Yesterday, Berkshire Hathaway's annual shareholder letter came out. Warren Buffett used the letter as a chance to remind people of one of his business strategies: Treating people very well is good for business. If you treat people well, they'll often sell their companies to you and work for you for less than they would the competition.
The latest Berkshire Hathaway annual shareholder letter came out yesterday, and in it, Warren Buffett gives us a status update on two portfolio managers that came to work for the company in recent years.
In a year in which most equity managers found it impossible to outperform the S&P 500, both Todd Combs and Ted Weschler handily did so. Each now runs a portfolio exceeding $7 billion. They’ve earned it. I must again confess that their investments outperformed mine. (Charlie says I should add “by a lot.”) If such humiliating comparisons continue, I’ll have no choice but to cease talking about them. Todd and Ted have also created significant value for you in several matters unrelated to their portfolio activities. Their contributions are just beginning: Both men have Berkshire blood in their veins.
Weschler and Combs are evidently grade-A investors, who now have the greatest resumes imaginable, and yet neither make that much money by industry standards.
As Andrew Ross Sorkin reported for Dealbook back in 2013, Weschler and Combs will pay much higher taxes working for Berkshire (than they would at hedge funds), because they're compensation doesn't use the carried-interest loophole that allows managers across the industry to pay 15% taxes (rather than 35%) on their compensation.
Moreover, their base and bonus pay, does not match up with the normal industry structure.
“Both Todd and Ted will have performance pay based on 10 percent of the excess return over the S.&P., averaged over multiple years,” Mr. Buffett told me. “If the S.&P. averages 5 percent annually in the future, this means that the average hedge fund manager has received a 1 percent performance fee — 20 percent of 5 percent — before Todd and Ted receive anything.”
“Nevertheless, I expect them to make a lot of money,” he added. “The difference is that they have to earn it by true investment performance.”
In addition, both men receive modest salaries that Mr. Buffett said “will work out to about a tenth of 1 percent” of the assets they manage. “This compares to the 2 percent nonperformance fee which most hedge fund managers charge, even if they are losing money.”
So why are these managers leaving so much on the table?
Conor Sen, writing on his blog, offers up some insight based on his experience in the industry:
Those familiar with hedge fund economics might not understand why Todd Combs and Ted Weschler would take less money working for Berkshire than they might be able to get in the hedge fund world. But having spent half my career at a hedge fund, I totally get it. If your investment management style requires a long-term perspective, long-term patience, and long-term capital, and you know what you want to do for the rest of your career, why take a gamble on the potential for more money if you have to operate in an environment that is notoriously short-term, at times unethical, and often not loyal?
But there’s more to employee compensation and satisfaction than wages. Schedule flexibility matters. Workplace flexibility matters. The implicit or explicit promises of employers matter. Trust is a form of goodwill not found on any balance sheet. This is a cultural thing that will take time to appreciate, and not everyone will get it. But, and there’s no good way to quantify this, companies worthy of that trust may find it easier to maintain present profit margins more than profit margin skeptics appreciate.
This strategy of creating goodwill to get lower prices is an explicit part of Berkshire's strategy.
I went to a Berkshire Hathaway shareholder meeting a few years ago (disclosure: I own a single B share) and during the Q&A section of the meeting, Buffett made the exact point that Berkshire can make acquisitions cheaper than other companies can because when they're buying a family business, the family can trust that Berkshire isn't going to plunder the assets, lay off workers, and chop it up. Owners of companies are often willing, according to Buffett, to accept less money for the promise that their prize possession will be taken care of once sold.
It's for this reason that Buffett, in his letter, devotes space to talking about the Nebraska Furniture Mart — a Berkshire company that's just a rounding error in his bottom line. Read this section:
I can’t resist, however, giving you an update on Nebraska Furniture Mart’s expansion into Texas. I’m not covering this event because of its economic importance to Berkshire – it takes more than a new store to move the needle on Berkshire’s $225 billion equity base. But I’ve now worked 30 years with the marvelous Blumkin family, and I’m excited about the remarkable store – truly Texas-sized – it is building at The Colony, in the northern part of the Dallas metropolitan area.
When the store is completed next year, NFM will have – under one roof, and on a 433-acre site – 1.8 million square feet of retail and supporting warehouse space. View the project’s progress at www.nfm.com/texas. NFM already owns the two highest-volume home furnishings stores in the country (in Omaha and Kansas City, Kansas), each doing about $450 million annually. I predict the Texas store will blow these records away. If you live anywhere near Dallas, come check us out.
I think back to August 30, 1983 – my birthday – when I went to see Mrs. B (Rose Blumkin), carrying a 11⁄4-page purchase proposal for NFM that I had drafted. (It’s reproduced on pages 114 - 115.) Mrs. B accepted my offer without changing a word, and we completed the deal without the involvement of investment bankers or lawyers (an experience that can only be described as heavenly). Though the company’s financial statements were unaudited, I had no worries. Mrs. B simply told me what was what, and her word was good enough for me.
Really, there's no trick about it. Buffett never skips a chance to emphasize that he treats people humanely, and that Berkshire is a family. This has allowed him to buy companies at lower prices, and get top talent for cheaper than the levels he considers obscene.
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