One week ago, less than a month after his 96th birthday, Warren Buffett stepped down as chairman of Berkshire Hathaway, the company he had run for 61 years.
What makes Buffett one of a kind?
I’ve written about this before, in Why There Will Never Be Another Warren Buffett.
Lots of people talk about Buffett’s obsessive brilliance: near-miraculous analytical skill combined with a prodigious memory and 85 years of thinking non-stop about almost nothing but investments. Others cite his flexibility: buying the tiniest, most obscure stocks in the 1950s and 1960s, then shifting to big brand names in the 1970s, then buying entire private companies outright. Still others admire his long-term focus: ignoring the headlines, waiting for years to sell (or buy), always taking the other side of the investing public’s emotional trade.
Buffett himself has often credited much of his success to luck, or what he calls the ovarian lottery: if he’d been born with the same abilities and interests in a different time or place, he might never have become an investing titan.
I like to talk, instead, about structure.
In 1962, three years before Buffett took over at Berkshire, the business historian Alfred D. Chandler wrote that “unless structure follows strategy, inefficiency results.”
What did he mean? Businesses that design themselves around what they’re trying to achieve are the most likely to succeed. That’s structure following strategy. Instead, at all too many businesses, it’s the other way around: What they can achieve is constrained by how they’re designed. That’s strategy following structure.
Buffett’s longtime business partner Charlie Munger liked to say that if you want to figure out how to succeed, look at how other people have failed and then do the opposite.
And if you wanted to design an investing firm that was sure to underperform, all you would need to do is look around at the thousands of examples on and off Wall Street.
It would charge high annual management fees, 1% or more in public markets and vastly more in private markets.
It would trade too much, incurring even more costs.
It would have a gigantic staff, turning every decision into goulash overcooked by committee.
It would manage too many funds across too many types of assets, becoming a jack of all trades and a master of none.
It would tank up on leverage, borrowing to amp short-term returns regardless of risk and the potential for rising interest rates to crush the advantage of using other people’s money.
It would measure its returns and incentivize its staff over short horizons, rewarding market-chasing and myopia while impeding the long-term view.
It would seek to maximize its assets under management rather than its net after-tax returns for investors. That way, it could earn high fees even from low performance. Its top objective wouldn’t be to earn superior returns, but to earn returns that would never alienate its clients. Copying the market, rather than beating it, would become the name of the game.
Above all else, instead of being countercyclical, it would be procyclical: acting greedy when other people are greedy and fearful when everyone else is, too. In bull markets, this kind of investing firm would hype its unsustainably high returns and welcome a tidal wave of hot money. In bear markets, it would curl up in a ball as fair-weather investors yank their money back out. As a result, the firm will act as a forced buyer just when assets are at their most expensive –and a forced seller in a world of bargains. Its own conduct interacts with the worst tendencies of its investors to make everyone behave even worse.
Of course, I’m not describing a hypothetical investing firm. I’m describing how all too many asset managers have run their businesses for all too long. In fact, this sort of structure is typical in the investment industry, and it doesn’t just influence strategy. It determines it.
Above all, what makes Buffett one of a kind is how well he succeeded in actualizing Chandler’s rule. Buffett made structure follow strategy instead of the other way around.
His strategy was to earn the highest possible net after-tax return on the assets investors entrusted to him – nothing more and never anything less.
From that, structure had to follow.
Initially, Buffett ran an investment partnership that paid him no salary and no fees unless he outperformed a minimum, usually 6%.1 Above that, he got 25% of the gains – and soon become wealthy as he earned some of the highest returns of any investor in history.
But when stocks got overvalued in the late 1960s and Buffett could no longer find investments he wanted to buy, he did the unthinkable: He shut down his fund and handed his investors their money back, forgoing a huge potential stream of performance fees.
When the strategy wouldn’t work, the structure had to go away.
Buffett replaced his partnership with a new structure: Berkshire Hathaway. It wasn’t a mutual fund, hedge fund or any other pooled investment. It was just a failing textile company that he turned into his personal blank “canvas,” where he could invest exactly as he pleased. The only way you could participate was to buy its stock from somebody else. Investors couldn’t flood Berkshire with cash at market tops or pull money out at the bottom.
It charged no management fees. It charged no performance fees. It had no investment committee.
Berkshire didn’t have to invest only in large U.S. value stocks, only in large U.S. stocks, only in stocks or only in the U.S. It didn’t have to invest at all, and sometimes it went for years without buying much. Along the way, Buffett simply bought whatever he thought was cheap: silver, Treasury bonds, junk bonds, newspaper stocks, insurance stocks, bank stocks. Like a private-equity baron before the term “private equity” even existed, he often bought entire companies outright: shoes, rugs, railroads, Dairy Queen, furniture, manufactured homes, machine tools, and on and on.
He was unstoppable because no one could stop him. He had structured his business that way. If he had housed the same abilities and drive inside a business where strategy followed structure, Buffett never would have reached his full potential.
There will never be another Warren Buffett until another supremely skilled investor finally musters the courage and the forbearance to make structure follow strategy: to forgo short-term fees in the pursuit of long-term excellence, to make everything subordinate to the single goal of maximizing net returns for everyone who comes along for the ride.
It might happen someday. But I wouldn’t hold my breath if I were you.
- A limited number of his clients owned partnership interests without a minimum threshold, or “hurdle,” for Buffett to earn fees, but for those accounts Buffett took a lower performance fee. ↩︎