“Four years ago, I told you that we needed to add one or more younger investment managers to carry on when Charlie, Lou and I weren’t around. At that time we had multiple outstanding candidates immediately available for my CEO job (as we do now), but we did not have backup in the investment area.
It’s easy to identify many investment managers with great recent records. But past results, though important, do not suffice when prospective performance is being judged. How the record has been achieved is crucial, as is the manager’s understanding of – and sensitivity to – risk (which in no way should be measured by beta, the choice of too many academics). In respect to the risk criterion, we were looking for someone with a hard-to-evaluate skill: the ability to anticipate the effects of economic scenarios not previously observed. Finally, we wanted someone who would regard working for Berkshire as far more than a job.
When Charlie and I met Todd Combs, we knew he fit our requirements. Todd, as was the case with Lou, will be paid a salary plus a contingent payment based on his performance relative to the S&P. We have arrangements in place for deferrals and carryforwards that will prevent see-saw performance being met by undeserved payments. The hedge-fund world has witnessed some terrible behavior by general partners who have received huge payouts on the upside and who then, when bad results occurred, have walked away rich, with their limited partners losing back their earlier gains. Sometimes these same general partners thereafter quickly started another fund so that they could immediately participate in future profits without having to overcome their past losses. Investors who put money with such managers should be labeled patsies, not partners. (more…)
Profits resulting from the violation of one’s own system or methodology constitute the most treacherous mirage of success. We’ve all been tempted at one time or another to suspend our collection of pre-defined rules (so painstakingly accumulated, yet so easily put aside) for the possibility that for this one particular moment, distinguished from all others, things might be different. And perhaps we were right — this time — and the register rung. Yet for those of us who have chosen the way of the System, the momentary suspension of discipline is a transgression beyond profit or loss. For no matter the what the outcome of the trade executed, the damage has already been done — any gains secured in such a manner will only serve as future tuition until that particular lesson is learned. This must be understood before forward progress can occur, for unless process takes precedence over result, the cycle repeats ad infinitum.
Pull a portion of winnings out of the market to prevent trading disci-pline from deteriorating into complacency. It is far too easy to rational-ize overtrading and procrastination in liquidating losing trades by say-ing, “It’s only profits.” Profits withdrawn from an account are much more likely to be viewed as real money.