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Warren Buffet is bearish on the dollar

March 15, 2004

Ace American investor Warren Buffett talks about his investment strategies.

Warren Buffett's letter to shareholders of his investment firm, Berkshire Hathaway, is one of the most eagerly awaited statements among investors across the globe as it records his investment strategies and views on issues haunting corporate America.

In this year's letter to shareholders Buffett condemned mutual fund companies and greedy chief executive officers and questioned the role of independent directors in companies and mutual fund boards. Buffett reaffirmed his bearish view on the dollar and said he is loading up on foreign currency.

Excerpts from the 22-page letter:

Investments

  • We bought some Wells Fargo shares last year. Otherwise, among our six largest holdings, we last changed our position in Coca-Cola in 1994, American Express in 1998, Gillette in 1989, Washington Post in 1973, and Moody's in 2000. Brokers don't love us.
  • We are neither enthusiastic nor negative about the portfolio we hold. We own pieces of excellent businesses all of which had good gains in intrinsic value last year but their current prices reflect their excellence. The unpleasant corollary to this conclusion is that I made a big mistake in not selling several of our larger holdings during the great bubble.
  • In 2002, junk bonds became very cheap, and we purchased about $8 billion of these. The pendulum swung quickly though, and this sector now looks decidedly unattractive to us. Yesterday's weeds are today being priced as flowers.
  • We've repeatedly emphasised that realised gains at Berkshire are meaningless for analytical purposes. We have a huge amount of unrealised gains on our books, and our thinking about when, and if, to cash them depends not at all on a desire to report earnings at one specific time or another.
  • During 2002 we entered the foreign currency market for the first time in my life, and in 2003 we enlarged our position, as I became increasingly bearish on the dollar. We have and will continue to have the bulk of Berkshire's net worth in US assets. But in recent years our country's trade deficit has been force-feeding huge amounts of claims on America to the rest of the world. For a time, foreign appetite for these assets readily absorbed the supply. Late in 2002, however, the world started choking on this diet, and the dollar's value began to slide against major currencies. Even so, prevailing exchange rates will not lead to a material letup in our trade deficit. So whether foreign investors like it or not, they will continue to be flooded with dollars. The consequences of this are anybody's guess. They could, however, be troublesome and reach, in fact, well beyond currency markets. As an American, I hope there is a benign ending to this problem.
  • Then again, perhaps the alarms I have raised will prove needless: Our country's dynamism and resiliency have repeatedly made fools of naysayers. But Berkshire holds many billions of cash-equivalents denominated in dollars. So I feel more comfortable owning foreign-exchange contracts that are at least a partial offset to that position.
  • When we can't find anything exciting in which to invest, our 'default' position is US Treasuries, both bills and repos. No matter how low the yields on these instruments go, we never 'reach' for a little more income by dropping our credit standards or by extending maturities. Charlie and I detest taking even small risks unless we feel we are being adequately compensated for doing so. About as far as we will go down that path is to occasionally eat cottage cheese a day after the expiration date on the carton.

Corporate governance

In judging whether corporate America is serious about reforming itself, CEO pay remains the acid test. To date, the results aren't encouraging. A few CEOs, such as Jeff Immelt of General Electric, have led the way in initiating programs that are fair to managers and shareholders alike. Generally, however, his example has been more admired than followed.

It's understandable how pay got out of hand. When management hires employees, or when companies bargain with a vendor, the intensity of interest is equal on both sides of the table. One party's gain is the other party's loss, and the money involved has real meaning to both. The result is an honest-to-God negotiation.

But when CEOs (or their representatives) have met with compensation committees, too often one side the CEO's has cared far more than the other about what bargain is struck. A CEO, for example, will always regard the difference between receiving options for 100,000 shares or for 500,000 as monumental.

To a comp committee, however, the difference may seem unimportant particularly if, as has been the case at most companies, neither grant will have any effect on reported earnings. Under these conditions, the negotiation often has a 'play-money' quality.

Overreaching by CEOs greatly accelerated in the 1990s as compensation packages gained by the most avaricious a title for which there was vigorous competition were promptly replicated elsewhere.

The couriers for this epidemic of greed were usually consultants and human relations departments, which had no trouble perceiving who buttered their bread. As one compensation consultant commented: "There are two classes of clients you don't want to offend actual and potential."

In proposals for reforming this malfunctioning system, the cry has been for 'independent' directors. But the question of what truly motivates independence has largely been neglected.

In last year's report, I took a look at how 'independent' directors -- as defined by statute -- had performed in the mutual fund field. The Investment Company Act of 1940 mandated such directors, and that means we've had an extended test of what statutory standards produce.

In our examination last year, we looked at the record of fund directors in respect to the two key tasks board members should perform -- whether at a mutual fund business or any other. These two all-important functions are, first, to obtain (or retain) an able and honest manager and then to compensate that manager fairly.

Our survey was not encouraging. Year after year, at literally thousands of funds, directors had routinely rehired the incumbent management company, however pathetic its performance had been.

Just as routinely, the directors had mindlessly approved fees that in many cases far exceeded those that could have been negotiated.

Then, when a management company was sold -- invariably at a huge price relative to tangible assets -- the directors experienced a 'counter-revelation' and immediately signed on with the new manager and accepted its fee schedule.

In effect, the directors decided that whoever would pay the most for the old management company was the party that should manage the shareholders' money in the future.

Despite the lapdog behavior of independent fund directors, we did not conclude that they are bad people. They're not. But sadly, 'boardroom atmosphere' almost invariably sedates their fiduciary genes.

On May 22, 2003, not long after Berkshire's report appeared, the chairman of the Investment Company Institute addressed its membership about 'the state of our industry.'

Responding to those who have "weighed in about our perceived failings," he mused, "It makes me wonder what life would be like if we'd actually done something wrong."

Be careful about what you wish for. Within a few months, the world began to learn that many fund-management companies had followed policies that hurt the owners of the funds they managed, while simultaneously boosting the fees of the managers.

Prior to their transgressions, it should be noted, these management companies were earning profit margins and returns on tangible equity that were the envy of corporate America. Yet to swell profits further, they trampled on the interests of fund shareholders in an appalling manner.

So what are the directors of these looted funds doing? As I write this, I have seen none that have terminated the contract of the offending management company (though naturally that entity has often fired some of its employees). Can you imagine directors who had been personally defrauded taking such a boys-will-be-boys attitude?

To top it all off, at least one miscreant management company has put itself up for sale, undoubtedly hoping to receive a huge sum for 'delivering' the mutual funds it has managed to the highest bidder among other managers. This is a travesty.

Why in the world don't the directors of those funds simply select whomever they think is best among the bidding organisations and sign up with that party directly? The winner would consequently be spared a huge 'payoff' to the former manager who, having flouted the principles of stewardship, deserves not a dime.

Not having to bear that acquisition cost, the winner could surely manage the funds in question for a far lower ongoing fee than would otherwise have been the case. Any truly independent director should insist on this approach to obtaining a new manager.

The reality is that neither the decades-old rules regulating investment company directors nor the new rules bearing down on corporate America foster the election of truly independent directors.

In both instances, an individual who is receiving 100 per cent of his income from director fees -- and who may wish to enhance his income through election to other boards -- is deemed independent. That is nonsense.

The same rules say that Berkshire director and lawyer Ron Olson, who receives from us perhaps 3 per cent of his very large income, does not qualify as independent because that 3 per cent comes from legal fees Berkshire pays his firm rather than from fees he earns as a Berkshire director.

Rest assured, 3 per cent from any source would not torpedo Ron's independence. But getting 20 per cent, 30 per cent or 50 per cent of their income from director fees might well temper the independence of many individuals, particularly if their overall income is not large. Indeed, I think it's clear that at mutual funds, it has.

Let me make a small suggestion to 'independent' mutual fund directors. Why not simply affirm in each annual report that "(1) We have looked at other management companies and believe the one we have retained for the upcoming year is among the better operations in the field; and (2) we have negotiated a fee with our managers comparable to what other clients with equivalent funds would negotiate."

It does not seem unreasonable for shareholders to expect fund directors -- who are often receiving fees that exceed $100,000 annually -- to declare themselves on these points. Certainly these directors would satisfy themselves on both matters were they handing over a large chunk of their own money to the manager. If directors are unwilling to make these two declarations, shareholders should heed the maxim "If you don't know whose side someone is on, he's probably not on yours."

Finally, a disclaimer. A great many funds have been run well and conscientiously despite the opportunities for malfeasance that exist. The shareholders of these funds have benefited, and their managers have earned their pay.

Indeed, if I were a director of certain funds, including some that charge above-average fees, I would enthusiastically make the two declarations I have suggested.

Additionally, those index funds that are very low-cost (such as Vanguard's) are investor-friendly by definition and are the best selection for most of those who wish to own equities.

I am on my soapbox now only because the blatant wrongdoing that has occurred has betrayed the trust of so many millions of shareholders. Hundreds of industry insiders had to know what was going on, yet none publicly said a word.

It took Eliot Spitzer, and the whistleblowers who aided him, to initiate a housecleaning. We urge fund directors to continue the job. Like directors throughout corporate America, these fiduciaries must now decide whether their job is to work for owners or for managers.



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