5 things I learnt from the Buffett Partnership Letters

I revisited some of the annual letters Warren Buffett wrote when he was a fund manager some 50 years ago. Buffett's teachings then are still relevant today.

Many people may not know this. Before Warren Buffett became CEO of Berkshire Hathaway, he was a fund manager.  

And his track record was, unsurprisingly, phenomenal.

According to his fund's investor letter in 1969, his partnership produced an annual compounded return of 31.6 per cent, compared to the Dow's 9.1 per cent. 

Net of fees, limited partners (investors in the fund) gained a cumulative return of 1,403 per cent in just 12 years, or 25.3 per cent per year. Not bad.

Despite being written more than 50 years ago, Buffett's teachings in his fund's investor letters are still relevant today.

Here are five things I learnt from the great man's writings.

DON'T TIME THE MARKET 

The market will swing in the short term. But over a long time frame, you can bet your last dollar that it will be up. Buffett wrote:

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"I am certainly not going to predict what general business or the stock market are going to do in the next year or two since I don't have the faintest idea. I think you can be quite sure that over the next ten years there are going to be a few years when the general market is plus 20 per cent or 25 per cent, a few years when it is minus on the same order, and a majority when it is in between.

I haven't any notion as to the sequence in which these will occur, nor do I think it is of any great importance for the long-term investor."

Today, many hedge funds and financial advisors try to manage their clients' money to reduce near-term volatility. But timing the market is a fool's game.

Buffett's right-hand man, Charlie Munger certainly agrees, saying, "Time in the market is more important than timing the market."

IT IS NOTORIOUSLY DIFFICULT TO BEAT THE STOCK MARKET INDEX

When Buffett started his fund, he set the goal of beating the Dow Jones Industrial Average, which at that time was the most widely followed stock market index in the US.

If you thought this was easy to achieve, think again. In his 1961 annual letter, Buffett noted that out of 70 funds listed in Arthur Wiesenberger's book with a continuous record since 1946, only seven outperformed the Dow. And those that did were superior by just a few percentage points.

Today the story is no different. Bob Pisani, wrote in an article on CNBC earlier this year that 64.49 per cent of large-cap funds lagged the S&P 500 in 2018. It marked the ninth consecutive year that actively managed funds trailed the index.

Over a 10-year period, 85 per cent of large-cap funds underperformed the S&P 500. Over 15 years, that figure increases to 92 per cent.

THE JOYS OF COMPOUNDING 

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A few percentage points can really add up when compounding. Buffett observed:

"It is always startling to see how relatively small difference in rates add up to very significant sums over a period of years. That is why, even though we are shooting for more, we feel that a few percentage points advantage over the Dow is a very worthwhile achievement. It can mean a lot of dollars over a decade or two."

Buffett added the table below to show how much more you would make if you compounded a $100,000 investment at 15 per cent instead of 10 per cent or 5 per cent.

The results were indeed staggering, and also demonstrates that the difference in absolute returns mushrooms the longer the investment compounds.

INDIVIDUAL THINKING IS IMPORTANT

In his annual letter in 1962, Buffett warned that it is not safe to simply follow what others are doing. Individual thinking is essential. He wrote:

"You will not be right simply because a large number of people momentarily agree with you. You will not be right simply because important people agree with you.

In many quarters the simultaneous occurrence of the two above factors is enough to make a course of actions meet the test of conservatism."

He added: "You will be right, over the course of many transactions, if your hypotheses are correct, your facts are correct, and your reasoning is correct. True conservatism is only possible through knowledge and reason."

MAKING BIGGER BETS ON HIGH-CONVICTION STOCKS 

While modern portfolio theory suggests ample diversification, Buffett had a somewhat less conventional style. His fund had the mandate to invest up to 40 per cent of its assets in a single stock!

In his 1965 letter, Buffett reasoned:

"Frankly, there is nothing I would like better than to have 50 different investment opportunities, all of which have a mathematical expectation of achieving performances surpassing the Dow by, say, fifteen percentage points per annum."

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But he adds: "It doesn't work that way. We have to work extremely hard to find just a few attractive investment situations. Such a situation by definition is one where my expectation of performance is at least ten percentage points per annum superior to the Dow."

Because of that, Buffett does not mind allocating a larger chunk of his portfolio to stocks that he expects to outperform the index and has a very low probability of loss.

Based on his track record, its clear this strategy has done really well for him.

THE GOOD INVESTORS' CONCLUSION 

Even at a young age (he was just 25 when he started), Warren Buffett was already a great investor. His performance as manager of the Buffett Partnership all those years ago speaks for itself.

More importantly, for investors today, his writings back then are still relevant today. If you want to read more of Buffett's annual letters during his time at Buffett Partnership, you can head here.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.