In the summary of a 19-page memo Warren Buffett sent to the The Washington Post Company (NYSE:WPO)‘s Katharine Graham in 1975, he wrote:
A mildly non-conventional investment approach, emphasizing a business approach to security selection, gives some opportunity for long-term results slightly above average without corresponding increase in investment risk.
According to Fortune, this simple advice may have saved The Washington Post Company (NYSE:WPO)’s pension plan. It also remains the most sensible investment strategy around for ordinary investors, in my opinion.
Buffett has recently shared the original 19-page memo with Fortune. You can read the amazing document in its entirety here. The memo laid out some of the overall challenges facing The Washington Post Company (NYSE:WPO)’s pension plan in considerable depth. The discussion of investment management is simply outstanding, and it is one of the clearest expressions of Buffett’s philosophy I’ve ever read.
Where everyone is actually below average
Buffett begins his section on investment management by confessing he’s skeptical that professional money managers would be able to deliver outperformance for a pension fund. This, of course, makes complete sense if you look at conventional money management in the aggregate.
According to Buffett, professionally managed money makes up too much of the investing universe to be able to perform above average as a group. It’s analogous, he says, to someone sitting down at the poker table and announcing, “Well, fellows, if we all play carefully tonight, we all should be able to win a little.” All in all, Buffett declares that he’s “virtually certain” that professional money management cannot deliver above-average performance. Indeed, it will deliver below-average performance because of fees.
So now what do we do, Warren?
If professional money management cannot deliver outperformance, then how should a pension fund manage its money? Buffett attempts to answer that question in the main body of the memo by suggesting and analyzing five options.
The first option would be for the pension fund to just go with conventional money managers with the “expectation that performance will be slightly poorer than average because of costs involved.” The second option might be to create a portfolio that merely aims to recreate the market. The third option, which would be very difficult to implement, would be to identify superior, yet unknown, money managers whose record has been good for the right reasons. The fourth option would be to invest everything in fixed income.
Attitude is everything
Buffett tees up the fifth and final option by admitting that it’s “the one to which I lean,” even though it’s somewhat unconventional. The key to this option is that it “involves treating portfolio management decisions much like business acquisition decisions by corporate managers.”