Wednesday, September 21, 2011

Why Berkshire Is No Bargain

Whitney Tilson, manager of T2 Partners, tells the WSJ that Berkshire is cheap.  So cheap, in fact, that Berkshire is Tilson's largest position.  I disagree, strongly, with his analysis that Berkshire is cheap.

Warren Buffett works for free.  There are very few people in finance, money management especially, who work for free.  (This is why he pays no taxes, right?  If we all worked for free, and sold stock when we needed cash, we'd pay very low tax rates too, but I digress...)

With great fanfare, Berkshire has hired Weschler and Combs as money managers.  Who knows what they're getting paid right now.  We do know two things for certain:
  • They aren't working for free
  • Their now spectacular credentials ("Yes, Warren hired me to manage Berkshire's money...") mean that their market price is the lion's share of a hedge fund fee: 2% management fee and 20% performance share.
Over the next 10 years, Berkshire is going to move from one portfolio manager who works for free to any number of portfolio managers who work for something (again, guessing) closer to a 10% - 15% share of their performance.  As I've written here, performance fees paid to venture capitalists, private equity firms and hedge funds amount to extremely valuable the managers, not the investors along for the ride.

Fundamentally, Berkshire's compensation model must shift from altruist investor to commercial fund-of-funds.  Yes, right now Warren Buffett is hiring managers much like a fund-of-funds invests in hedge funds.  This new model may work, but it certainly has far higher embedded costs of operations than the current operation. 

The succession planning challenges faced by the board have become real.  They will have real costs.