Street Capitalist: Event Driven Value Investments

Here’s an excerpt from an interview with Nassim Taleb at Portfolio:

N.N.T.: A burning building is going to be a lot more anecdotal than a statement about what happened—and a statement about what happened is going to be a lot more anecdotal than statistics of what happens in the world to put it in context. To give you an idea, I go to Beirut all the time. If I watched television, I couldn’t—it would sort of convince me to not go. The risk of death is nothing, right? I mean, it’s minor compared to the risk of being killed in a car accident, you see?

L.G.: So statistically it’s more likely to have a car accident and injure yourself in a Westchester bedroom community than in—

N.N.T.: Than in Lebanon. Iraq is the only place where you’re vastly much more likely to get hurt or killed, but if you count how many people die every year in the States by car versus how many people die violent deaths in Lebanon, it’s minor.

World According to … Nassim Nicholas Taleb (Portfolio)

Taleb’s contrasting of anecdotal information versus factual information is important for investors. The news, especially on TV seems to have a habit of creating manias and panics. Just a week ago I witnessed this when my local news in Houston reported about “Hurricane” Edouard ,which turned out to be just a tropical storm. Instead of giving us credible information to make informed decisions (like the fact that most refineries in the Gulf of Mexico did not shut down) they bombarded us with footage from past hurricanes and gave out emergency precaution information.

Similarly, financial news outlets do the same thing. The minute-by-minute reporting of how the market moves only creates noise and clouds the judgement of investors. I don’t know if you have to turn off the news and stop reading newspapers like Taleb does, but you should know how to tune out and exploit it. The retail sector is a good example of this because they have to report same store sales on a monthly basis. The monthly reporting adds more noise to the market and makes retail more volatile than most. If you let the noise get to you, you’ll sell your positions out of fear because of the wide swings in a stock’s price that with missing one month’s same store sales estimates. But if you understand that the noise is often without merit, you’ll find that there are attractive buying opportunities created by these irrational movements.

The video above is a great interview between Charlie Rose and Mohammed El-Erian of PIMCO.

El-Erian gives us his views on the a couple of big transformations that are changing our financial system

1. The engine of growth is shifting from the US to the rest of the world.
For a long time the global economy has been fueled by the US consumer, it’s now tapped out. India and China are emerging to take our place along with other economic powers.

2. Poor countries are financing the rich.
He specifically criticizes how Americans spend, using our homes as “ATM” machines to finance our spending and purchase goods beyond our means. Conversely, the countries that emerged from financial crises saved.

One other aspect that I enjoyed is El-Erian’s criticism of the G7 and how because of their bias in favor of western nations, they ignore emerging economic powers like China and India. This is unfortunate because those two countries are shaping up to be important long-term players in our global economy and should be included when coordinating changes in policy.

News stories are already circulating about the poor performance of certain hedge funds (quite a few within the “value” group). While my portfolio is largely concentrated in Fairfax Financial (FFH), its performance has still fallen from its highs and one of my newer positions – Air Transport Services Group (ATSG) is almost 50% lower than my initial position. It is times like these that an investor’s fortitude is really tested and Jason Zweig’s latest Intelligent Investor column How to Control Your Fears In a Fearsome Market (WSJ) provides a solution for us.

Zweig points out that seeing your investments fall actually triggers a neurological response by your brain:

Merely reading the words “market crash” in this sentence can instantaneously jack up your pulse and your blood pressure, the output of your sweat glands and the tension in your muscles. Stress hormones will flood your bloodstream. Your eyes will widen and your nostrils flare, making you hypersensitive to any further danger. All this occurs automatically, involuntarily and unconsciously. You can’t be an intelligent investor if, without even knowing it, you are thinking with the panic button in your brain.

The good news is that these feelings can be controlled. Zweig outlines four steps for controlling your fears. He says first, we need to:

Reappraise. Forget what you paid for that stock or fund; instead, imagine it was a gift. Now that it is priced, say, 20% more cheaply than in December, should you want to return the gift?

I try to use the reappraisal method often. You need to really write out your thesis for investing in a company so that you can test it against any changes in the environment. It’s also pretty helpful to talk to other people about the same idea and get some contrasting opinions – this can test your thesis further.

This line of thinking is similar to what Zweig advocates next:

Step outside yourself. Imagine that someone else has suffered these losses. Think of questions you might ask to give that person advice: Other than the price, what else has changed? Is your original rationale for this investment still valid?

Then there is taking yourself away from the market:

Control your cues. Even witnessing someone else’s pain, or glancing into another person’s frightened eyes, can fire up your amygdala. Because fear is as contagious as the flu, quarantine yourself from anyone who obsesses over the momentary twitching of the Dow. Tear yourself away from the computer or television; better yet, while the market is closed, make an advance date with friends or family to get your mind off stocks during market hours.

Many of the best investors spend most of their day reading and researching. There s a definite lack of action, it is the antithesis of day trading. Some of the best investors don’t even reside in financial capitals like New York City or London. They’re often found in places that they are comfortable in. Warren Buffett has Omaha and Sir John Templeton had the Bahamas. By removing yourself from the crowd you give yourself room to think and breathe.

Finally, Zweig ends with a nod to Benjamin Graham:

Track your feelings. Fill in the blanks in this sentence: “Today the Dow closed down [or up] ___ points, and that made me feel __________.” Your emotions shouldn’t be hostage to the actions of the roughly 100 million other people who compose the collective beast that Benjamin Graham called “Mr. Market.”

The daily movements of the market are just noise; they burden us and cloud our judgment. I find that it is helpful to not really look at the movement of the market every day. One of the things I’ve noticed is that over and over, when investors like Buffett are on CNBC or Bloomberg they’re asked poor questions like “futures have moved X this morning, what are you thinking?”Often the answer is that they don’t care because it has no impact on their own investing.

Zweig’s checklist is excellent and what I like is that it is a systematic approach for re-evaluating your investments and keeping your cool under pressure. By taking this kind of approach, you distance yourself from emotions. Some of this is applicable to trading in general. A friend who recently began day trading told me that his main problem is that he’s nervous when pulling the trigger on buys and sells. I told him that his main issue is that he hasn’t really come up with a system for how he trades. Until he does, he will be at the mercy of his instincts and emotions which will prevent him from acting properly under pressure.

Zweig says that this kind of checklist will help us counteract the signals that our brain sends, so if you aren’t using one already maybe it is worth adopting. If you doubt the effectiveness of a simple checklist look at a graver scenario – being a patient in the intensive care unit at the hospital. Peter Pronovost a critical-care specialist at Johns Hopkins Hospital started employing a checklist at ICUs in 2001 with great success:

Pronovost and his colleagues monitored what happened for a year afterward. The results were so dramatic that they weren’t sure whether to believe them: the ten-day line-infection rate went from eleven per cent to zero. So they followed patients for fifteen more months. Only two line infections occurred during the entire period. They calculated that, in this one hospital, the checklist had prevented forty-three infections and eight deaths, and saved two million dollars in costs…

Within the first three months of the project, the infection rate in Michigan’s I.C.U.s decreased by sixty-six per cent. The typical I.C.U.—including the ones at Sinai-Grace Hospital—cut its quarterly infection rate to zero. Michigan’s infection rates fell so low that its average I.C.U. outperformed ninety per cent of I.C.U.s nationwide. In the Keystone Initiative’s first eighteen months, the hospitals saved an estimated hundred and seventy-five million dollars in costs and more than fifteen hundred lives. The successes have been sustained for almost four years—all because of a stupid little checklist.

The Checklist (The New Yorker)

The I.C.U. and the market have similarities. Both can be complex and terrifying, leading doctors and investors to make mistakes. Pronovost noticed that in many cases at the I.C.U. doctors would forget to take even simple precautions. In a similar sense, an investor may forget the concept of intrinsic value when watching one of their companies dive 50% in one day of trading. If you believe that in order to make out-sized market beating returns you have to take a contrarian approach, then you will have to master your fears and emotions. A checklist provides an easy way to do both.

Today’s New York Times magazine has an article on Jim Rogers and green energy. Not Jim Rogers the commodity investor, but Jim Rogers of Duke Energy. The article is a very worthwhile read. Value investors aren’t known to be the most visionary people, we tend to pick our spots and stick with them. Usually, when I read articles on green energy, I’m not very enthused. The latest solar companies and ethanol companies are often fueled by untested technologies that lack the financial viability needed to be a solution for our energy problem. The article though is interesting:

When asked why Rogers ended up taking such a contrary approach to his job, friends point to the fact that he never trained as an engineer — the background of most energy executives. He isn’t as insular, Sharp points out, so he’s interested in what critics have to say. “Usually what people do is circle the wagons,” Sharp says, “but he listens.”

Rogers comes from a public advocate and legal background, I think it’s one thing that lets him see the problems we face from a different perspective than the rest of the industry. Sometimes, when faced with complex problems that seem unsolvable, they can be solved from going contrarian or bucking the usual trend. So maybe Rogers has some promise.

Allegations like these perturb Rogers no end. Many protesters, he told me, are an “eco elite” who don’t understand the need working-class people have for affordable energy. But then, in another breath, he admits he also understands why they view him askance.

“There’s an interesting contradiction in my position,” he said. “I’ve struggled with it. On the one hand, I want to smooth out the transition for the customers, because we’ve got low prices. But on the other hand, and this is sort of the awkwardness of it, the other truth is as prices go up, people’s behavior is modified.” Change needs to come, but how fast?

“That’s the art in this, and not the science.”

A Green Coal Baron? (New York Times)

These dilemmas: keeping in mind the working class, the speed of our change, and the degree of transition will all shape our energy policy.

I didn’t attend the annual meeting, but I have read through a few Q&As and was pretty happy about the questions and answers. What I’ve done here is used Peter Boodell’s notes from here: Berkshire Q&A Transcript by Peter Boodell and annotated them with some of my own thoughts.

There are only 9 of the questions listed here but you can read the rest at the link above. Peter Boodell did an excellent job so I suggest you read all of what he’s transcribed.

I’ve chosen to use the quotes that best resonated with me because some things I just felt were too clear/have been reiterated by Warren Buffett a thousand times (things like invest like buying a business).

Q16: Germany, fixed income markets at discounts. Will you take advantage?

WB: We have seen some important dislocations. I’ve brought some figures. Tax exempt money market funds [auction facilities]. $330b of them. Repricing of first grade muni’s every 7 days. LA County Museum of Art. Jan 24th: 3.1%. Jan 31st: 4.1%. Feb 7th: 8%. Feb 14th: 10%. Fell back down to 3% on Feb 21st. Now 4.2%. Somehow rates were much higher on Valentine’s day. Look at bid sheet of Citigroup. Repricing every 7 days. You would find same issue on several different pages. Same broker at same time on different pages quoting different prices. On one page we bid 11%, and someone else bid 6%. You found this in 1974, after LTCM. These are great times to make extra money. Auctions in esoteric securities. We have $4bil in it. We will have made some insignificant money in this for a few months. There may be opportunities that we can’t spot. If you have enough time you can figure out something that are really mispriced. We don’t play with that, just don’t have enough time. If you spend enough time you may find those that Charlie and I can’t find because we just can’t look at that many things.

CM: What is interesting is how brief these opportunities are. Some idiot bought muni’s, bought 20x what he could afford at incredible margin, those things were dumped on margin calls and suddenly got really mispriced. The dislocation was very brief, but very extreme. The moves are fast and short. You must think fast, resolutely. You have to be like man who stands by a stream and fish comes by once a year.

The Q&A here is most indicative of the idea that Berkshire does not operate on a consensus basis. Decision making is relegated to mostly Buffett with Munger consulting. The advantages here are huge, Berkshire is able to take quick, opportunistic investments in the market.

Other organizations might not be able to move so quickly and make big bets in areas that were seemingly dislocated. An example that comes to mind is the story about Goldman Sachs’ great sub-prime bets. The organizational structure at Goldman was arranged in a way where traders were able to quickly push ideas like that to the company’s top management and act quickly. Without that sort of structure there is a high likelihood that you would have missed out, and we saw that. Certain investment banks did not make the huge “short sub-prime” trades and suffered as a result.

What this indicates to me is that most value investors are probably best suited to acting mostly alone. The fact is, inherently many value investments arise out of highly contrarian situations. The decisions here are not easy to make in a group situation and make it easy for you to miss out.

Q20: Philadelphia, I’m 12 yrs. There are a lot of things they don’t teach you in school, what things should I be looking into?

WB: I’d read a daily newspaper. You want to learn about world around you. Bill Gates quit at letter P in World Book Encyclopedia. Just sop it up, and find what is most interesting to you. More you learn, the more you want to learn. It is fun.

CM: My suggestion is that the young person has already figured out how to succeed in life.

What I feel important to mention here is how Buffett says to learn about the world around you. A few investors that I speak to spend most of their time just reading the Wall Street Journal or Financial Times. I think that this is a good start but it does not give you a comprehensive view of the world. You can read more. Reading more seems to fit in with Charlie Munger’s Latticework of Mental Models. Most of the books Munger has recommended at past meetings typically come from science backgrounds where the c onnection is investing may not be immediately recognizeable.

Reading business publications will only help you to an extent. I could read thousands of books on value investing, but it would not necessarily help me. They all say mostly the same thing. Look for companies that are undervalued. Take a long term horizon. Maybe they’ll express some accounting concepts. But they don’t teach you enough to act in an uncertain world, and that’s the world we live in.

Buffett has referenced this idea a bit when he discusses the four CIO candidates. He says he is looking for someone wired in a way that they can perceive and deal with risks that we have never faced before and I believe this is where the lattice work of mental models really comes in to play.

Q26: New York City. American Express and Washington Post – big positions. How do you get confident enough?

WB: If we were running only our own money, 75% of net worth outside Berkshire has never been a significant amount. Several times I have had 75% of my non-Berkshire net worth in a situation. You will see things where it would be a mistake not to act. You won’t see them often, and the press and your friends won’t be talking about them.

CM: Sometimes I have had more than 100% in individual investments.

WB: You just had a good banker.

WB: Look at LTCM – they put 25x their money in things that had to converge – but couldn’t play out the hand. There are people in this room with more than 90% of their worth in Berkshire. I saw things in 2002 in junk bonds. You could have bought Cap Cities in 1974 – selling for 1/3 the property value, with best manager and in a good business. You could have put 100% in Coca-cola when we bought it and that wouldn’t have been a dangerous position.

CM: Students learn corporate finance at business schools. They are taught that the whole secret is diversification. But the exact rule is the opposite. The ‘know-nothing’ investor should practice diversification. Diversify– but it is crazy if you are an expert. If you only put 20% in the opportunity of a lifetime – you are a not being rational. Very seldom do we get to buy as much of any good idea as we would like to.

What is most important to takeaway here is the idea of concentration with respect to your positions. If you want to truly earn outsized returns you must concentrate your positions with ideas that you have high conviction in. If you look at most of the value investors out there, you’ll notice a huge wealth gap between Buffett and pretty much everyone else. A good answer for that is simply due to how they invest their wealth. Around 99% of Warren Buffett’s wealth is invested in Berkshire and Berkshire’s rise has been instrumental in the rise of his own wealth. There’s no other way around that.

Part of this has to do with good analytical work on your part. This means that doing your own analysis of a company, not relying on a random stock tip you pick up. If you put in the effort you should be able to be reasonably comfortable with a highly concentrated portfolio.

Mohnish Pabrai is a proponet of the 10 position portfolio, because he argues that when you exceed 10 positions the benefits of diversification fall, you end up being too diversified and it erodes on your returns. He also has a limit that no position can exceed 10% of Pabrai Funds, again, this is a pretty good idea. Pabrai targets for some of his investments to go totally to zero, but for others to go gain 100%, and for some to not move at all. So far this method has worked quite well and even with DFC becoming a zero, Pabrai funds has not faced massive redemptions like we’re seeing elsewhere, so things must be working.

The one caveat could be when you employ leverage. If you’re employing leverage whilst utilizing a highly concentrated portfolio, you can lock yourself into a death spiral due to volatility. The fact is, a concentrated portfolio will most likely swing widely in value on a month-to-month basis. But in the long term it should do great. Unfortunately, if you are employing leverage you run the risk of being at the mercy of a margin call and not the merits of your own investments.

Shareholder: What do you think of the food shortages we’re seeing right now?
Munger: Turning American Corn into motor fuel is one of the dumbest ideas i’ve ever seen. The idea is so monstrously dumb it is probably on its way out.

I’ve blogged about the Food Crisis before. It’s important, there is no way around it. As emerging market nations grow, they will have larger middle classes who are going to eat more food. Take China, India, or even Brazil. All of these countries are having larger middle classes as their consumption is appreciating in step. This creates a huge increase in demand for food.

Couple this with the supply aspect. Droughts are scattered around the world, we had a cyclone in Myanmar, and finally farmers are planting corn for ethanol which reduces the amount of space that’s left for other crops, which pushes them up in value as well. Certain areas are cutting their production of key cereal crops, like Saudi Arabia who used to produce 12% of the nation’s cereal crops. By abandoning that production, they’re going to fill the 12% by acquiring it from the global market, thus taking more off the table for other countries and helping push prices higher.

Q34: Idaho. Are investment banks too complicated? Risks unknown.

WB: Exceptionally good question. Answer probably yes in most places, though there are a few CEOs I respect a lot. Gen Re had 23k derivative contracts. I could have spent full time on that, and I probably still couldn’t have gotten my head around it all. And we had exposures that I thought were possible and heads of business units didn’t – I don’t want slim, I want none. I am Chief Risk Officer. If something goes wrong, I can not assign to committee. I think big investment banks and big commercial banks are almost too big to manage effectively in way they have elected to run their business. It will work most of time. You may not see the risk. A 1 in 50 year risk - it won’t be in interest of 62 year old executive who is retiring at 65 to worry about it. I worry about everything. Many CEOs say they didn’t know about what was going on. It’s easier to admit he doesn’t know what’s going on than to admit that he knew what was going on and let it go on. I’ve been asked for advice on regulation. Somehow press hasn’t picked up on this too much. OFHEO supervised Fannie and Freddie – activities had public element, and were semi-regulated. For 200 people it was their sole job to examine the books. They were 2 for 2 with 2 of biggest accounting scams in history of world. Person at top must have it in their DNA to see risks. In many ways, there are firms that in terms of risk are too big to manage. If too big to fail, there are interesting policy implications.

CM: It is crazy to allow things to get too big to fail, run with knavery. As an industry, there is a crazy culture of greed and overreaching and overconfidence trading algorithms. It is demented to allow derivative trading such that clearance risks are embedded in system. Assets are all “good until reached for” on balance sheets. We had $400m of that at general re, “good until reached for”. In drug business you must prove it is good. It is a crazy culture, and to some extent an evil culture. Accounting people really failed us. Accounting standards ought to be dealt with like engineering standards.

WB: Salomon was trading with Marc Rich who had fled country. They said they wanted to keep trading with him. Only by total directive could we stop it. I think Fed did right thing with Bear. They would have failed on Sunday night, and walked to a bankruptcy judge. They had 14.5tril of derivative contracts – not as bad as it sounds, but the parties that had those contracts would have been required to undo the contracts to establish the liability from the estate. The $400m at Gen Re we had took 4-5 yrs, at Bear it would have been 4-5hours. It would have been a spectacle. Two of witnesses said at testimony, ‘we understood we couldn’t borrow unsecured, but we didn’t understand we couldn’t borrow secured’. The world does not have to lend you money. If they don’t want to lend you money, an extra 10bps won’t make a difference. It depends on people’s willingness to lend you money which comes down to how other people feel about you. If you are dependent on borrowed money, you have to wake up every day worried about what world thinks of you.

I don’t think there is anything to add here, I just felt like their arguments were strong. Particularly Charlie Munger’s comments on trading algorithms and accounting. It was the overconfidence in financial models that lacked a proper future looking component that has gotten us into a tremendous amount of mess already. In terms of accounting, simply put, we’ve having billions of dollars seemingly evaporate from balance sheets per quarter. Or we have sketchy actions where banks offer financing to cover the amount needed to buy debt off of their balance sheets. These situations lead to a really slippery slope.

Q51: How do we better measure leverage and accounting of assets, integrity?

WB: It is a very tough thing. I still lean strongly towards fair value accounting – it is hard to use, but should we use cost? I think there are more troubles when you start openly valuing things at prices that don’t matter instead of best estimates even if inaccurate. I would stick with financials reporting assets at fair value. When you get into CDOsquared, the documentation is enormous. If you read a standard residential security – it consists of thousands of mortgages, then different tranches. Then take CDO and take junior tranches on a whole bunch of juniors – put them together and diversified in theory – a big error to start with. That was nuttiness squared. You had to read 15,000 pages to get a CDO, then 750k pages to evaluate one security in a CDOsquared. To let people use 100cents they paid vs. the 10cents it trades at in market is an abomination. Fair value discipline, mild as it may be, may keep managements from doing some stupid things. I lean toward the market value approach. When you get towards complex instruments, I don’t know how you value it. Charlie, back at Salomon I think you found one mismarked by $20m, right?

CM: A lot goes on in bowels of American industry which is not pretty. A lot of people got overdosed on Ayn Rand. They would hold that even if an axe murderer in a free market is a wise development. I think Alan Greenspan did a good job on average, but he overdosed on Ayn Rand that whatever happens in free market is going to be alright. We should prohibit some things. If we had banned the phrase, “this is a financial innovation which will diversify risk”, we would have been far better off.

Most of the points here are reiterated in my own comments above, but I’ll add one thing. This quote here is probably one of the main reasons I really love reading anything from Charlie Munger. He’s an investor who is attacking Ayn Rand. There seems to be this gross obsession with Ayn Rand that perversely affects the financial community.

A while back I did a post on the follies of Value Investors, and I discussed how some value investors obsess over a strict ideology on how they should invest that sometimes it clouds their judgement detrimentally. The Ayn Rand obsession is another case of that. An argument Munger makes repeatedly is not to become an extremist, someone who follows only one really strong version of some ideology. You can see it in his “man with the hammer” idea.

When you get swept up in a philosophy like Rand preaches, you run the risk of making mistakes because of your tunnel vision.

Q55: To win, first you must not lose. If corporate default rates escalate, will the credit default swap problem materialize as a threat to financial system? You are great pricer of risk. You must consider selling insurance without pricing appropriately. Is there a chance CDS market may eclipse subprime?

WB: CDS notional is about 60trillion, there are lots of double counting, etc, but no doubt it is a lot of money. They are swaps, or insurance against companies going bankrupt. We have written two types of derivatives, and we have insured a swap that pays to someone else in event of default on high yield indices. I think we will make significant money. I think there is no question that corporate default rate will rise. That has been included in price in writing this insurance. Will CDS market lead to chaos? Probably not, but if bear had failed you would have had chaotic conditions. A CDS is a payment by one party to another. When someone loses money on a loan, they’ve lost real money, but there is not a swap of dollars immediately when loan goes bad. In CDS, there is an exchange of cash. Whether counterparties fail — I don’t think it will happen. We’ve had enormous collateral payments from one firm to another in this recent crisis. Fairfax Financial made $1bil in CDS. This means another guy lost $1bil. They have been most volatile of instruments – and it really hasn’t created a problem in system. If Fed must step in, I don’t think it will be due to CDS. It may cause big losses, but will be matched by big gains by others. There is a problem of an overnight disruption in the system (bear, nuke bomb) – where discontinuity and collateral postings inadequate. At that time, large CDS exposure could exacerbate chaos to considerable degree.

CM: Could we have mess in CDS? Yes, but stupidity not as bad as sweeping bums off skid row to give them houses. There is an issue of insuring against outcome of losing money on $100mil bond issue, when you have $3bil of contracts on $100m bond issue – there are incentives to manipulate the smaller loss to make big collection on the larger position. It used to be illegal to buy life insurance on people you didn’t know, with big payoffs in event of their death. Why did we want enormous bets to be made in unregulated markets? We have a major nutcase bunch of regulators and proprietors in this field.

WB: Charlie 1 point, Invisible Hand 0 points.

I don’t think the credit default swap market is bad. It serves a real purpose like Munger says, as opposed to his example of using bums to collect insurance. The CDS market helps hedge risk for coporations, and while there is some counter-party risk, I don’t think it is as bad as people make it seem.

Also, I was happy to see Buffett mention Fairfax Financial Limited (FFH).

Q59: Jim James, MN. Will you share your influences on you, your educators?

WB: Biggest educator was father. It is important who you marry. Those are great teachers. Ben Graham. Dave Dodd. I devour books. Charlie likes Ben Franklin. My grandfather at the family grocery store. Most important job you have is to be the teacher to your children. You are the big great thing to them, you don’t get rewind button, you don’t get to do it twice, teach by what you do not what you say. By the time they get formal school they would have learned more from you than school. Provide warmth and food and everything else. It won’t change when they get to graduate school – and you get no rewind button. You teach with what you do, not what you say.

CM: Differing people learn in differing ways. I was put together to learn by reading. If someone is talking to me – it doesn’t work as well. With a book, I can learn what I want at speed that works. It works for my nature. For those people who are like me, welcome, it is a nice fraternity.

WB: Did you learn more from your father? Your father probably had more impact on you before your readings?

CM: Father did have an impact. He always took more than his share of work and risk – that was helpful. Conceptual stuff – I learned from books. Those authors are fathers in a different sense.

WB: If you keep reading books, you’ll learn a lot. If you read 20 books, you can learn a hell of lot. Having right parents is very lucky. If you get the right spouse, that’s just doubled down.

This goes back to my comments that I made earlier regarding Munger and the Latticework of Mental Models. I’ve seen that Buffett reads multiple newspapers every day (The Financial Times, USA Today, Omaha World Herald, and The New York Times)

I think it’s important to understand the existance of biases in the world, again, if you do not you run the risk of having tunnel vision and missing some of the parts of the equation. This is simple, if you read something that has a left-bias, maybe read something with a right-bias as well. Do not limit the perception you have of the world around you, it’s just a dumb thing to do. In an investing environment tunnel vision/acting only on biases can be devastating. It’s important to be open-minded but also confident in yourself so you can make the right decisions and employ concentration.

Q61: Pharma? (How do you valuate the pipeline of drug companies)

WB: Unlike many businesses, when we invest in pharma We don’t know answer on pipeline and it’ll be different pipeline 5 years from now anyway. We don’t know whether Pfizer or Merck etc have better chance, which of those will come out with a blockbuster. But we do feel we have a group of companies bought at a fair price that overall will do well - should offer chances for decent profits. These companies are doing very important things. I could not tell you potential in the pipeline. A group approach makes sense. Not the way we would go at banks. If you buy pharma at reasonable multiple, you will probably do okay 5 – 10 yrs from now.

CM: You now have a monopoly on our joint knowledge of pharmacology.

What is outlined here is to me, a method for investing in industries or countries with uncertainties that are greater than you are used to. Concentration is somewhat sacrficied, but at the same time you are making bets across a wide number of cheap companies.
This is a good way to invest in an area where you want exposure but are unsure of who will be the best to profit from whatever you perceive to be coming. Some may lose, but you’re bound to come out on top if you bought the pool when they were cheap. Buffett has employed this method before in Korea and it worked particularly well. It is specifically noted that Buffett would not employ this with banks, a place where he has more expertise and can leverage that expertise for concentration. But maybe he would feel comfortable using 10% of his capital on a pool of 10 banks, or something similar.

I wasn’t satisfied with a few answers, but they dealt mostly with social issues. On some of these issues, I think it’s important to look at the contrary perspective of things, from the eyes of the people who may have had to endure hardships because of their situations. Contrarian thinking and overcoming bias is a good thing, so you should make an effort to practice it. I think in the end it will help you tremendously.