Imagine Berkshire Hathaway as a hedge fund
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Jeffrey Goldfarb
Warren Buffett is finding it ever more difficult to beat the market, while recruiting potential successors isn’t getting any easier. It might be heresy to suggest a hedge-fund-like fee structure at the company the 80-year old billionaire runs, Berkshire Hathaway. But it could be the best way to secure future returns.
Buffett is optimistic about America and Berkshire while simultaneously conceding the constraints of his company’s immense size. Just consider Berkshire’s cash balance: the $38 billion on the books easily could swell to $60 billion by the end of this year.
Berkshire’s book value per share has underperformed the S&P 500 index for two consecutive years and four of the last eight. Buffett’s preferred measure of success probably understates Berkshire’s intrinsic value, but with $158 billion of stock, bond and cash investments, it’s no surprise the company’s performance is slouching toward the market’s on a more regular basis, and probably more frequently so in the good times.
That could prove daunting to any future leaders of Berkshire. Even if Buffett runs the show for another decade, the board needs to plan for alternative outcomes. Todd Combs may deliver great things, but has never managed more than $400 million. And while Buffett and his partner Charlie Munger have accumulated wealth by way of Berkshire stock, newcomers can’t expect anything approaching the same promise.
That’s how changing Berkshire’s reward system to something approximating a hedge fund’s might help, notwithstanding Buffett’s misgivings of such structures. If history is any guide, shareholders might still do very well.
Had Buffett accepted an arrangement paying him a 2 percent management fee and 20 percent for investment gains since 1965, he still would have bested the market, net of fees, with a compound return of 14 percent against 11 percent for the S&P 500 index.
Or consider a more conservative alternative. Berkshire’s book value per share has improved by an annualized compound rate of 20 percent under Buffett. Taking a management fee of 1 percent and 10 percent of any returns above the S&P’s performance only would have reduced the net annual return to Berkshire shareholders to 18 percent.
In this year’s letter, Buffett recalls how in the early days he failed to allocate capital properly, before “eventually I came to my senses.” Berkshire may need another light-bulb moment about how to use its lucre to ensure its long-term future under a new regime.