave their job to go start square one doing Buffett way with no money. But if you’re an individual investor, peel off some money and let somebody doing — that’s doing concentrated load turnover business-driven investing, give them a chance and say, “Hey, you know, let’s see what you’re doing and, you know, I’ll check with you at six months from now, a year from now, and we’ll keep going.”
If you’re already in a money management business and they’re not doing that, then you’ve gotta have a coming to Jesus moment and figure out what you wanna do.
Matt: I’m picturing this — come to the dark side, Luke, and launder volatility. Somebody’s gonna get that message. And somebody else is gonna get this message of like, “Okay, 20 cents on the dollar sounds like a pretty achievable outcome.”
Robert: Yeah. Absolutely. 100%.
Matt: Bogumil, stick around with me for just a minute, but Robert — I wanna thank you for walking us through this presentation. We wanted to dedicate this chat just to this because it was so cool. People wanna find you on the internet — does a public version of the actual presentation exist anywhere?
Robert: No, it doesn’t. But we can talk about that. Maybe we’ll figure out a way to get that to you guys.
Matt: Let’s see if we can make that happen. And —
Robert: You have a copy of it, yeah.
Matt: Yeah. We have a copy of it. Maybe we can make something happen. Check the Excess Returns Substack — we’re gonna talk about this behind the scenes. But it’s an incredibly useful, insightful tour de force through the history of this, why it matters. Man, it impacted me in just the way I think about work, so we’d love to share it.
Robert, people wanna find you on the internet — where should we send them?
Robert: EquityCompass, all one word, equitycompass.com. And underneath there is the Global Leaders Portfolio, and there is my portfolio. You can look at it, and my commentaries and things of that nature. That’s, and then you can go to Amazon and, and pick up the Warren Buffett Way books. And we did the Warren Buffett Portfolio, which was Charlie Munger’s favorite book, and we just released the 25th anniversary on that. So it’s out there. It’s out there.
Matt: It’s all out there. Bogumil, stick around with me. Robert, thanks so much for joining us.
Bogumil: Thank you so much, Robert. Take care. So good to see you.
Robert: Take care. Thanks again.
Bogumil: I love the topic, and I got to hear it when Robert presented at Guy Spier’s ValueX — I think two years ago.
Matt: I was gonna ask if you were in that room.
Bogumil: I did. I did. And I saved some of the questions that we included in the previous episodes, but I’m so grateful we got to do a full episode just on this, because Robert has so much to say. And then if you include the benchmarks and private equity, which we touched on, it would be yet another episode to follow up on.
But I think the audience will have an idea. For me, it’s this realization that we grow up in investing with a certain theory that’s there, and it just comes to you from all directions when you’re getting your education or your certificates, and you take it as the truth, and you don’t even have a chance to ask, “Where did it come from? Was it always there? And how did people invest before this was even known?” And I think he gave us this chance today to realize it wasn’t always there. It wasn’t in the Bible. It’s not God-given. It was written, forgotten, unhelpful, until it was reclaimed, repurposed, reused, and took over the minds for the following 50 years.
Robert: I’m right there with you.
Matt: You know what I was thinking — funny enough? And I know I’ve thought of this before, and I’ve regularly likened most investment philosophies to religions.
Bogumil: Yep.
Matt: It’s like, yeah, you can love Buffett or you can hate Buffett. And those are both valid religions in my mind. There’s some things that rhyme. It’s like morality — this rhymes across many things, but doesn’t. So in the Old Testament when they’re talking about measurements — I forget if it’s in Numbers or which book it is — they talk about the cubit. Do you remember the cubit? Did you go to enough Sunday school to learn about cubits?
Bogumil: It’s all fading away, but remind me.
Matt: The cubit is just a unit of measurement. And basically the idea was it was like — I think it was elbow to your wrist or your wrist bone or something.
Bogumil: Yeah, yeah, yeah.
Matt: It’s one of those things. Well, how do you build a house? Well, you want this many cubits by this many cubits. Everybody’s forearm’s different. The obvious flaw is you’re gonna get a bunch of variation depending on the guy doing it. And heaven forbid two of us are working on the same project.
Bogumil: That’s crazy.
Matt: Because then we’re gonna get a... The arbitrary nature of the rulers that we use and that we impose — if we don’t step back and say what’s common, what’s not, what is this actually used for, what’s not — it’s really easy to get caught up in a belief and forget that that belief is probably founded on some ideas, and we actually should spend more time deconstructing those ideas, because the nuance is actually useful here. It’s a better human experience if we see the nuance for what it is.
Bogumil: I like what you’re saying, and I’m thinking how the profession has created layers between the actual individual and their money and the end investments. It can be in one product that’s layered in another product. It can have allocators in between. It can be a fund of funds. And obviously we have derivatives and other things that we invented since. So there can be many, many layers between the actual individual that saved money over their lifetime, or sold a business that it took two generations to build, and the actual investments they’re holding.
And And I think the theory and, what we talked about today had a chance to, to slip in once that gap was created and became so big that you don’t really know whose money is being managed. You don’t really know what the money is in. It’s a nameless group of 500 stocks that we don’t really know. Some people would be surprised with some of the stocks that are in the S&P 500.
Matt: And they are. They’re like, “I didn’t think I wanted to own that, and here I do.” Or —
Bogumil: That’s still around, people say?
Matt: Or I heard about this company on a podcast. I wish I owned some. It’s like, well, you do if you own the S&P 500 or something.
Bogumil: My, my professional goal has been to create this immediate — almost, you know, I can reach my hand and know the client. I know the people I work for, and I know the investments that are in the portfolio. I know the businesses. In many cases, I know people who are running them. I got to meet them at some point. I know who they are. And I like this idea of directness. I think it brings with it a certain sense of responsibility, and you can have a higher conviction if you know what you own. You can understand better what the client wants.
Once you create this anonymous pool of money that’s invested in an anonymous pool of stocks that are listed, by definition, the outcome will be peculiar and not necessarily what you intended. And the idea that that capital that you invest can be easily replaced with more capital that can be raised — I wanna have the same clients my entire lifetime. If somebody comes on board and joins me, I tell them, “You know, this is almost like marriage. I, I intend for us to work together for as long as I’m doing this, and then, you know, probably five minutes longer.”
But on the other side, I wanna know what the businesses are that I own, and I completely am oblivious to the benchmarks, and I feel like benchmarks have really done more harm. Especially the minute that we’re convinced that we can invest in an index. In some circumstances, I know it plays a role. It gives you exposure. It’s low cost. But any good idea taken to its limits — and it’s one of those ideas that I think we took to its limits — passive index investing, the outcome is bizarre. Like if you actually pause and look at how this machine works, it’s a bizarre outcome.
Matt: Bizarre is a good word for it. And this is not a pushback or criticism — it’s just parsing the nuance. If somebody wants to know, and I think there’s an insanely powerful connection in understanding what you own. Personal experience, I find that more to be true with business owner clients. I find it more to be true with people who have had some type of decision-making capability over a private enterprise or something where they understand stuff at that intimate level. Where behaviorally, it’s more comfortable for them to be able to own at least some portion of their portfolio in individual securities where they truly feel like they have an understanding of the business. And that’s what gets them through the ugly cycles, because they come. That’s the reality of it.
Other people who sort of, they wanna anonymize it. They wanna — they want to just own the market. To me, I don’t have a problem with that. I just wanna know how you’re wired and what you think is right, and then, then set the expectation. You can do this. Just never ask me an outperformance question.
Bogumil: Mm-hmm.
Matt: We’ll solve the taxes and the legal and all the other crap that goes around with this. We’ll make this as efficient as possible. We’ll make this as clean as possible. We’ll solve for the right amount of risk allocation to these assets, but never have the expectation that you are going to do better than some arbitrary benchmark, because you’re building the thing that allows you to scale up this exposure and outsource caring. And it’s not a criticism against them, it’s just investor know thyself over and over and over again.
Bogumil: You know, a certain magic happens — and because I host a podcast and people email me, I get to hear incredible stories of how people actually think about money. They’re very capable, competent individuals that have taken on a huge role in their families of managing their family wealth. And initially it starts as a small snowball, but then 10, 20 years later when they write to me, it’s an incredible amount of money that could really set them for life and for a generation or two.
But the way they think about that money and what they point out to me is exactly what Robert was saying, is they don’t look at the benchmark and think, “I have to have this. I, I have to perform this way,” or, “I have to have a bit of energy because there’s energy,” or —
Robert: “I have to have something else —”
Bogumil: “— because that’s where the headlines are headed this week.” That’s not how they manage this money. And they’re actually, in my mind, more capable of doing it the right way because they don’t have outside clients, because they’re not being compared to a benchmark, because they don’t have to explain what they do at a professional conference to their peers. So they exist in a context that Buffett continued to exist in.
Look at Buffett. Even — we love Berkshire, no recommendation of any kind — but in the last 12 months, the market index, whichever one you look at, is up double digits, and Berkshire is flat or down. If it was a professionally managed fund that has to report month to month and explain on phone calls why they’re doing what they’re doing — Berkshire, if it was not a permanent pool of capital, I would bet it would be seeing some redemptions. But we don’t care, and Buffett doesn’t care.
He’s repositioning this portfolio with Greg Abel at the helm in a whole different direction and thinking about the next few decades where this business could be. He, he can have that freedom, you know, permanent pool of capital that individuals have. Professionals, unless they set it up correctly, actually can’t have it.
Matt: Yeah. But with great responsibility comes great freedom, right? Like if you can do this, if you can handle this, it’s right there for the taking.
Bogumil: Mm.
Matt: This was an outstanding conversation. I’m so happy we drilled into just this presentation with Robert.
Bogumil: He has so much to share. I wanna leave this audience with what he mentioned at the beginning — Bill Ruane’s advice. If the clients don’t get it, fire them basically. Find the right clients. And it’s easier said than done. And trying to convert people — I get asked questions that are trying to figure out which box I fit in, and I don’t. I’m trying to manage money in a thoughtful way, the same way I manage my own money, the way I would manage any family fortune. I have certain aspirations in terms of returns. But it’s just a thoughtful way, as Robert described — deliberate about how you structure the portfolio. And some people will get it, and as Bill Ruane reminded him half a century ago, some will not. And maybe the energy is better spent letting the right ones find you, instead of trying to convert the ones who have to find their own way.
Matt: There’s a time and a place to swim upstream.
Bogumil: Yeah.
Matt: The rest of the time — it’s not a lazy river, but it’s calling. There’s a current. It’s there for a reason. I’m so with you on that. Bogumil, people wanna find you — where should we send them?
Bogumil: My Substack is the best place — Bogumił Baranowski on Substack. I post everything: podcast, writing. And I shared it with you before — I write to a bunch of readers now and then, so don’t be surprised if you get a personal email. It’s really me, it’s not AI. I’m actually curious who is reading, who is listening, so be aware.
Matt: Be aware — Bogumił’s out there. Check him out on the Bogumił Baranowski Substack on Talking Billions, and head over to Excess Returns on Substack. Make sure you see the episode summaries. And we’re gonna talk to Robert behind the scenes, see if we can maybe share that presentation, put it up over there in some way, shape, or form.
This is The 100-Year Thinkers. We’re gonna have Chris Mayer back with us again sometime in the very, very near future. But until then, like, comment, subscribe, all the things below, and we are out.