Dear Client,
In the first quarter of 2002, our average account gained approximately +2.4%.
The biggest art fair in the world takes place in Maastricht, Holland every year in March. This year, the night the show opened, the Italian police raided the establishment with a hundred officers, looking for stolen or illegally exported artifacts. The next day, the Chairman of the fair was quoted in the New York Times as saying, “We have nothing to hide. I hope they didn’t find anything.” This combination of braggadocio, followed almost instantly by the craven admission of guilt, seemed to us to nail the current spirit of the age right on the head. If you, like us, are foolish enough to watch C-Span through the night, you got to watch Jeffrey Skilling, the former chief executive officer of Enron, masquerade as Sergeant Schultz for two solid days before Congress. “I know nothing!” was the gist of Mr. Skilling’s remarks. Ignorance of everything going on around him did not stop Mr. Skilling from taking hundreds of millions of dollars in compensation over the last five years, while his criminal enterprise traipsed about costumed as a successful business.
For many years we have read with great pleasure the quarterly letters of our friend Richard Gilder, who is both a sage and a brilliant investor. Gilder likes to remind himself and his readers that in a small business, the management is the business. As we get older, the fundamental wisdom of this observation keeps growing on us, such that we have taken to wondering whether they aren’t all small businesses.
In this season of cupidity, we can ease your mind on one point. The managers of the companies whose shares you own are a remarkable collection of decent and honorable people. Before we trusted them with your money, we thought through whether they were trustworthy. Doesn’t sound like much of an encomium to us, does it? And yet in the hyperactive world of mutual fund managers, who so dominate trading today, maybe it is. As the partners at Tweedy, Browne point out in their year end letter, a typical mutual fund manager turns over his portfolio 300% per year. What incentive does he have to learn the names, let alone the habits, of the people running the underlying businesses in his portfolios? He’s lucky if he can remember the symbols.
We recently had the most delightfully re-assuring illustration of this point. In back to back days we heard the managements of La-Z-Boy Chairs and Furniture Brand International extol the acumen of Farook Kathwari, long-time head of Ethan Allen. You may think you have backed the right horse, but there is nothing like hearing it from the other horses mouth. Ever make a mistake, and not known how to own up to it? Log on to www.BerkshireHathaway.com and read the chairman’s most recent letter. Warren Buffett wrote his shareholders with so much humility it prompted a young colleague here to ask, “Is this the guy with all the billions?” In the same vein, the next time Charlie Ergen of Echostar has a quarterly conference call, sometime around May 10, call in. Charlie’s candor makes most listeners bubble over with laughter.
We have share turnovers, managers retire, and sometimes we are disappointed in people. But that last is rare. When our friend Shad Rowe noted some years ago, “It’s been my experience people don’t normally alternate between smart and dumb,” he might also have noted they do not switch between honest and crooked so fast either. Angelo Mozilo at Countrywide Credit has recently pointed out to us that he has compounded money for his shareholders at 22% for 26 years. He is unlikely to start treating us badly tomorrow (with corrupt options plans or excessive salary demands or fictitious earnings reports) because he isn’t in the habit, and no one with much experience in the world can imagine him changing. This is what makes Wall Street’s and the New York Times’ sudden discovery that there was villainy afoot in capitalism so deeply amusing. Telling good guys from bad guys mattered plenty long before the technology bubble ever started inflating.
Almost fifty years ago John Kenneth Galbraith wrote a book that put forward the concept of the “bezzle”. The “bezzle” was the amount of money that had been embezzled from financial institutions, or that society had otherwise been cheated out of. You could never know exactly what the number was, but you could say a lot about whether it was rising or falling, and something about how fast. The “bezzle” is a drastically lower number now than it was two years ago, and despite the daily headlines being full of skullduggery, that makes the financial environment a much safer place today.
We do not mean by this that the all clear has necessarily sounded, and we can all go back to speculating madly. Twenty-two years at this have taught us to hazard very few market predictions, especially about the future. But we would note that the time to be vigorous in comparing investment records, in judging what style makes sense as against what was always really a flash in the pan, is right about now. Or as our friend Seth Klarman puts it, “You only really find out who’s swimming naked when the tide rolls out.”
Sincerely,
Edwin A. Levy
Michael J. Harkins