Berkshire Hathaway released the 2016 annual letter to its shareholders written by its legendary chairman Warren Buffett.
In the letter, Buffett provided an update on Berkshire’s many businesses, explained the rationale for many of its portfolio picks and discussed wide-ranging investing and economic subjects.
The US economy
While shying away from actively discussing political developments, including the election of Donald Trump as US President (Buffett had backed Hillary Clinton), the Berkshire chief talked about the value immigrants bring to the economic system while maintaining that he was long-term still bullish on the prospects of United States’ economy.
“Our efforts to materially increase the normalized earnings of Berkshire will be aided – as they have been throughout our managerial tenure – by America’s economic dynamism. One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers.
You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling USD 90 trillion.”
Greed and fear
The psychology that drives investing decisions – good and bad – has always been Buffett’s pet subject and he has always lucidly explained how investors should try to take advantage of the greed and fear cycle.
In the 2017 letter, he wrote:
The years ahead will occasionally deliver major market declines -- even panics -- that will affect virtually all stocks. No one can tell you when these traumas will occur -- not me, not Charlie [Munger], not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: "We spend a lot of time looking for systemic risk; in truth, however, it tends to find us."
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively financed American businesses will almost certainly do well.
‘Fees never sleep’
The Berkshire chief also railed against Wall Street’s culture of charging high fees on investment products, in particular hedge funds -- a subject that frequently attracts Buffett’s ire.
He also touched upon a USD 1 million charity bet that he undertook nine years ago: he bet that over a decade, an investment in a low-cost index fund would fare better than one in any selection of funds the hedge fund manager made.
His primary contention was to do with the fact that while active stock picking is hard, hedge funds’ high fees makes the net results worse.
In the letter he provided an update:
“The compounded annual increase to date for the index fund is 7.1 percent, which is a return that could easily prove typical for the stock market over time. That’s an important fact: A particularly weak nine years for the market over the lifetime of this bet would have probably helped the relative performance of the hedge funds, because many hold large “short” positions.
Conversely, nine years of exceptionally high returns from stocks would have provided a tailwind for index funds. Instead, we operated in what I would call a “neutral” environment. In it, the five funds-of-funds delivered, through 2016, an average of only 2.2 percent, compounded annually. That means USD 1 million invested in those funds would have gained USD 220,000. The index fund would meanwhile have gained USD 854,000.
The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”