Buffett’s Trust Strategy Makes Sense—But Not for Active Capital Allocators

During their recent episode, Taylor, Carlisle, and Chris Bloomstran discussed Buffett’s Trust Strategy Makes Sense—But Not for Active Capital Allocators. Here’s an excerpt from the episode:

Christopher: Yeah. There’s an eclecticism to capital. You need to be opportunistic. Yeah, pigeonholing yourself doesn’t make a lot of sense. You’re always trying to make money and you’ve always got cash, you’ve always got dividends, you’ve always occasionally proceeds from security sales, you’ve got deposits from clients, you’ve got your own personal net savings, ideally.

I want to segue thought about something, and it ties back to what we were talking about earlier about the cap weighted S&P 500 and you get into Buffett. I think people should consider– I get this question all the time, because Warren would sit there at the deus and talk about– When asked about Berkshire, when he would proffer advice on investing, he’d always say, “The S&P 500 is a marvelous tool, because it’s low cost, low turnover, tax efficient, very hard to actively pick stocks. You’ve really got to know what you’re doing. And even there, a lot of people don’t do well with it.” Charlie would always say, “Yes, but Warren, I think Berkshire will do better.” Anytime Charlie said, “Yes, but Warren, Berkshire would do better,” Berkshire did better. But of late with Warren’s second wife, he’d said a few years ago that Astrid would have a trust set up for her benefit, and it was going to own the S&P 500, I think 90% S&P and 10% T-bills.

At last year’s annual meeting, somebody asked the question about cap weighted S&P versus market cap weighted S&P. He never answered that question. But what he said was, “Look, there’s so much money that’s going to be in this trust for her benefit that she doesn’t care about beating the S&P 500. It doesn’t matter. She’ll never spend enough money that’s being produced just by the dividends being distributed. So, it really doesn’t matter.” But then he said what I’m glad he said, because I’ve been saying this for a long time and that was, “And there’s this little thing, because you don’t want to get the trustee to get sued.”

Jake: Yeah. [crosstalk] man argument.

Christopher: This will be an irrevocable trust distributing income. And from a fiduciary standpoint, Prudent Investor Rule, now Prudent Investor Act in every state, you cannot hold a single concentrated position in the security. I was an expert witness in a lawsuit. An heiress of the Procter & Gamble family had a charitable trust, and I wound up defending the bank, because they had a document that expressly allowed the retention of Procter & Gamble, which was a blue chip. If you read the Prudent Investor Rule and Act, it allowed for concentrated positions. But they come up with a game plan to slowly diversify.

Well, they made the mistake they being the bank manager of buying tech stocks with the proceeds, but they were two or three months in and P&G had earnings miss and the stock got cut in half. And in turn, because the portfolio got cut in half, the income distribution to the donor got cut and there was a lawsuit. And the attorney general in Ohio got involved and the bank lost. They wound up settling it. But it was a crazy loss, because the document actually allowed for a fully concentrated position in P&G. No, you’ve got to diversify. So, there’s a requirement.

I think it’s similar to Warren’s just having bought the energy business from Walter Scott’s estate or in part from the kids, but ultimately in the foundation, wherever it was at that iteration, I presume that was going to be a very big position. Walter ran [unintelligible 00:49:45] and he certainly had assets outside of Berkshire, but that Berkshire Hathaway energy position was huge, and I think it required diversification. So, I think there’s a lot more to Warren saying the S&P makes sense.

To me, the S&P makes sense for the family that’s going to sit down and dollar cost average over a lifetime. Occasionally, you’re going to buy some stock when it’s cheap, sometimes it’s going to be fairly priced, sometimes expensive, but you’re going to save a lot of fees, you’re going to save a lot of frictional costs. It makes sense if you’re uninitiated. It’s terrible advice at a moment where you’re sitting at a secular peak where you’re 26 times earnings, where the deck is stacked against return, when there are way more favorably priced attractive things to do with capital.

If you’re a pension fund or you’re somebody that has capital today, owning the cap weighted S&P is a terrible, terrible thing. He never made that caveat. Charlie was more prone to make that caveat than Warren would have been or would be today.

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