Buffett’s 2018 Letter / Fees Matter When Investing “Forever” / Clear Your Calendar for April 11th
In the Oracle of Omaha’s 54th annual letter to Berkshire Hathaway shareholders, Warren Buffett celebrates the dynamism of the American economy while cautioning investors against high-cost advisory fee arrangements.
Buffett attributes the success of the United States to the American tailwind – a force animated by patriotism, sacrifice, and the belief that “generations beyond would live far better lives than they themselves had led.” The discipline of prior generations who spent less than they earned, investing their hard-earned savings, drove productivity gains and raised living standards. Just like America’s, Berkshire’s geometric growth, Buffett says, can be attributed to the accumulation and reinvestment of the holding company’s “savings,” or as corporate managers would call them, retained earnings.
“In 1788 – to go back to our starting point – there really wasn’t much here except for a small band of ambitious people and an embryonic governing framework aimed at turning their dreams into reality. Today, the Federal Reserve estimates our household wealth at $108 trillion, an amount almost impossible to comprehend.
“Remember, earlier in this letter, how I described retained earnings as having been the key to Berkshire’s prosperity? So it has been with America. In the nation’s accounting, the comparable item is labeled ‘savings.’ And save we have. If our forefathers had instead consumed all they produced, there would have been no investment, no productivity gains and no leap in living standards.”
Buffett recalls how on March 11, 1942, at age 11, with battlefronts opened wide in the European and Pacific theaters, he traded his “life savings” of $114.75 for three shares of Cities Service preferred stock. How much would the $114.75 be worth today, if the proceeds generated from young Buffett’s lawn-mowing/snow-shoveling/golf ball-collecting and resale operation had been placed in a no-cost index fund tracking the S&P 500, with dividends reinvested?
“If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the latest data available before the printing of this letter). That is a gain of 5,288 for 1. Meanwhile, a $1 million investment by a tax-free institution of that time – say, a pension fund or college endowment – would have grown to about $5.3 billion.
“Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various ‘helpers,’ such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.”
These figures are a wake-up call for investment committees overseeing perpetual funds of nonprofit institutions, small and large. The Sarasota-Manatee region is home to three community foundations, a half dozen private foundations, several higher education institutions and dozens of independent nonprofits with endowed funds. We will exclude the few hundred million sitting in the reserve accounts of local municipalities, as state statute restricts investment options to short-term, high-grade, fixed-income instruments. By our calculations, in the two-county area there is well over $1 billion in charitable dollars invested in some form of traditional endowment model, an investment approach that tends to lean heavily on “exotic,” generally illiquid alternatives (hedge funds, private equity, and real assets), with the balance invested in more familiar global marketable equity and debt securities. Frequently this investment mix is developed and overseen by a consultant, who selects and monitors a stable of underlying managers. Two layers of fees – consultant and manager – are now added to brokerage and custody costs. Now, if this “outsourced chief investment officer” (OCIO) model were “working,” the alpha generated from the underlying managers and the skill of the OCIO in setting asset class exposure targets and selecting top-performing managers would, over time, surmount the added fee layers and produce returns that, at minimum, meet a benchmark.
However, a recent study authored by Professors Sandeep Dahiya of Georgetown University’s McDonough School of Business and David Yermack of New York University’s Stern School of Business analyzed the returns of 28,296 nonprofit endowments from 2009–2016. They found the median return for the 8-year period across 28,000+ organizations to be 3.75%, while a 60% domestic equity/40% Treasury bond construction delivered 9.28%. After a decade of lagging results nationwide, it is time for a sea change in how monies designated for perpetual charitable support are invested.
With $1 billion in philanthropic dollars managed in a framework similar to that of the thousands of endowments surveyed by Dahiya and Yermack, we are giving up $50 million of local charitable support annually. Over 20,000 children in Sarasota County schools rely on a free or reduced lunch. That is 20,000 families who need every potential charitable dollar brought to bear on summer nutrition programs, help with housing, basic medical care, and job training.
On April 11th, we will elevate this conversation around health, hunger, and philanthropy. National and local authorities are convening for our third annual Financial Literacy Day at the USF Sarasota-Manatee campus. Dr. Judith Monroe, President and CEO of the Center for Disease Control Foundation; Lisa Marsh Ryerson, President of the AARP Foundation; and Erin McLeod, President and CEO of the Friendship Centers, will lead a panel discussion. A dozen other nationally recognized speakers will discuss topics related to global financial markets, the trade war, and Federal Reserve policy. Please call 800-257-7013 or visit http://sar.usfsm.edu/event/financial-markets-and-the-economy/ to confirm your attendance and participation. Cost is just $50 to cover a light breakfast and catered lunch.
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