2019: Do alternative investments belong in pension funds?

AUDIENCE MEMBER: Warren and Charlie, my name is Brent Muio. I’m from Winnipeg, Canada.

First, thank you for devoting so much time and energy to education. I’m a better investor because of your efforts. But more important, I’m a better partner, friend, son, brother, and soon-to-be first-time father.

There’s nothing more important than these relationships. And my life is better, because you’re willing to pass on your experience and wisdom.

My path into finance was unconventional. I worked as an engineer for 12 years, while two years ago, I began a career in finance, working for the Civil Service Superannuation Board, a $7 billion public pension fund in Winnipeg.

I work on alternative investments, which include infrastructure, private equity, and private credit. I go to work every day knowing that I’m there to benefit the hardworking current and future beneficiaries of the fund.

Like most asset classes, alternative purchase multiples have increased. More of these assets are funded with borrowed money. And the terms and covenants on this debt are essentially nonexistent.

With this in mind and knowing the constraints of illiquid, closed-end funds, please give me your thoughts on private, alternative investments, the relevancy in public pension funds, and your view on long-term return expectations.

WARREN BUFFETT: Yeah, if you leveraged up investments in just common stocks, and you’d figured a way so that you would have staying power, if there were any market dip, I mean, you’d obviously retain extraordinary returns.

I pointed out, in my investing lifetime, you know, if an index fund would do 11 percent, well, imagine how well you would’ve done if you’d leveraged that up 50 percent whatever the prevailing rates were over time.

So, a leveraged investment in a business is going to beat an unleveraged investment in a good business a good bit of the time. But as you point out, the covenants to protect debtholders have really deteriorated in the business. And of course, you’ve been in an upmarket for businesses. And you’ve got a period of low interest rates. So, it’s been a very good time for it.

My personal opinion is, if you take unleveraged returns against unleveraged common stocks, I do not think what is being purchased today and marketed today would work well.

But if you can borrow money, if you can buy assets that will yield 7 or 8 percent, you can borrow enough money at 4 percent or 5 percent, and you don’t have any covenants to meet, you’re going to have some bankruptcies. But you’re going to also have better results in many cases.

It’s not something that interests us at all. We are not going to leverage up Berkshire. If we’d leveraged up Berkshire, we’d have made a whole lot more money, obviously, over the years.

But both Charlie and I, probably, have seen some more high-IQ people — really extraordinarily high-IQ people — destroyed by leverage. We saw Long-Term Capital Management, where we had people who could do in their sleep math that we couldn’t do, at least I couldn’t do, you know, working full time at it during the day and, I mean, really, really smart people working with their own money and with years and years of experience of what they were doing.

And you know, it all turned to pumpkins and mice in 1998. And actually, it was a source of national concern, just a few hundred people. And then we saw some of those same people, after that happened to them once, go on and do the same thing again.

So, I would not get excited about so-called alternative investments. You can get all kinds of different figures. But there may be — there’s probably at least a trillion dollars committed to buying, in effect, buying businesses. And if you figure they’re going to leverage them, you know, two for one on that, you may have 3 trillion of buying power trying to buy businesses in — well, the U.S. market may be something over 30 trillion now — but there’s all kinds of businesses that aren’t for sale and that thing.

So, the supply-demand situation for buying businesses privately and leveraging them up has changed dramatically from what it was ten or 20 years ago.

And I’m sure it doesn’t happen with your Winnipeg operation, but we have seen a number of proposals from private equity funds, where the returns are really not calculated in a manner than — well, they’re not calculated in a manner that I would regard as honest.

And so I — it’s not something — if I were running a pension fund, I would be very careful about what was being offered to me.

If you have a choice in Wall Street between being a great analyst or being a great salesperson, salesperson is the way to make it.

If you can raise $10 billion in a fund, and you get a 1 1/2 percent fee, and you lock people up for ten years, you know, you and your children and your grandchildren will never have to do a thing, if you are the dumbest investor in the world. But —

Charlie?

CHARLIE MUNGER: Well, I think what we’re doing will work more safely than what he’s doing. And — but I wish him well.

WARREN BUFFETT: Yeah, Brent, you sound — actually, you sound like a guy that I would hope would be working for a public pension fund. Because frankly, most of the institutional funds, you know — well, we had this terrible — right here in Omaha — you can get a story of what happened with our Omaha Public Schools’ retirement fund. And they were doing fine until the manager started going in a different direction. And the trustees here — perfectly decent people — and the manager had done OK to that point, and —

CHARLIE MUNGER: Yeah, but they are smarter in Winnipeg than they are here.

WARREN BUFFETT: Yeah. Well — (Laughter)

CHARLIE MUNGER: That was pretty bad here.

WARREN BUFFETT: It’s not a fair fight, actually, usually, when a bunch of public officials are listening to people who are motivated to really just get paid for raising the money. Everything else is gravy after that.

But if you run a fund, and you get even 1 percent of a billion, you’re getting $10 million a year coming in. And if you’ve got the money locked up for a long time, it’s a very one-sided deal.

And you know, I’ve told the story of asking the guy one time, in the past, “How in the world can you — why in the world can you ask for 2-and-20 when you really haven’t got any kind of evidence that you are going to do better with the money than you do in an index fund?” And he said, “Well, that’s because I can’t get 3-and-30,” you know. (Laughter)

CHARLIE MUNGER: What I don’t like about a lot of the pension fund investments is I think they like it because they don’t have to mark it down as much as it should be in the middle of the panics. I think that’s a silly reason to buy something. Because you’re given leniency in marking it down.

WARREN BUFFETT: Yeah. And when you commit the money — in the case of private equity often — you — they don’t take the money, but you pay a fee on the money that you’ve committed.

And of course, you really have to have that money to come up with at any time. And of course, it makes their return look better, if you sit there for a long time in Treasury bills, which you have to hold, because they can call you up and demand the money, and they don’t count that.

They count it in terms of getting a fee on it. But they don’t count it in terms of what the so-called internal rate of return is. It’s not as good as it looks. And I really do think that when you have a group sitting as a state pension fund —

CHARLIE MUNGER: Warren, all they’re doing is lying a little bit to make the money come in.

WARREN BUFFETT: Yeah. Yeah, well, that sums it up. (Laughter)