[00:02:59] Kyle Grieve: Another thing that gravitates me towards his early days is in regard to the fact that he invested much smaller sums of money, and I believe this allowed him to use strategies that were just not replicable by a lot of other investing legends or investors that are managing larger sums of money, such as where he is today.

[00:03:18] Kyle Grieve: Thirdly, in the time of the Buffett partnerships, he was hungrier about finding very specific opportunities at a younger age. And he spoke to this in his letters as he aged that that hunger kind of, it changed as he got older. Then the kind of the last one here was that he discussed and detailed the different subtypes of investments that he made and why he was making them.

[00:03:36] Kyle Grieve: And I really enjoyed the fact that he did this because he was very intentional about the different types of investments he made. And, and he understood them at a really deep level. So I’m really excited just to share all of my learnings with you today. So I’ve found that I greatly relate specifically to his early days as I personally enjoy looking at a lot of these kind of undiscovered investing opportunities.

[00:03:58] Kyle Grieve: And this was exactly the type of investing that Warren was doing in those early days. So in the 2024 Berkshire Hathaway annual meeting, Warren mentioned how impressed Charlie was after they met. Because Warren was aware of some obscure stock based in California that barely any investor had ever heard of so, you know Warren He wasn’t always investing in Apple if you look back to his early days He was investing in stocks that literally no one really understood other than you know, Charlie Munger in this example here So today I’m really excited to discuss a book that I just don’t see mentioned that often But found incredibly informative.

[00:04:34] Kyle Grieve: And that’s going to be Warren Buffett’s ground rules by Jeremy Miller. So the book is about Warren Buffett’s ground rules, which he learned while operating the Buffett partnership. So the author did a wonderful job of summarizing a bunch of large lessons from these days and this part of his career. So he made the book practical.

[00:04:53] Kyle Grieve: He showed how pretty much any investor could take a very similar approach and why it makes sense. The way the book was kind of structured was that Jeremy would give his thoughts at the beginning of each chapter and then he would take passages from the Buffett partnership letters and just allow Warren to give the reader his own reasoning on why he did what he did for his partners back in those early days.

[00:05:13] Kyle Grieve: So let’s get started by discussing the basics of Warren Buffett’s ground rules. So there were the, the ground rules, but then he had these primary principles that he followed that he stated, I think, very early in these Buffett partnership letters. So there’s three of them. The first one is just the Mr.

[00:05:28] Kyle Grieve: Market analogy, which I think everyone’s going to be aware of. The second one is the business owner’s mindset. And the third one is dealing with forecasting. So R and TIP listeners are probably going to be very well versed in the first of these two points that Warren learned from his mentor, Benjamin Graham.

[00:05:44] Kyle Grieve: But for those who aren’t, I want to just briefly go over them in a little more detail so that I’m not leaving you hanging. So the Mr. Market analogy uses a theoretical person that’s called Mr. Market to basically just discuss how the market tends to act. Mr. Market will try to trade stocks with you every day.

[00:06:01] Kyle Grieve: Sometimes, Mr. Market is euphoric. In those cases, Mr. Market will charge you a lot of money for the stocks that you want, but sometimes Mr. Marco will be depressed and beg you to sell a stock to you at rock bottom prices. Much of the time, Mr. Market is in a neutral mood. So the key point is that you should understand Mr.

[00:06:20] Kyle Grieve: Market’s mood and act accordingly. When Mr. Market is euphoric, it’s probably not going to be the best time to buy. Selling might be a better option. And when Mr. Market is depressed, well, buying or adding to current positions is usually going to be the intelligent move. So I just wanted to make a point here that you have to remember that Mr.

[00:06:40] Kyle Grieve: Market is just a thinking tool. So just because there are areas of the market that are expensive or cheap does not mean everything in the market is expensive or cheap. So the second point here is on the business owner’s mindset. So the business owner’s mindset basically means that you think of stocks as a fractional ownership stake in a real business.

[00:07:00] Kyle Grieve: So that means you don’t trade the business away on things such as interest rate changes, macroeconomic factors, wars in far off countries, market sell offs or price fluctuations. A business owner just focuses on the businesses that they have. So a great example that I really like using when I’m trying to think of this business owners mindset is just imagining that I personally own a specific business.

[00:07:24] Kyle Grieve: So let’s, you know, I’m in Vancouver, British Columbia. So let’s say I own a laundromat in Vancouver, BC. Okay. So this laundromat will just for the simplicity of this example, we’ll say it’s def free. Let’s say I’ve owned it for five years. And let’s say that, you know, I don’t actually have to do anything. I just own the business and it just produces cashflow that comes back to me and I get a nice dividend to check, let’s say at the end of each year.

[00:07:44] Kyle Grieve: So now let’s say I’ve, I’ve owned this business and then a couple of things happen. Let’s say interest rate goes up. Let’s say there is a war on the other side of the planet. And let’s say that stock market plunges. So then I’m just going to ask myself, okay, would any of these events make me want to sell my business in Vancouver, British Columbia?

[00:08:00] Kyle Grieve: And realistically, it’s doubtful that these events would impact my business at all. Interest rate changes make no difference to my business. People are always going to need to clean their clothes. You know, it’s not really a business where you have an option of cleaning your clothes. I mean, you could always go and buy a washing machine, of course, or use the services of a laundromat.

[00:08:19] Kyle Grieve: So yeah, interest rates just aren’t going to make too big of a difference to the business. And like I said, it’s also debt free. So, you know, maybe a war could have an impact on the global economy, but it’s probably not going to impact the fact that my business just doesn’t require me to buy things from impacted areas.

[00:08:36] Kyle Grieve: So I’m still going to be able to run my business. You know, maybe there’ll be some short term pricing issues, but for the sake of this example, we’ll just say that it doesn’t make any difference to my business. And then obviously the last one there, the fact that the stock market goes down makes zero difference to me.

[00:08:52] Kyle Grieve: The stock market going up, down, sideways makes no difference to the dividend payments I’m getting paid at the end of each year. So, to me, this is kind of the key to investing in public stocks like a business owner. The other key point to remember is that what happens in your business can often have delayed recognition in public markets.

[00:09:10] Kyle Grieve: So Buffett sums it up really nicely, the course of the stock market will determine to a great degree when we will be right, but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen, not when it should happen.

[00:09:28] Kyle Grieve: So the third point that we talked about here was just kind of dealing with forecasts. Buffett is not a fan of forecasters. He said prophecy reveals far more of the frailties of the profit than it reveals of the future. My favorite case study on the frailties of market forecasting and trying to profit from it is examining John Maynard Keynes, one of the most influential economists to ever live.

[00:09:50] Kyle Grieve: So Maynard Keynes, as he liked to go by, started his investing career by trading and basically attempting to use his superior knowledge of economics to try and forecast what would happen in markets. So for nearly a decade, he toiled in these types of short term trades. Losing 80 percent of his capital from peak to trough.

[00:10:09] Kyle Grieve: So pretty rough. He finally smartened up and settled on a different investing strategy. So no longer would he attempt to prophesize market movements? No, instead he use the value of a stock as his investment guide, basically, you know, buying when the price was far below value and selling when the price exceeded value, kind of your traditional value investing principles.

[00:10:30] Kyle Grieve: So next here, I want to move on to Buffett’s thoughts on Einstein’s 8th wonder of the world, which is compounding. So Buffett was very, very smart about compounding from a young age, and it’s quite impressive. So one of Buffett’s first books that he read on businesses was Francis Minaker’s book called 1000 Ways to Make 1,000 Practical Suggestions Based on Actual Experience for Starting a Business of Your Own and Making Money in Your Spare Time.

[00:10:54] Kyle Grieve: Very long title, I know. So Warren learned an incredible lesson though on compounding from one of this book’s case studies. So in chapter 10 of 1000 Ways to Make 1, 000 Minaker reviews a case study about a man named Harry Larson. So Harry Larson was shopping one day. And some curious person, I guess that he met there, asked him what he weighed.

[00:11:14] Kyle Grieve: And Harry did not know what he weighed. So he basically went over to a scale machine, threw a penny into it and got his weight. So an interesting thing happened though, while he had this experience as, as he waited in line to buy whatever he went to go shopping for, he basically observed that there were multiple other customers that were just going up to the scale, putting a penny in, finding out what they weighed.

[00:11:36] Kyle Grieve: And so that just kind of got him interested. So he went over and inquired with the store owner about the weighing machines and just trying to figure out, you know, what are the economics of it? So basically, the store owner made 25 percent of the machines profits while doing pretty much nothing. But the remaining 75 percent that he was interested went to the owner of the weighing machine.

[00:11:54] Kyle Grieve: So from there, Harry took some of the savings and just bought three of those weighing machines. From those three machines, he started making about 98 a month in profit. Now, this next part is what really hit Warren. Harry took all the profits from these machines and then plowed the earnings from those three machines into 67 more machines without paying a penny from his bank account.

[00:12:15] Kyle Grieve: So with 70 machines each earning 33 a month, he would clear about 2, 300 a month. So Warren could see that earning something as small as a penny many, many times over could add up to very, very large sums of money over time. And with that, Warren’s obsession with compounding was born. The author points out that Warren’s conceptualization of compounding was so good in his mid-twenties that he knew he’d be rich if he could just basically continue compounding his capital at his historical rates of return.

[00:12:44] Kyle Grieve: So he returned to Omaha with a little over 100, 000 after working with Benjamin Graham. And according to inflation adjusted numbers, this, 1 million today. At this point in life, Warren basically figured he’d do a couple of very simple things, read a lot and, you know, maybe attend some university classes.

[00:13:01] Kyle Grieve: But as Warren’s wealth grew, he started spending more and more time trying to figure out what the best uses of his wealth would be. This was especially in regard to his children. You know, Warren has famously said that Jesse Owens child’s development would not necessarily be helped by allowing them to start a 100 yard sprint at the 50 yard line.

[00:13:20] Kyle Grieve: Perhaps you let them start at the 10 or 20 yard line to give them a little bit of help, but you don’t want your child basically cruising through life. He felt he would be actually doing them a disservice if that was the case. Well, let’s get back to some pretty epic thought experiments that Buffett discussed in his letters.

[00:13:34] Kyle Grieve: Regarding compounding. So the first one here was a very popular story about the Indians who own the Island of Manhattan. So essentially in 1627, it’s hold it for what appears to be a very piddly sum of 24 and Buffett then thinks about, okay, let’s say they did sell it and now let’s say they had an investment advisor who was really good with compounding money at not super high rates of return and could do it for decades and centuries.

[00:14:04] Kyle Grieve: So basically, he came up with this number six and a half percent return from 1627. All the way he wrote this in 1965. And his point was that at that 6. 5 percent return, the 24 billion again in 1965. So in 1965, the island of Manhattan was reportedly worth 12. 5 billion. So even though they’d sold it, if they were able to compound their money, they’d still are making multiples.

[00:14:29] Kyle Grieve: Of their initial investment or multiples of what Manhattan would have actually been worth had they just held it for the entire period of time. So I just think that this is such a good story because it really kind of synergizes with most people’s difficulty in really understanding the powers of compounding.

[00:14:45] Kyle Grieve: So as a bonus to the story, Warren also mentioned that let’s say the investor was maybe able to eke out just 0. 5 percent more to get the rate of return to an even 7%. So in that case, the value of the initial investment jumps from 42 billion to 205 billion. So that just shows you how, you know, a very, very small increase in your rate of return over a long period of time just amplifies your results.

[00:15:07] Kyle Grieve: So the other point about this story I found interesting was that it does a really good job of showing how important it is to avoid frictional costs. So things like taxes, commissions, fees, really just seem trivial on a short term basis. But as this example shows, a small decrease in your rate of return can have major effects down the road.

[00:15:25] Kyle Grieve: This is a good lesson to remember for investors who are paying high fees, either through their own trades or through fees to their managers. So whenever you look at the little statements that have, you know, the very, very fine writing, it’s always going to be very, very small. It’s going to say this really small amount of management fees.

[00:15:40] Kyle Grieve: And it looks small to the naked eye, but when you look at what the amount of money that they’re actually taking from you over a long period of time, it’s not a small number. So just be cognizant of that. So another really cool example here that I actually had never seen before was this example that Warren discusses about the sale of Leonardo da Vinci’s Mona Lisa.

[00:15:59] Kyle Grieve: Uh, and this was, he goes back in time here, he’s going all the way back to 1540 to Francis the first of France. So he found out that it was sold for 4, 000 acres. Warren was kind enough to gives us, gives us the exchange rate and came to a figure in 1964 of about 20, 000. So he pointed out again, if Francis the first had a trustee who maybe could have found another investment that compounded at 6 percent that the money that he spent on Mona Lisa would have been worth one quadrillion in 1964, just because it’s not a normal number.

[00:16:31] Kyle Grieve: It’s basically a one followed by 15 zeros. So. Warren also noted that this number represented 3, 000 times the US’s national debt in the same year. So both examples here just show how an unfathomable amount of money can be made through compounding and through compounding over long, long periods of time.

[00:16:52] Kyle Grieve: Now, obviously, you know, we don’t all have the Luxury of being on earth for multiple centuries, but the point still stands, you know, even if you can do it just for a couple of decades, it’s very, very powerful stuff. So I think the fact that Warren also understood compounding at such a good level was also part of the reason why he just didn’t like spending very much money.

[00:17:12] Kyle Grieve: You know, he understood very well that a few thousand dollars today would be worth a heck of a lot more money, you know, maybe a couple of decades into the future of Warren Buffett could basically put that money into his compounding machine. Okay. So the primary lessons I think from this chapter on compounding is just how important it is to really understand it Not only can it generate wealth for those who understand compounding But it can also be used as a sort of break on spending if you truly feel the pain of buying Let’s say you buy a used car and maybe the used car, you know, maybe you have option one and option two, and maybe the second option is 10, 20, 000 more expensive.

[00:17:52] Kyle Grieve: Well, if you understand compounding really well and you have, you know, maybe you can see into the future and you know that you’re able to compound money, well, that 000 difference can make a huge difference in 50 years if you can compound it. So I think it’s just an interesting kind of thought experiment to use if you need help to reign in your spending, just to kind of see the opportunity costs of spending money.

[00:18:10] Kyle Grieve: So now I want to take a turn here and kind of look at the other side of frictional costs that I just discussed. So that’s namely how individuals and institutions get taken advantage of for being overactive. The problem is kind of hidden in the fact that people who urge you to be active are actually incentivized to increase your rate of transactions.

[00:18:33] Kyle Grieve: So a broker makes nothing if you hold stocks for decades, but if you decide to day trade, that broker will be your best friend. As every buy and sell that you do will be slowly padding his pockets while unfortunately lightening your own. And I think this concept goes much further than just the world of investing.

[00:18:51] Kyle Grieve: For business owners, some people will approach you with some magical fix for a problem you never even knew you had. These frictional costs can add up, and they can mean the difference between running a business into the ground versus running a successful business for decades. But Warren’s advice to investors is really quite simple.

[00:19:07] Kyle Grieve: Quote, resulting frictional costs can be huge, and for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, invest in stocks as you would a farm. Unquote. So this chapter does a wonderful job of showing why, and how, Warren developed his disdain I think for much of the financial world.

[00:19:26] Kyle Grieve: Through his in depth understanding of compounding and his ability to see how big of a difference fees could make, he explained why he preferred index funds, which did not yet exist at the time of these writings. So here’s what Warren said about investment companies in the 1960s. The result of these investment companies in some way resemble the activity of a duck sitting in a pond.

[00:19:46] Kyle Grieve: When the water mark rises, the duck rises. And when it falls, back down goes the duck. I think the duck can only take credit or blame for his own activities. The rise and fall of the lake is hardly something for him to quack about. The water level has been of great importance to Buffett Partnerships performance.

[00:20:04] Kyle Grieve: However, we have occasionally flapped our wings, unquote. So this final sentence here is so important. We have occasionally flapped our wings. This means that he’s essentially added value to his partners through his thoughtful investing skills. The crazy part about all of this is that the fund industry, you know, today is essentially the same way it was back in the 1960s.

[00:20:25] Kyle Grieve: Funds are searching for ways to just kind of match the index. Certain people have been able to kind of take advantage of the changing tides and the price just by floating with the market. So I think a really good example of this is ARK funds ran by Kathy Woods. So I think, you know, during COVID, obviously the ARK funds were doing really, really well.

[00:20:45] Kyle Grieve: So during the height of ARK on February 13th, 2021, it was actually up 737 percent versus 120 percent for the S& P 500, an astounding difference. But using Buffett’s analogy, investors, I think, thought that ARK had flapped its wings to create this value. Robert But in reality, it was propped up by a mix of factors and largely being propped up by a rising tide in all stocks.

[00:21:08] Kyle Grieve: And when the pond drained and the ducks floated back down, ARK ended up with lower returns than the S& P 500 at about 150 percent versus 231 percent over the prior 10 years. So what accounts for this lack of performance by institutions versus unmanaged indexes? Is it intelligence? How about integrity?

[00:21:28] Kyle Grieve: Buffett actually did not attribute the lack of performance to either of these factors. Instead, he attributed it to five things. First, group decision making. So Buffett, you know, he just did not believe that outstanding management could be the product of a group making decisions. Number two, orthodox thinking, which basically is mindlessly copying what and other people in the industry are doing.

[00:21:52] Kyle Grieve: Third, the safety of average. If you get the same results as everyone else, you’re seen as successful. Even if that success was a result of undue risk taking. Four following standard diversification dogma and five inertia. So he made the statement back in 1965 and I think these points are just as valid today and will probably be valid in another 50 to a hundred years from now.

[00:22:15] Kyle Grieve: So this kind of makes me think about some of the investors who I won’t mention by name, but you know, a lot of them started as really, really successful hedge fund managers, but then things kind of started changing as a scaled up their assets. Here’s kind of a narrative for how some of these investors go.

[00:22:33] Kyle Grieve: So they started as upstarts, right? They’re often working on their own, or maybe they have a partner and they have a lot of success and they make very, very high returns. But as they start scaling up. They need to bring on more employees and, you know, increase the size of the business and maybe get more backend people involved.

[00:22:51] Kyle Grieve: And as they get more and more of these employees, the employees who’ve probably worked at other firms or coming out of school, they mimic the behavior of, of other people doing things, you know, like everyone else’s. Because of all this, the returns that the fund once had is just no longer really achievable.

[00:23:09] Kyle Grieve: You know, the fees just eat into it and it’s just, it’s just hard and you grow. And obviously that has its own problems as well that we’ll be going over in the future. So the returns the fund once had are no longer achievable and they basically take safety in just being average and tracking the returns of the markets and even, you know, their competitors.

[00:23:26] Kyle Grieve: So, you know, they used to have these Very concentrated funds, some, most of them, and then all of a sudden you look and 20 years in the future and now they have a hundred positions. So it kind of looks like they’re just essentially trying to track the industry. And then finally, the, you know, you can’t really go back once you, once you’ve taken this route, that that’s kind of where you’re stuck.

[00:23:45] Kyle Grieve: It’s hard for you to go from a hundred positions to 10 positions. You know, your investors are probably going to be perplexed as to, as to why you’re doing that. So essentially, they just kind of stick with it and that’s what everyone else is in the industry is doing and they probably, you know, they might have billions of dollars under management and it works so they just stick with it kind of like the lemmings example that Warren Buffett says that people just like doing what everyone else is doing.

[00:24:10] Kyle Grieve: So I think the lesson here is best dated by the use of one of my favorite metal models, which is inversion. So if we know what accounts for the lack of performance and. If we want to perform really well, well, let’s just avoid being guilty of a lot of these mistakes. We, we know what the mistakes are, so let’s invert them.

[00:24:28] Kyle Grieve: So there’s obviously five. So there’s five things we want to do. We want to make our own decisions. We want to think like a contrarian think differently. We don’t want to chase average results. We want to chase some sort of result that a little bit above it doesn’t have to be super high above but chase a result that’s not average.

[00:24:45] Kyle Grieve: We want to concentrate our investments on our highest conviction ideas. And then lastly, we want a willingness to improve our previous strategies when we have mistaken that are identified, we don’t want to just get stuck doing the same thing over and over again that doesn’t work or isn’t giving us the returns that we’re looking for.

[00:25:04] Kyle Grieve: So this ability to think independently and chase out performance is a really good segue, I think, into the next part of the book that I want to discuss, which is how Warren compared his performance to the index. So when Buffett wrote the Buffett partnership letters, he was competing with the Dow Jones industrial average, or just the Dow.

[00:25:20] Kyle Grieve: So the Dow is composed of 30 prominent companies listed on us stock exchanges. Many investors, you know, follow this index simply because it’s just a good benchmark for determining whether they’re adding any value to the investing process. Sadly, you know, most investors, both retail and professional lag, the index, but because of some of the problems that we’ve just discussed, it is tough to beat the index.

[00:25:44] Kyle Grieve: And, you know, for the few that are beating the index, they’re probably following those five tenants that I just mentioned when we inverted them. So let’s kind of get into how Warren compared himself to the Dow and some of the specifics about how he thought his partners should evaluate his performance.

[00:25:59] Kyle Grieve: So Warren thought that he should be compared to the index on kind of a three to five year basis. So the reason he liked this format was that it would show his portfolio performance both through an up cycle and a down cycle. Warren felt that a good investor should be able to perform well in pretty much any environment.

[00:26:19] Kyle Grieve: Warren went so far as saying, quote, if any three year or longer period produces poor results, we all should start looking around for other places to have our money, unquote. But we must also keep in mind that the index can do some pretty wild things. Since the market in the short run is a vehicle for the overall mood of the market, one can underperform the market and still be doing a very good job of investing.

[00:26:41] Kyle Grieve: And Warren understood this very, very well. So throughout his letters, he constantly mentioned that Buffett partnerships would probably underperform in bull markets and would often outperform in bear markets. And it was, in fact, expected that the performance of Buffett Partnerships would fluctuate and it would sometimes underperform.

[00:26:59] Kyle Grieve: So, another interesting point here was that Buffett considered a year in which his fund declined 15 percent versus a 30 percent decline for the index to be a superior year where both his fund and the index, let’s say, advanced 20%. And this kind of goes with that ducks analogy that we just talked about.

[00:27:15] Kyle Grieve: So, he has a quote here. Over a period of time, there are going to be good and bad years. There is nothing to be gained by getting enthused or depressed about the sequence in which they occur. I think this really speaks to Buffett’s ability to think long term. In the appendix of this book, you can see the results of Buffett’s partnerships.

[00:27:32] Kyle Grieve: And even though he never had a down year versus five down years for the Dow, he did have wildly varying results. So from 1957 and 1969, he only underperformed the Dow on insanely low one time. So I don’t even think Buffett would have predicted that going into, into the partnership. Another point on performance that Buffett really emphasizes was basically how anyone managing money should be able to state two things.

[00:27:56] Kyle Grieve: So first, they should be able to clearly state the returns that they are attempting to achieve. And second, they should be able to state how the investor should be measured at achieving those returns. So this means that people managing money should not continuously change their yardsticks. You don’t want to be looking at a manager and maybe you went back 10 years in time and they were, you know, let’s say they’re having a really, really good year and because they had a really good year, they may over promise their investors in the future saying, okay, you know, we did 50 percent so you know, who knows the sky’s the limit for, for going ahead.

[00:28:30] Kyle Grieve: And unfortunately, you know, you got to put a break on that kind of thing cause that’s just not the way things work. And one of humans most powerful biases is that we do attribute skill to lucky outcomes a very often in a large magnitude. This is just a point that you should be aware of managers who are changing their yardsticks during the good times, because chances are that the good results that they’re having over a short period of time will regress back to the mean.

[00:28:55] Kyle Grieve: And oftentimes a very large outperformance can be followed by a very large underperformance. Just keep that in mind. If you paid attention to the markets in 2022, you’ll, you’ll see that in 2021, there were some funds that did incredibly well in 2021 and then went down like 50 percent or more in 2022. So Buffett’s points on not attempting to beat the market during wild market swings is very valuable because I think it helps investors avoid trying to chase higher returns that are often accompanied by higher risk.

[00:29:24] Kyle Grieve: This is precisely why Warren shut down the partnerships in the late sixties, which we’ll be going over in some more detail later. The author of the book here, Jeremy Miller, does a great job at the end of this chapter discussing why performance measurements today has been largely corrupted and obfuscated with terms like alpha, beta, sharp ratios, trainer ratios, and so forth.

[00:29:42] Kyle Grieve: It doesn’t have to be all that complicated. Investors who decide to go the active route simply need to think it through ahead of time and commit to sticking to a measurement plan. Now, I just think this is wonderful advice. And to be honest, I don’t have a firm grasp of many of the terms he listed above, because I just don’t think they matter to my personal investment goals.

[00:30:03] Kyle Grieve: So just be wary of salespeople that are using, you know, overly complicated terms to try to justify you paying for mediocre results. So I wanted to end this, this section here with just a case study, I think on one of my favorite investors, which is Francois Rochon, who Clay interviewed recently. So I would highly recommend reading his shareholder letters regularly.

[00:30:22] Kyle Grieve: They’re very, very much worth it. One thing that I really like about him is just how simple he makes things. I opened up his latest letter. And just search for all those, those words, you know, sharp ratios, trainer ratios above, and you can’t find them. He’s doesn’t mention them once instead. He’s basically telling you what returns that he’s attempting to achieve.

[00:30:43] Kyle Grieve: So basically, he’s trying to achieve 5 percent higher than their benchmark. So because he invests not just in one geography, he’s using a hybrid index. So he’s using the S and P T S X composite, the S and P 500. The Russell 2000 and the MSCI E. A. F. E. So he does a really good job of clearly showing the results.

[00:31:01] Kyle Grieve: He’s had versus the index since the inception of his fund back in 1993. You know, he’s not changing things or blocking numbers out. And I went back 20 years to, I guess that would have been 2004 and the benchmarks were all there. They, they were the same. I mean, he, he, so he, he wasn’t using the MSI MSCI EAFE, but all three other ones were there.

[00:31:22] Kyle Grieve: He’s using the same index throughout. And I think that’s really powerful. And I think that I can give you just a really good picture of the type of investor that he is, and that he’s obviously a very highly skilled investor as well. So now that we have a better understanding of what Buffett used to benchmark his performance, let’s look at the partnership structure that he made in a little more detail.

[00:31:41] Kyle Grieve: So Warren doesn’t talk much about cloning, but his fund clearly was cloned from Benjamin Graham. Graham had kind of pioneered this structure with a general partner, a GP who managed the fund and then took a percentage of profits and limited partners, LPs, who basically contributed capital and took part in the gains and losses but had no part in managing the capital.

[00:32:02] Kyle Grieve: So, although Warren is very well known for being incredibly intelligent when investing at a young age, he wasn’t necessarily predestined to manage money. So, here’s what Buffett said about how the fund was initiated, quote, By pure accident, seven people, including a few of my relatives, said to me, Hey, you used to sell stocks, and we want you to tell us what to do with our money.

[00:32:22] Kyle Grieve: I replied, I’m not going to do that again, but I’ll form a partnership like Ben and Jerry had. And if you want to join me, you can. My father in law, my college roommate, his mother, my aunt Alice, my sister, my brother in law and my lawyer all signed on. I also have my hundred dollars. That was the beginning.

[00:32:37] Kyle Grieve: Totally accidental. So the fund was quite simply structured on this 0, 6, 25 system that barely any funds follow today. So basically the way it was, was that he took a 0 percent management fee and he took, he had this 6 percent interest provision, kind of like his watermark that he had to beat. And then pass that provision, he would then take 25 percent profits.

[00:33:00] Kyle Grieve: So basically in essence, he was offering a 6 percent return to his investors before taking a penny for himself. So I’ve kind of always wondered where the 6 percent number came from. And the book’s author mentioned that Buffett figured that the market at this time would go up, say five to 7%. And he just kind of split the difference with that 6 percent watermark.

[00:33:18] Kyle Grieve: An interesting feature in the structure of the fund was that some people planned on investing in the fund and then using the proceeds for income. Others wanted to just keep their money in the fund to maximize the amount that they had invested. To appease both parties, Warren would allow investors to keep their capital in the fund for those who did not want the income.

[00:33:35] Kyle Grieve: It would just be reinvested the following year. And for those that did want income, he would basically distribute 0. 5 percent each month, which comes to that 6%. This is one of my favorite partnership structures, and it’s hardly used by the financial industry today. So the norm is a two and 20 structure.

[00:33:51] Kyle Grieve: So in this structure, the manager takes a 2 percent management fee based on the assets under management, and then they take 20 percent of any profits. So the problem with this structure is it does not align the manager, in my opinion, with its investors. So let’s go over some of the issues with the two and 20 system.

[00:34:08] Kyle Grieve: So the manager has zero exposure to the downside. The manager does not lose anything if the fund goes down, say 10 percent in a year, but obviously the partners do. Since the managers incentivize on assets under management, AUM, they are encouraged to increase AUM rather than increase shareholder returns.

[00:34:28] Kyle Grieve: So for instance, let’s say a manager takes AUM from 1 billion to 2 billion in the same 2 percent management fee. That means that their fees basically go up from 20 million to 40 million just by increasing AUM. But during this time, they could theoretically have zero returns and basically be offering no actual value to their partners.

[00:34:49] Kyle Grieve: And yet they’re doubling their fees. It, you know, the, the alignment there is just, it’s off. So the 20 percent performance fee can also force managers to take undue risk in kind of a short timeframe frame, since they have no downside managers might be looking to invest in strange products, derivatives, expensive stocks, maybe trying to ride momentum all while ignoring potential downsides.

[00:35:10] Kyle Grieve: Because like I said, they don’t have to, they don’t lose anything. If the value of the fund goes down. And lastly here, the compounding effects of these fees do really eat into the returns of the shareholders at an alarming rate. I think we covered that pretty well in the section there on compounding. So I personally, I’m always emphasizing the importance of partnering with aligned management teams in the businesses that I personally invest in, and I don’t think that advice should change for investors looking for managers to invest with.

[00:35:36] Kyle Grieve: Search for managers who are incentivized to make you money, not just collect fees. A good manager should have to face the pain of losing money for the fund, just like their investors will feel if money is lost. So even though Buffett mentioned the hundred dollars that he put into the fund, I believe this was just at the very, very beginning.

[00:35:54] Kyle Grieve: The evidence for this is in his 1960s letter to partners while discussing provisions to the fund. So he actually mentioned that his and his wife’s life savings were Invested in the Buffett partnerships. He also said that they were the single largest investor and that they owned about one sixth of all the partnerships assets.

[00:36:11] Kyle Grieve: So to me, this is a cherry on top of an already excellent partnership structure. So the next section of this book that I want to cover is going to be about the investing buckets that Warren Buffett thought about for the fund. This book discusses four investment types. One, the generals, two workouts, three controls, and four asset plays.

[00:36:29] Kyle Grieve: So we’re going to go over all these in a little more detail. We’re not going to talk too much about asset plays, but let’s start off here by talking about the generals. So generals made up the largest percentage of the portfolio. He kept their names highly secretive. And I think the simple reason for this was that since many of these businesses were small and illiquid, he didn’t want to necessarily have to compete with his partners to acquire shares in these generals.

[00:36:53] Kyle Grieve: And another potential reason for keeping his investments a secret could have been to help him control biases. So the specific bias I’m referring to is commitment bias in the nomad investment partnerships. They wrote commitment bias occurs when we publicly disclose our positions, which most definitely affects our objectivity towards the position.

[00:37:11] Kyle Grieve: So in investing, as anyone who has held a losing position knows, we need to be able to let go of an idea. When it doesn’t fit with our initial hypothesis. So perhaps Warren believed that sharing the names of his generals would bias him into making poorer decisions and lower his willingness to part ways with an idea if partners, family members, friends, and colleagues knew he was invested in it.

[00:37:33] Kyle Grieve: So after speaking with Annie Duke on TIP623, I learned how to best handle commitment bias. In her book Quit, she has some great passages on why quitting is so hard. Whether it is on the level of an individual, an organization, or a government entity, when we are getting bad news, when we are getting strong signals that we are losing, signals that others plainly see, we don’t merely refuse to quit.

[00:37:55] Kyle Grieve: We will double and triple down, making additional decisions to commit more time and money, and other resources, towards the losing cause. And we will strengthen our belief that we are on the right path. This means that when all the signals say we are wrong, it can often become even more stubborn. My favorite tool she outlined to combat this bias was what she called Kill Criteria.

[00:38:18] Kyle Grieve: So Kill Criteria has two parts, a state and a date. It’s very simple. So here’s an example from my own portfolio. So I own a business called Aritzia, which I haven’t spoken too much on the podcast about, but let’s use that business and see what one of my Kill Criteria might look like. So, I’ve made it a habit now since learning about these kill criteria to make them for every single business that I own, but one of the ones that I noted for Aritzia specifically was to do with gross margins.

[00:38:46] Kyle Grieve: So, essentially the kill criteria is, okay, if Aritzia has gross margins below its 10 year floor of 36%, And that’s again, over a 12 month time period, then that’s a kill criteria. So you can see this code criteria has both the state and the date. The state is gross margins below 10 year floor, and the date is 12 months.

[00:39:07] Kyle Grieve: So obviously it’s floating. I don’t, I don’t have to say, okay. And the 12 months from now, because they just had their latest quarter and they’re not, the numbers are way higher, so it wouldn’t really apply now. So that’s kind of why I made it a 12 month period. You know, maybe it needs to be longer, maybe it needs to be shorter.

[00:39:21] Kyle Grieve: It’s completely dependent on you and what you’re comfortable with your businesses. So if this kill criteria was actually hit by the business, I think that’s a, it’s a really good signal that the fundamentals of the business are, are maybe falling apart. And you know, I wish I’d had this framework for some of my businesses in the past, because I feel like, you know, if, if I’d made the kill criteria, a lot of them probably would have been hit and I probably could have sold out a lot earlier and lost less money.

[00:39:45] Kyle Grieve: So I think that’s why kill criteria do have so much value. Now, I don’t know if Warren Buffett ever actually used kill criteria, but given his intelligence and rationality, it would not surprise me one bit if he just wanted to avoid his own biases as much as possible. And I think keeping his ideas a secret might have been a really good technique for avoiding those biases.

[00:40:04] Kyle Grieve: As with all Buffett investments, the generals were acquired at a discount to intrinsic value. He took this notion even further and actually sought to look for discounts to private market value in public markets. This was a pretty incredible undertaking. After all, many private companies go public specifically because they want to increase the value of their holdings of their shares.

[00:40:24] Kyle Grieve: So generally speaking, public evaluations are just higher than private markets. So Buffett knew that if he could find these generals trading below private market prices, the multiple rewriting alone could deliver very impressive returns to Buffett and his partners. With his generals, he also knew that he could heavily invest in a single idea.

[00:40:41] Kyle Grieve: For instance, Buffett invested 10 20 percent of the partnership’s assets into Commonwealth Trust Co. in 1959. He calculated the intrinsic value of Commonwealth to be around 125. The price at the time was 50 on earnings of 10 a share. So he was getting a 20 percent earnings yield on the business. In a 1964 letter to partners, he further discussed the advantages of the general segment.

[00:41:04] Kyle Grieve: He wrote, There is often little or nothing to indicate immediate market improvement. The issues lack glamour or market sponsorship. Their main qualification is a bargain price, that is, an overall valuation on the enterprise substantially below What careful analysis indicates is value to a private owner to be in typical Buffett fashion.

[00:41:24] Kyle Grieve: He displayed his trademark contrarianism that has helped fuel his investing career. Now I want to touch on this concept of market sponsorship because it’s an area that I’ve noticed more and more over the past year. So when I first started investing, market sponsors were a completely foreign concept to me.

[00:41:39] Kyle Grieve: I, you know, I don’t think I spent a second ever actually thinking about it, but You know, back then I was also investing in larger businesses and I don’t think that market sponsors were necessarily needed because so many people in the market just knew about the business and their products. But once I started investing in some of these small cap businesses, then I started realizing, okay, this sponsorship ideas is actually really, really powerful.

[00:42:02] Kyle Grieve: So there’s one that I own a small cap that I won’t mention its name, but it’s a business that has an incredible product. But the problem with it is that. The product is not very well known by anyone, including their customers. So they actually literally have to go out to their customers, say, Hey, look at our product.

[00:42:20] Kyle Grieve: It’s really good. Here’s what it’ll do for you. Here’s how much money it’ll save you. You know, a business like Amazon, they don’t have to do that. You know, everyone listening to this probably used Amazon once or twice and knows that, uh, They know what, what Amazon does. So just understanding this difference here between small caps and larger caps and the different types of products and services that they sell is just really showed me how important having that sponsor is because, you know, if you have the right person or, you know, company or whatever, that, that does the sponsor work for other business, it could just be really powerful, right?

[00:42:55] Kyle Grieve: Because not only can it bring that idea to other potential investors, but it can also help spread the word on their products, which kind of has this, you Second order effect of also maybe even helping the business find more actual business partners to sell the product to. And so one of the big problems is that a lot of these smaller businesses kind of flounder in obscurity for long periods of time, because investors don’t know who they are and they just, a lot of people just don’t know what their products are.

[00:43:19] Kyle Grieve: So I think a market sponsor, especially in these smaller businesses, can really help solve this problem by just getting exposure to the business, both in terms of finding other investors, but also maybe even finding customers for his products. So the last point here that I want to make on generals is that Buffett was looking at very, very boring businesses.

[00:43:38] Kyle Grieve: So as the Buffett quote, I just referenced points out, they tend to lack glamour. And I think this really plays to Buffett’s avoidance of technology, but also more importantly to his avoidance of overpaying for stocks and for assets. So the next type of investing bucket, the book covers here are workouts.

[00:43:54] Kyle Grieve: Another really easy way to think of workouts is just as arbitrage. For instance, if you can find, let’s say the same stock trading on two different exchanges at different prices, you just, you know, buy it on the cheaper exchange and then sell it on the more expensive exchange. And there you go. There’s your arbitrage.

[00:44:10] Kyle Grieve: So one of Buffett’s best known arbitrage deals from his past was in Rockwood and co. So this was a business that really seemed like a very lousy business with very minuscule profits. But They were a chocolate business. And because they were making chocolate, they also owned large amounts of cocoa and they had cocoa sitting in their inventory.

[00:44:29] Kyle Grieve: And Buffett had found out that this cocoa they were sitting on in their inventory was acquired at about 5 cents per pound. So in 1954, there was a shortage in cocoa and this was causing a major supply demand imbalance. And because of the imbalance, it was shooting the price of cocoa up to over 60 cents per pound.

[00:44:48] Kyle Grieve: So Rockwood was pretty intelligent about actually, they decided basically they want to sell their inventory of cocoa to take advantage of this temporary cocoa bubble, but there was a problem they couldn’t just sell the cocoa by itself because if they did that, they would have had about a 50 percent tax on the proceeds, which was very high and they didn’t want to deal with that, but the tax code came to the rescue.

[00:45:09] Kyle Grieve: So there was a provision in the tax code that Last in first out profits of inventory could actually be distributed to shareholders as part of a restructuring plan for the business. So basically Rockwood had to terminate one of its businesses to satisfy this restructuring requirement. And then the sale of 13 million pounds of cocoa bean inventory was part of that downsizing.

[00:45:32] Kyle Grieve: So in order to return value to shareholders, They basically would buy back their shares in exchange for cocoa beans, paying 80 pounds of beans per share. So Buffett said here, for several weeks, I busily bought shares, sold beans and made periodic stops at Schroeder Trust to exchange stock certificates for warehouse receipts.

[00:45:49] Kyle Grieve: The profits were good. And my only expense was subway tokens. So Buffett basically would buy the Rockwood shares at 34, then exchange the beans were 36. So there is arbitrage was just 2. And, you know, obviously keep doing that over and over again. And it’s a decent little deal. The only thing that was really needed in order to make sure that this arbitrage continued to work was that the price of cocoa beans had to remain elevated.

[00:46:13] Kyle Grieve: Obviously, if cocoa beans kind of went back down to its normal price, then the arbitrage would no longer work. He probably actually, you might end up losing money. So you can see how this type of arbitrage can create some interesting short term profits. But you know, there’s not really much compounding available because the arb deal eventually is going to be found out by people.

[00:46:32] Kyle Grieve: And the arbitrage between, you know, the buy and the sell price closes and it doesn’t last for very long. So, you know, merger arbitrage just doesn’t really necessarily seem like a very scalable strategy, but Buffett still employs it, you know, as recently as 2023, when he was part of the Activision and Microsoft merger.

[00:46:50] Kyle Grieve: So Buffett saw Activision shares trading for 73 a share, and then the proposed acquisition price by Microsoft was actually 95 per share. So although Warren ended up selling 70 percent of his initial investment for the merger, he was still able to eke out a 1. 4 billion profit on the, on the merger ARB.

[00:47:09] Kyle Grieve: So pretty good. So even though workouts require a lot of work, and I think is probably the opposite of sit on your butt investing that Charlie Munger was such a proponent of. It really did have great results for Buffett. So as the book’s author, Jeremy Miller outlined using the record of Graham Newman, Buffett partnerships and Berkshire Hathaway in the 65 years through 1988, Buffett figured the average unleveraged returns in the arbitrage business was about 20 percent per year.

[00:47:33] Kyle Grieve: In the annual report that year, he said, give a man a fish and you feed him for a day, teach a man arbitrage and you feed them forever. Indeed, we know what 65 years of 20 percent average annual compounding does. It turns 100 into 14 million. So another investment bucket that Warren used here is what he called controls.

[00:47:53] Kyle Grieve: So the simple way of thinking about controls is just as activist investing. You know, think of investing legends such as Carl Icahn or Bill Ackman. And I think you’re going to be on the right track here. Controls require that the investor kind of have to get their hands dirty and often do things that might upset the traditional way of doing things inside of a business.

[00:48:10] Kyle Grieve: So let’s jump into the Sanborn maps case study that’s outlined in the book. Sanborn maps was a business which required a jolt to a system in order to unlock its full value and Buffett basically would be that jolt. So what did Buffett see in this business in the first place? The business was quite simple.

[00:48:27] Kyle Grieve: It had two value levers. First, it basically just sold maps to insurance companies. So revenue had declined in the previous 20 years. Sanborn But even though it had declined, it basically was unlikely, very, very unlikely to go to zero because the product had a very, very high replacement costs. So these insurance companies would just keep on shelling out money to Sanborn maps specifically for the maps.

[00:48:49] Kyle Grieve: And then the second value lever was just that it held an equity portfolio, which distributed dividends. So this is the important part. So when Buffett found it, the map business was being evaluated at minus 20 with the stock owners, unwilling to pay more than 70 cents on the dollar for the investment portfolio.

[00:49:05] Kyle Grieve: So he put money into the idea, a lot of money. In fact, he put in 35 percent of the partnerships assets just in this one bet. So he knew that the equity portfolio alone was worth more than the entire businesses market cap. So he bought up shares from unhappy shareholders and established a board C for himself.

[00:49:21] Kyle Grieve: Though he had to go through some pushback, he eventually got the business to basically sell off its stock portfolio and distribute it back to shareholders. Buffett ended up making about a 50 percent profit on this investment in less than two years, which is somewhere around a 22 and a half percent compound annual gain.

[00:49:36] Kyle Grieve: I wasn’t exactly sure on the date. So if the date was shorter than two years, that compound annual gain is going to go up. So now let’s look in how Warren valued these controls. Cause he, he obviously he’s conservative and everything else. He’s probably going to be conservative in the controls as well. So Warren wouldn’t use an appraisal of what he thought the control would be worth in the future.

[00:49:57] Kyle Grieve: Basically, it wasn’t a number that he hoped it would be worth, or even a number that say an overeager buyer would pay him for it. Instead, he basically would use a number that he felt was realistic to sell under current market conditions in a very short period of time. Another valuation is how Buffett would use assets a business owned to calculate its value, the more traditional type of value investing.

[00:50:19] Kyle Grieve: On this subject, Jeremy Miller made a great point. Quote, when you do your valuation work, the assets are always worth what they can be sold for, and the liabilities are always assumed to be due in full. That’s the difference between accounting value and economic or intrinsic value. So his point is that valuing a business based on asset value requires making adjustments to those assets.

[00:50:40] Kyle Grieve: Assets for lower quality businesses tend to not trade at par value, so adjusting them downwards at a conservative increment would probably yield the most conservative type of valuation. Benjamin Graham had some very rough rules of thumb here. He would ascribe 100 cents on the dollar for cash, 80 cents on the dollar for receivables, 67 cents on the dollar for inventory, and 15 cents on the dollar for fixed assets.

[00:51:03] Kyle Grieve: Buffett stopped investing in controls a few years before closing the partnership down. In a 1968 partnership letter, he discussed the importance of doing business with people that he liked. He also pointed out that, although controls might offer higher returns, it got to a point where it just was not pursuing for Warren personally due to the aggravation of dealing with people who did not want to do business with him.

[00:51:23] Kyle Grieve: So he said, it seems foolish to rush from situation to situation to earn a few more percentage points. It also does not seem sensible to me to trade known pleasant personal relationships with high grade people at a decent rate of return for possible irritation, aggravation, or worse, at a potentially higher return.

[00:51:39] Kyle Grieve: So the final point on controls I’d like to touch on here are why he had this segment in the partnership in the first place. As previously noted, he eventually grew tired of investing controls, but before he reached that point of peak aggravation, there was a reason that controls actually existed. So they were actually a hedge to his larger allocation into generals because controls would eventually be valued fairly in a reasonably short period of time.

[00:52:05] Kyle Grieve: They could prop up the returns of the portfolio during times where the generals were lagging a little bit. Additionally, controls that asymmetric upside, there were really only two outcomes. One, the market price is the business closer to intrinsic value and then Buffett would sell at a profit or two, the market continues to underprice the asset, in which case Buffett just buys more until the market comes to its senses.

[00:52:26] Kyle Grieve: So the next section of this book that I found fascinating was on a chapter called conservative versus conventional. Now, this chapter does an exceptional job explaining some more of the details on why Buffett placed such a high value on contrarian views. And why other investors should place very little emphasis on conventional views.

[00:52:44] Kyle Grieve: Warren’s views on the opinions of others was largely molded by, I think, his relationship with his father. So his father was a fan of some of Ralph Waldo Emerson’s greatest philosophical concepts. Self-reliance being one of them. Now this is why Buffett did not take solace in whether or not the market agrees with him.

[00:53:00] Kyle Grieve: It also meant that he was ambivalent towards the thoughts and opinions of those with high levels of influence and authority. Another great concept he learned from his father about conservatism was that conventionally speaking once the consensus was in agreement, a thought or opinion was considered conservative.

[00:53:17] Kyle Grieve: So if you go through all of Buffett’s investments, most of them were not bought when the consensus viewed that stock in a positive light. So a great example of this straight from Warren Buffett is just Apple, right? He started buying Apple back in 2016. But when he started buying it, it was at a very, very low multiples at the time.

[00:53:36] Kyle Grieve: I think he got it somewhere between 10, 11, 12 times earnings. So compare that now it’s cheap. So he bought it at very low double digit P multiples, say around 10 to 12. Now a stock trading at a P of 10 to 12, especially in kind of the tech area does definitely does not scream consensus to me. And another interesting point here is that since 2021, Apple has never sold for a price earnings ratio of less than 20 times.

[00:54:02] Kyle Grieve: So he’s done really well. On this investment, you know, both because obviously his returns have been very good, but he obviously bought it when it was out of favor, knowing that it would at some point, I’m sure he had no idea when it would be back in favor, which it’s been now for quite a long time. The odd thing about Apple is that many hedge fund managers probably saw it as a very conservative estimate at 20 times earnings because the consensus view was somewhat similar.

[00:54:27] Kyle Grieve: So in the 1965 letter to partners, Buffett wrote, we derive no comfort because important people, vocal people, or a great number of people agree with us, nor do we derive comfort. If they don’t, a public opinion poll is no substitute for thought when we really sit back with a smile on our face is when we run into a situation we can understand where the facts are ascertainable and clear in the course of action.

[00:54:51] Kyle Grieve: Obvious, yes. In that case, whether conventional or unconventional, whether others agree or disagree, we feel we are progressing in a conservative manner. Now, Warren’s propensity towards concentration is pretty well documented. As I’ve already outlined, Warren liked to invest large portions of the partnership’s assets into a single opportunity, if the risk and reward was right.

[00:55:12] Kyle Grieve: In the 1990s, Warren gave a speech to a group of students. In it, he outlined the following diversification criteria. He’s basically said six wonderful businesses is all the diversification that you need. Investing money into your seventh best idea is probably going to be inferior to investing in your best idea.

[00:55:30] Kyle Grieve: He made a point that very few people have gotten rich investing on their seventh idea, but many people have gotten rich off of their first idea. And then his final point here was that for anyone working with normal capital, six positions is great. And he would actually put half of his capital into his most loved idea.

[00:55:45] Kyle Grieve: So Warren has known for well over 50 years that orthodox views on diversification are just plain silly. In his 1964 letter to partners, he wrote, if good performance of the fund is even a minor objective, any portfolio encompassing 100 stocks, whether the manager is handling 1, 000 or 1 billion is not being operated logically.

[00:56:04] Kyle Grieve: The addition of a hundred stock simply can’t reduce the potential variance in portfolio performance sufficiently to compensate for the negative effect its inclusion has on the overall. Portfolio expectations. So I just love this point here. He’s definitely been quoted about it a lot in regard to diversification, but the thing that’s always kind of confused me about being diversified is just trying to come to grips with understanding a hundred businesses as well.

[00:56:33] Kyle Grieve: Like, I, I think that’s maybe part of the reason for the fund industry, right? A lot of these funds will have, you know, many, many analysts, right? So if you have a team of 20 people, then sure, maybe. You know, each person gets five businesses and they can understand them at a high level and that’s kind of how they justify it themselves.

[00:56:49] Kyle Grieve: But as an individual, you know, six businesses, I think, yeah, you could definitely understand that. Maybe you could go take that up to 10, 15, whatever. It depends how much time you have in your day, but it’s just, it doesn’t make a lot of sense to try to have 100 businesses. Because you’re just not going to understand it at a very deep level, you know, maybe you can do things where you’re only looking at the business, just, just looking, just reading there, let’s say, reading their annuals and their quarterlies and maybe listening in that that’s probably all the work that you’re going to be able to do if you have a ton of businesses, but that means that you’re also a Disregarding a lot of other work that could be really helpful, such as looking at competitors, looking at the industry, you know, talking with people involved in the business or maybe customers or suppliers, you know, all these other things that all these things take time, right?

[00:57:32] Kyle Grieve: And there’s only a certain amount of time in the day. So, yeah. If you have a lot of ideas, it basically means that you’re spreading yourself thin, and you’re probably not going to understand your businesses as well as if you are a more concentrated investor. So I guess, you know, if you have no edge in the business that you own, or you don’t have the desire to, then you are, you know, best off diversifying just, but the beautiful thing about that is you can just buy an index fund and not actually have to spend a, you know, a second of time looking into the individual stocks that you own, and you can probably just do really well.

[00:58:01] Kyle Grieve: So the final point from this chapter I want to discuss is on time horizons and performance. So Warren was perfectly content with having a high variance of returns from year to year. Between 1957 and 1969, Buffett Partnerships maintained its margin versus the Dow ranging from a low of 2. 4 percent to over 38%.

[00:58:19] Kyle Grieve: So this meant that the partners had to make do with a wide variance. Now, many investors might be unwilling to have such large swings in portfolio returns, and that’s okay. But Warren used the fact that he was chasing long term returns to his advantage. Warren knew that he would have been able to smooth out his variance if he wanted to and accommodate maybe shorter term partners if he wanted to, but doing so would have sacrificed overall performance of the fund in the long term.

[00:58:47] Kyle Grieve: Now, one of the aspects of Buffett’s early days, I find most enticing is how the role of size affected as a performance. So his funds started in 1958, but by 1966, he was actually no longer taking on outside capital as his capital is growing too quickly for him to continue using the strategy that had been working so well.

[00:59:04] Kyle Grieve: So Buffett Partnerships. Aum was 43 million in 1966. And he said at this time that as circumstances presently appear, I feel substantially greater size is more likely to harm future results than to help them. This might not be true for my own personal results, but it is likely to be true for your results.

[00:59:23] Kyle Grieve: So the point on size and performance is profound. And I think we’re digging into a little deeper. Why would scaling up lead to decreased performance in Buffett partnerships? There are two primary reasons. The first is an inability to invest in obscure businesses with inefficient prices. As you grow larger and larger, you have to find larger and larger businesses to invest in.

[00:59:43] Kyle Grieve: And I think, wow, yes, you can find inefficient pricing in those. It’s just a much lower frequency. And the second one is just market cap problems. You know, if let’s say he wanted to stick with the smaller ones, he could theoretically do it, right. But the position sizes would be small, right. And, and, you know, sure, maybe he could find something that could double in the next year.

[01:00:04] Kyle Grieve: But if he could only put 0. 5 percent of his funds’ assets into that one idea. Well, it wouldn’t make too big of a difference to the overall returns. So if we look at Buffett partnerships performance through its life cycle, it returned 29. 5 percent compounded annually before fees. So it’s too bad that Buffett didn’t, didn’t track intrinsic value at this time, but it probably just didn’t really make sense given the sense of the structure of the fund.

[01:00:26] Kyle Grieve: But if you look at the book value of Berkshire Hathaway, which Warren has said is a good proxy for long term returns, you can actually see that the book value is growing at a decreasing pace. So, I went back and looked in 2000 and the kegger book value at that point was 24 percent and in 2024 that’s dropped to 20 percent and my assumption is in 20 more years, it’s probably going to be some number less than 20 percent as well.

[01:00:48] Kyle Grieve: Now, if we look back at just the past 10 years, book value has grown at a compound annual growth rate of only 9. 8 percent and market cap has grown at a compound annual growth rate of 9. 6%. So the point is obviously that Berkshire Hathaway has slowed down its growth as it has scaled. And unfortunately, that’s kind of just an inevitable consequence of scaling.

[01:01:06] Kyle Grieve: It can’t go on forever. So the important takeaway here is that if you are working with modest sums of money, you do not need to follow in the footsteps of money managers who are investing large sums of money. Avoiding businesses with small market caps does you a disservice to your ability to compound your money.

[01:01:22] Kyle Grieve: Now, touching again on the point about position size constraints. So Warren noted one additional reason for closing the fund. Due to AUM, he could basically not invest in positions where he could invest less than 3 million in a single position. So this obviously limited his investable universe even more.

[01:01:37] Kyle Grieve: So let’s transition to talking more about the go years in the 1960s. So Warren realized that his strategy, which allowed him to beat the Dow by such a wide margin all these years would basically no longer work as it once had. In 1969, he ended up closing the partnership down stating, I would continue to operate the partnership in 1970 or even 1971.

[01:01:56] Kyle Grieve: If I had some really first class ideas, not because I wanted to, but simply because I would so much rather end with a good year than a poor one. However, I just don’t see anything available that gives any reasonable hope of delivering such a good year, and I have no desire to grope around hoping to get lucky with other people’s money.

[01:02:13] Kyle Grieve: I am not attuned to this market environment, and I don’t want to spoil a decent record by trying to play a game I don’t understand just so that I can go out a hero. And with that, Buffett ended the partnerships and returned monies to his partners or suggested they invest with him in Berkshire Hathaway or invest with his friend Bill Ruane in Sequoia Funds.

[01:02:31] Kyle Grieve: Interestingly, Warren could have actually sold his partnership to someone else, generating himself additional money, but he decided not to go that route because of his business philosophies. The partnership was originally built to make money along with his partners. It wasn’t created to make money from his partners.

[01:02:50] Kyle Grieve: This big distinction I think is why he refused to sell it despite actually fielding offers for it. There is a vital lesson from Buffett’s reasoning for closing the partnerships that applies to investing principles. Namely, you should not drastically alter your investing principles just to make a quick buck while not understanding the risks involved with such an adjustment.

[01:03:09] Kyle Grieve: Buffett understood that the market at this time was favoring more speculative investments that did not appear to have a good risk return profile. The fact that more and more money was coming into the market was making his smaller and more obscure ideas harder and harder to find and justify investing in.

[01:03:24] Kyle Grieve: So here’s a wonderful quote Warren wrote about the high returns on speculative investments. My mentor Benjamin Graham used to say, speculation is neither illegal, immoral, nor fattening financially. During the past year, it was possible to become fiscally flabby through a steady diet of speculative bonbons.

[01:03:42] Kyle Grieve: We continue to eat oatmeal, but if indigestion should set in generally, it is unrealistic to expect that we won’t have some discomfort. Now, Warren noted that in the years leading up to the closure of the partnership, he was only able to find 2 3 ideas per year. I wasn’t able to find a reference point about what an average year looked like for him in the 50s or 60s, but since he specified that number, say 2 3, I can only assume that it was a much smaller number than he was accustomed to.

[01:04:06] Kyle Grieve: So I’ve now covered the bulk of Warren’s ground rules, but there was a very interesting point of emphasis in the book about how Warren looked at stocks as bonds that I want to share with you. So part of the reason Buffett closed the partnership was because he saw returns for the Dow being lower than 10 year bonds.

[01:04:22] Kyle Grieve: So at this time, tax free municipal bonds were yielding six and a half to 7%. Buffett thought stocks were unlikely to rise by more than, say, 6 percent per annum and pay 3 percent dividends. This gets you a 9 percent return, but remember, this is pretax. So to make the two comparable, Buffett reduced the 6 percent return from stocks to 4.

[01:04:41] Kyle Grieve: 75 percent and the dividend yield from 3 percent to 1.75%. When we add these together, you get 6. 5%, which approximates the yield on tax free bonds. For this reason, he assumed that the vast majority of money managers would underperform the market. Due to elevated prices and additional frictional fees, he I think this is part of the reason that he was so reluctant in trying to name other managers he trusted to provide similar results to the Buffett partnerships after it was shut down.

[01:05:05] Kyle Grieve: Now, I want to conclude this episode by going over six of my biggest takeaways. Number one, a good investing track record requires three to five years of experience going through a full market cycle. Number two, an investing track record does not mean your returns are always going to be positive. In fact, beating your benchmark in down years, even with a negative return, is still a sign of outperformance.

[01:05:27] Kyle Grieve: Number three, any stock pickers should be able to state their investment goals and not move the goalposts if performance suffers. If a money manager constantly moves a goalpost, that is a glaring red flag. Number four, make your own decisions and don’t rely on validation from other people or the market to impact your decision making.

[01:05:45] Kyle Grieve: Number five, if you think like everyone else, expect the same results as everyone else, which is underperformance and number six Don’t destroy timeless principles to warrant unnecessary risk taking. Thank you so much for tuning into my episodes today If you want to connect on X feel free to follow me @IrrationalMrkts or add me on LinkedIn if you’d like. I’m always striving to increase the quality and value of each episode that I release. So please feel free to provide me with any feedback you have both of the positive and negative variety so I can enrich your listening experience. Have a good one.

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