The Buffett strategy that nobody wants to copy
You have some typical approaches, some creative approaches, and then you have the Buffett strategy – but few go quite that far.
The typical approaches
Venture capital funds charge fees of 2% per year for ten years plus 20% of profits. Investors, known as Limited Partners (LPs) often cannot withdraw their funds for 10 years.
Private equity funds charge fees of 1-2% per year plus 15-25% of profits. Investors, also known as LPs, often cannot withdraw their funds for 3-10 years, or can only withdraw a limited portion.
Mutual fund managers charge ~1.5% of assets per year. Investors often can withdraw with minimal notice.
Index funds charge ~0.1-0.2% of assets per year. Investors often can withdraw with minimal notice.
With non-publicly traded investments (e.g. private equity), there is a risk in allowing investors to withdraw funds early or intermittently. Some low level of withdrawals can be fine, since the fund often has cash or some publicly traded investments it can sell to fund those withdrawals. But, when withdrawals increase in times of market turmoil, fund managers end up selling better liquid assets and investors who do not withdraw are left owning the more illiquid assets. This happened recently to Blackstone’s Real Estate Investment Trust, which offers daily liquidity.
The Creative Approaches (that make some comparisons with Berkshire)
Bill Ackman’s Pershing Square Capital & Howard Hughes
Bill Ackman’s Pershing Square runs a publicly traded investment company called Pershing Square Holdings (PSH) – traded in Europe – that charges an annual fee of 2% plus 16% of profits. Notably the profit share is only applied above a high water mark that is reset only upward after fees are crystallised each 31 Dec; no re-set after a loss year. Notably, Pershing Square owns ~25% of the capital in PSH so – although the management fee is there – there is much stronger manager-shareholder alignment than is typical in private equity or venture funds. Note that no redemptions are allowed from PSH (you can’t cash in your shares, you can only trade them to someone else), so the fund is a permanent capital fund – Bill Ackman does not have to worry about investors showing up, asking for their money back, and being forced to sell shares at short notice.
Separately, Pershing Square planned to launch a US publicly traded fund (PSUS) that would charge a flat 2% management fee and no performance fee – a significant departure below private equity fund fees towards more typical mutual fund fees. Interestingly, a portion of fees earned would be used to reduce the fees paid by investors in the European entity PSH, although PSUS would have to be large for this fee reduction to be material. This launch is pending with no firm date.
Separately again, Pershing Square owns a portion of and is proposing to own more of and control the investments of the publicly traded company Howard Hughes. In return for managing Howard Hughes, Pershing Square – under the latest proposal – would be paid a ~1.5% management fee (no performance fee, per the latest proposal). Again, as with PSH, Pershing Square already owns significant equity in Howard Hughes and would own close to 50% in the case of the deal clearing as per the latest proposal. As such, there is significant manager-owner alignment that is not present in many mutual and private equity funds.
Coatue’s Interval Fund
One of the issues with Venture Funds is that investors are locked in for a long time. And they often aren’t publicly traded, so there is no way to cash out through redemption (returning shares to the fund) or selling the shares to someone else on a stock exchange. On the reverse side, the fact that fund managers have only 10 years (often extendable to 12) means they have a finite time horizon over which they can compound.
Another issue with venture funds is that the incentive structure favours the manager investing all committed funds quite quickly – if you hold cash, you are driving down the performance metrics (annualised return) of the fund (assuming a counterfactual of making strong investments, a strong assumption!) AND you are delaying raising the next fund, which brings a new flow of 2% per year in fees.
The idea of the interval fund (quarterly in the Coatue case) is that you allow limited withdrawals – perhaps with some small fee for withdrawals above a threshold – BUT you have no fixed life for the fund. For investors, this gives them flexibility to withdraw. For fund managers, this hopefully means some of the capital stays in the funds for a long time and can compound (earning higher fees).
Since – in theory – there can be compounding for longer, interval fund managers can accept lower fees (although, to a degree, lower fees itself means the fund may attract more volume, and so this is partly just following the investing fee trend that if you want a larger fund, you typically have smaller fees). [See the last portion of this podcast here to hear Philippe Laffont speak about Coatue].
And so, you have the Coatue’s proposed interval fund charging about 1.5-2% all in in annual fees and a 12.5% share of profits beyond a 5% benchmark – which is meaningfully lower in terms of fees than a traditional VC fund charging 2% annually and 20% of profits (in some cases payable on any profits beyond money paid in). While often Venture or Private Equity firms might have the managers own funds account for 1%+ of the total fund, the interval fund seems to have a higher percentage, with suggestions that ~$150M would be contributed by Coatue partners and employees out of a fund with anchor investors totaling ~$1B. Again, as with Pershing Square (and Buffett below) this should enhance manager-shareholder alignment.
The Buffett Strategy
Buffett just didn’t charge fees. No annual percentage fee. No percentage of profits earned by the other shareholders. His only compensation other than the gain in value of his shares was a $100k salary and expenses.
And you could say, well, he benefited by having more capital under his control so he could do more deals and larger deals. But the counterargument is that having more capital often makes it harder – not easier – to earn a higher return.
Or, one could say he benefited from a large insurance float owned by Berkshire’s investing entities – and that this was enabled by Berkshire’s credibility and capital. But, much of the credibility came from Buffett himself, and from Berkshire being public, rather than its capital. And, on the capital front, Buffett – until quite recently – owned a very large percentage of Berkshire. 50% from 1965 until 1990 (see Table 1), which was reduced only ~10% points with Class B stock issuance, the General RE all-stock merger and the BNSF partial stock acquisition – combined! The main reason – by far – that Buffetts ownership has gone down is simply because he has given it away (see Table 2).
I had an 8,763 word discussion with the o3 model on ChatGPT. I tried to dig out from it why Buffett didn’t charge a fee, and I couldn’t find any motivation other than the fact that it was the most straightforward – although certainly not the most value extractive, in the short term – way to do business. (please email me or comment if you do.)
And what did Buffett get?
1. Permanent capital. Unlike Venture Funds or Private Equity funds or Index Funds, nobody can ever cash out their shares and require that Berkshire pay them out. Shareholders can only sell, not redeem their shares. This is the dream of any fund owner – not having to worry about coming into the office and having to sell off investments at short notice just so an owner can redeem.
2. Shareholder Alignment. Buffett was only ever it for growth in the value of his shares, which is as close as one could be in terms of alignment with the goals of other shareholders. For VCs and PE firms, the misalignment brought on by % annual fees (incentive to just grow the fund size, not profits) and % share of profits (incentive to take bets with large upside even at the expense of downsize, since profit share is asymmetric upwards).
3. A holding company that trades above book value. In other words, buyers of Berkshire stock have historically paid a premium to book value for Berkshire shares (although that calculation has become increasingly complex as there are sources of value – such as Berkshire’s insurance float – that is not captured entirely in book value). This is not trivial, and funds that charge fees and are publicly traded often risk trading at a discount to net asset value, as has been the case for Pershing Square Holdings (the European listed vehicle). Trading at a discount – rather than a premium – to book value or net asset value poses a big issue as it means a company or fund cannot easily issue shares to raise funds for new investments without selling part of the company/fund for less than what it is worth [6].
But it is so hard for fund managers to come around to doing what Buffett did by charging no fees – it’s the ultimate Ryanair strategy. Think of how much money Buffett made for other Berkshire shareholders (including me!) and he didn’t even get paid the 0.07% that Vanguard earns on its index funds.
And that’s the Buffett strategy that no-one wants to copy.
Appendix A: Other Notes
1. Possibly the closest thing to the Buffett strategy is CEOs like Bezos (when at Amazon) or Zuckerberg at Meta, who basically just benefit from the gain in their stock, but for little salary, options or fees. Notably, Musk at Tesla operates differently, and earns (unless quashed by a judge) large stock options.
2. The Coatue structure is interesting and really tries to mitigate the adverse selection brought about by liquidation – even charging a 2% fee to those who want liquidity beyond the quarterly allowance. The problem is, when markets crash, price impact is often non-linear and the impact can crash through the combination of these mitigation factors.
3. It’s surprising how often the performance fees on funds are 20% of profits beyond initial capital paid in. So, you’re paying a performance fee even if the fund doesn’t beat the S&P 500. The Coatue fund goes a bit beyond this and only charges a 12.5% fee for returns over 5%. Then again, if you are paid for performance beyond the S&P500, possibly that incentivises fund managers to create a fund that very closely mirrors the S&P500.
4. I’m tempted by the Coatue fund because regulation has made it hard for companies to go public (e.g. Stripe). This means it is possibly smart to have more private market exposure. But, the fees are still material – it will take exceptional performance to make up for the ~1.5-2% annual plus 12.5% profit share fee – plus risk of being left with the worse investments in the fund during periods of high redemptions.
5. One obvious question to ask is why Buffett didn’t just go alone and own everything. If you have $10M, it’s not as though having double that gives you a radically better starting point. The answer is likely just path dependence. The acquisition of Berkshire Hathaway was a terrible one because linen mills were doomed. Buffett salvaged and grew the business through new investments, but that meant he would never own all of it, not unless he ditched it and started elsewhere from scratch. And he had already started from scratch at least once over. Just prior to Berkshire Hathaway he was charging performance fees and did away with them.
6. The opposite scenario is where your fund/firm trades at a premium to net asset value and you have the option to profitably issue shares. This is more or less what is happening with Microstrategy, where the firm is worth more than the market value of the Bitcoin they own. Note that I don’t own nor ever plan to own Microstrategy stock.
Appendix B: Buffett’s Berkshire Ownership History
