2004: How would Buffett or Munger choose investment managers?

AUDIENCE MEMBER: Warren and Charlie, my name is Peter Brotchie from Beverly, Massachusetts. And I would like to thank you both for helping me become a better businessman and a better investor. Perhaps more importantly, you have created, by example, a kind of true north on the moral compass for me to steer by.

While the education has been fantastic, I have found that the demands of owning a successful business and having a large family do not leave time to apply the research stance I have become so wonderfully accustomed to by being a member of this cult.

Please imagine, for a moment, that you are 30 years younger, and have only —

WARREN BUFFETT: I like him.

AUDIENCE MEMBER: — a few holes left in your investment punch card. If you were in my situation, to the extent that you would diversify your holdings beyond Berkshire Hathaway, given this environment, how would you choose the investment managers? Or as Charlie has just discussed when addressing foundations, would you hunt for two more great companies to invest in via common stocks?

WARREN BUFFETT: Charlie, why don’t you take a swing at that?

CHARLIE MUNGER: Well, of course you’re hunting, that’s part of the fun of life. And — but I would say that the chief lesson would be that you’re unlikely to find very many in a whole lifetime. And when you find one in which you really have thought it out and have confidence, for God’s sakes, don’t do it in a niggardly fashion.

The idea that very smart people with investment skills should have hugely diversified portfolios is madness. It’s a very conventional madness. And it’s taught in all the business schools. But they’re wrong. (Applause)

WARREN BUFFETT: The question of finding other advisers is a tough one. I mean, when I wound up my partnership in 19 — at the end of 1969 — and I had all these partners that had counted on me and I was going to mail them back a lot of money, you know, I felt an obligation to at least suggest some alternatives for them.

And I recommended two people who I knew were exceptionally good and exceptionally honest. We put one of them on the board not long ago and reaffirmed it today — Sandy Gottesman. The other one was Bill Ruane.

Now, I’d been around the investment world for a long time at that point, and those were the two I knew, but they were more or less contemporaries of mine. And I’d gotten to know them over the years and I’d seen them for a long time.

So I not only knew their results, but I knew how they’d accomplished their results, which is terribly important. I don’t know that generation of managers now. But the fact that, with the number of people I knew, that I could only come up with two, at a time when I was very active, says something about the difficulties of finding managers.

The one thing I can almost guarantee to you is that the promotional types going around to solicit the institutional investors are very unlikely to meet any long-term tests of ability, and sometimes, integrity.

It’s not an easy job spotting an investor. I think it’s probably easier, depending on the amount of time — you know, you mention having children and a business and the amount of time you can spend on. Every now and then you do — if you’re conscious of the investment world and you have some kind of sort of grounding knowledge about what’s going on, and you can see something, you know, as we did in junk bonds a couple of years ago, or as we did with all kinds of things, some years back, when stocks were cheaper.

You will occasionally see something that you should load up on. And, as Charlie says, that’s what you really have to do. I mean, some of the people in this room loaded up on Berkshire many years ago. And the truth was, they didn’t need diversification, you know. I loaded up on it. Charlie did. And you’ll see opportunities occasionally but you’re not going to see them every day or every week.

If you think you’re going to see an opportunity every week, you’re going to lose a lot of money because people will come around and tell you that they’ve got them, and they may not be quite as flagrant as that fellow we had in the movie — (laughs) — but they’re a version of them.

Charlie?

CHARLIE MUNGER: The business of selecting investment managers was recently shown to be even harder than I had previously thought it was. A significant fraction of the institutional investment managers who run the nation’s mutual funds actually accepted propositions to take bribes for betraying their own shareholders.

It was as if a man came to you and said, “I have a wonderful proposition. Why don’t I kill your mother and we’ll split the insurance money?” And it was that ridiculous. And yet, a significant number of the people said, “Gee, I would like some insurance money.” And they just went right ahead.

WARREN BUFFETT: And they were already rich beforehand.

CHARLIE MUNGER: Yes. And they’ve destroyed themselves, many of them, by making this insane decision. And I think many of them will probably think the outcome is unjust.

WARREN BUFFETT: And the —

CHARLIE MUNGER: I mean the downfall they’ve had.

WARREN BUFFETT: And the interesting thing about it, of course, is that here is a huge industry that — where the people who weren’t doing it have a great interest in having that reputation of the industry not get stained. And a number of them had to know what was going on.

I mean, this was — I don’t — it’s hard for me to imagine that people at most large mutual funds, even the ones that didn’t — that are mutual fund management companies — even the ones that weren’t engaging in the activities mentioned weren’t aware of it. I mean, you just — if you’re in an industry like that, you’re going to hear what’s going on.

And the Investment Company Institute was busy patting itself on the back, you know, at one meeting after another and becoming very cozy with legislators.

And there wasn’t one thing done until a whistleblower when to [New York State Attorney General] Eliot Spitzer and he got active in a very strong way with a very limited staff.

And he uncovered, and put on the front pages, what was taking place. But the industry itself, with hundreds and hundreds and hundreds of people that most have known what was going on — and it went on for a long time. Never said a word. It’s — you know, it makes you wonder a little bit.