Shooter MacGavin

In this case I don't have to worry, but is that still true if you're unregistered?

Tim, Thank you. Yes, I proposed 0/25% because that's likely the only fee structure I would pay if I were investing with someone. Of course, it has its origins in the Buffett partnership and comes from a desire to do right by investors. But you're right, I'm reading Ground Rules, and he himself had various structures as you mentioned. Would love to hear other people's thoughts on fee structures that they use if they're willing to share in the group or privately. Thank you.

To current active managers / RIAs, I have a client interested in investing some money. let's say its between $1M and $5M. I think I have a pretty good idea of the pros/cons of a fund vs. an unregistered RIA structure for the moment and i'm choosing to manage through an IB friends and family account for the moment. if there's more money to come down the road, I'll roll into a fund structure. as of right now, its early so I can iterate if need be - in other words....nothing is in writing yet. I'm talking to lawyers, IB etc. one issue right now is fee structure. I proposed an 0/25 structure, but I think that was a bit idealistic. I won't have working capital, and I'll need to keep my own capital in cash to weather for a few years so this isn't ideal. I may go back and propose a sliding fee structure - the more capital , the less of a mgmt % and greater performance %... Anyone have any suggestions on anything that they wish they would have done differently / regrets / or anything/vendors they would recommend? If you don't wish to share here, would love to hear from you in PM too. Thank you very much in advance for your time/ comments

that makes a lot of sense. It's something i want to do too, and it's going to be tedious work to pull all my historic trades. Does it make a meaningful difference when you compare it to the returns on a total return index?

Something i've been puzzling about recently. It seems that when interactive brokers/fidelity or any other broker gives you personal returns, it's in dollar weighted terms (in IB's case, you can set it to this). That's appropriate when measuring personal returns. However, when they show you the benchmark, it's time weighted. Obviously the two are not apples to apples, but is a time weighted benchmark a good enough benchmark relative to dollar weighted returns? I'm not sure about this. Let's say you had equal dollar contributions once a month to an index fund vs. your stock picks, would the index be a decent benchmark? Thanks for your feedback

This is basically how I do my calc too generally. However... I think if you are growing the investment book from $145k to $166k, that's likely too conservative. the equity book, at 10% per year, will add $37k per A share alone. And then fixed income may add 3% per year..and float growth may add a point or so, which would be reinvested in marketable securities in the same proportion of FI to Equity presumably. Also on the operating side, even if pre-tax returns are 10% unlevered, berkshire is consistently levering them by issuing bonds and then reinvesting that levered capital. Some big users of capital; BNSF / BHE / Van Tuyl /PCP ...so maybe overall organic and acquired earnings growth is closer to 15%.

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%. yeah you're right. I didn't verify the math. I guess I could pay at most $48M to earn 10% or greater, as long as I could re-invest my coupons at 10%. Do some research on arbitrage (not saying that in a sarcastic way at all). You could pay a way higher price and still achieve 10%. Ignoring double taxation as your hypothetical was for conceptual illustration not details. Arbitrage isn't really the point though, the point is market prices and different amounts of risk in the underlying investments matter. And risks can often be hedged (if desired). I'm not exactly sure what you mean. Care to elaborate with an example?

If I'm understanding your hypothetical scenario, it sounds like a situation you could pay well in excess of 15mm and very safely earn far higher than 10%. yeah you're right. I didn't verify the math. I guess I could pay at most $48M to earn 10% or greater, as long as I could re-invest my coupons at 10%.

I don't know that Berkshire is going to have the highest return or not. It's somewhat undervalued. Internally I don't think it'll compound overall at more than a low double rate. And that's only because they're levering the operating side. Yeah, we don't know the future outcomes of anything - Berkshire or otherwise. But you have to have a conservative return expectation and mitigate the downside with price you pay for Berkshire stock. If cash rates go to 10%, then the stocks/bonds marks will temporarily tank. But future returns on the investment side will be far greater going forward. I personally don't care about market marks. I care about internal rates of return from holding investments. Acknowledging that equity returns are more variable, in a portfolio they'll still likely return more than cash with no more risk of impairment. In other words, even if you threw 15 darts on a board to pick stocks and just held those 15 stocks for 20 years without knowing anything about them, even if three of them ended up going bankrupt, you would still earn an ok return. Sure the equity book might be more "volatile" than cash but volatility isn't risk. The over all portfolio will still go up. Acknowledging the risk that Berkshire won't necessarily achieve expectations, I think you can only control that by having conservative base case expectations and then paying a low price. That being said, i'm not clear as to how this affects the $159k calc.

This is my point. You are implicitly applying an equity risk premium to cash and bonds. You need to risk-adjust your discount rate. I don't want to get too off-topic here, but just on this point, I don't think that one should automatically charge a lower rate to hold a bond than a stock. Or said differently, one should not automatically discount interest payments at a lower rate than earnings. Certainly when discussing a particular company, its bond is necessarily safer than its stock, but that doesn't mean all bonds, or a portfolio of bonds are automatically safer than a portfolio of stocks in general. In fact, I would argue that a generic portfolio of bonds is far less safe today than a generic portfolio of equities. The rates are low enough on average, bond holders are not getting compensated for the risks of default and the loss given default. Yet they're hungry for the illusion of guaranteed income so they continue to lend at absurd rates (negative in Europe). Consider two hypothetical auto companies A and B - each is like the other... both are highly cyclical in a commodity business earning 10% on capital. If A is capitalized with fixed rate senior debt at 7%, junior debt, and equity ....and B is capitalized only with equity...well in my mind, the junior debt of A, is far riskier than the equity of B, even though the junior debt of A is a bond and the equity of B is an equity. Inevitably both auto companies will have a loss making year, but A is more likely to go bankrupt if it can't service its senior debt. B is less than likely than A to go bankrupt. The bond of A in this case is far more risky than the equity of B. I'm getting pedantic , so just to bring it back to the per-share cash and investments of Berkshire, I consider the investment portfolio a ~6.5% return machine that is generally safe from a credit standpoint, whether my returns come in the form of interest or dividends or appreciation, it doesn't matter anyway. It's all retained and reinvested at roughly that 6.5%-7% rate. What do we pay for that? Another way to ponder over the same problem is: Consider two holding companies. 1) The first holds $100M in cash and will sit on it for 5 years. 2) Holds $100M of cash, and Lou Simpson will work for no salary to deploy it on day 1. Which one is worth more and how much more do you pay? In this case, $100M today will have very different paths in the future, so you can't just take $100M cash as worth $100M.

Well $20B is the minimum cash they'll hold to maintain a fortress balance sheet and the fixed income portfolio is there to maintain adequate additional liquidity to pay an ongoing stream of insurance claims. So as long as interest rates are low, all insurers suffer because they have to be liquid to pay a stream of claims and they earn very low rates on that excess liquidity. So fixed income is not placeholder..cash + fixed income has been generally been equal to float, or roughly 50% -60% of the investment book. It's a function of having an insurance business. So no, its not temporary. Now they'll earn an additional few billion from underwriting as well, but we're already counting that in our operating earnings.

My exact point is that the value to me is not determined by the quoted market price. When you say $100M "worth" of bonds, you're talking about the market's appraisal of it. Just to put structure to it: If the holding company holds bonds that have 1) 1.5% coupon 2) $100M face value 3) is as risky as an unlevered equity of the same company, and 4) I intend to hold your company's shares till the bond's maturity then absolutely I would only buy your holding company for $15M. Because I would choose to make 10% return on my capital, not 1.5%. I don't care if the market would outbid me by $85M for the same company. (This is just to simplify the exercise and drive the point home - yes I realize bonds are generally less risky because they are higher in absolute priority so maybe you slightly lower return requirement ). Asked differently, which would you rather have Berkshire hold for the next 5 years if you're an investor? $159k per share in cash, or $159k per share in carefully chosen equities? Would you assign the same value to both outcomes if you were considering buying the stock? Certainly the latter would make you wealthier in 5 years.

I see lots of people simply add the value of the cash plus investments per share disclosed by Berkshire to a multiple of Berkshire's pre-tax operating earnings to get the value of the stock. (I think the numbers adjusted for PCP should be roughly $145k and $13,498 per share.) However, my sense is that it's unlikely that the per-share investments can really organically compound at greater than a 6-7% rate right? If they've got 40% in equities and 60% in cash and fixed-income, then if equities do 12% over time and cash and fixed income does ~3%...then really you're looking at ~6.6% pre-tax returns reinvested at ~6.6% (and then on the liability side they've got this nice fat deferred tax liability that comes along with it). Personally, I value that less than $159,794 per share. So if 12x (~8% equity return) is a fair market multiple of P/E to apply to a stable company that is distributing 100% of its earnings, then maybe one that is reinvesting it at 6.6% should get a 9.9x multiple on earnings, or said differently that per share amount should be valued at $131,830 ( = 9.9/12*$159,794) . I think I tried to measure their investment per share performance over the last 5 years but since they've been reallocating some of their cash into operating businesses, its a little bit hard to figure out what the performance of their marketable securities have been historically. I think you used to be able to just look at the per-share investments, but now its not fair to do that anymore. Additionally the growth of the float has slowed. I don't know. what are board's thoughts on that $159k per share? Thanks for indulging me.

hmm. I guess if you bought a closer to the money put (at a higher premium) you could also alleviate that problem, say $130 instead of $120. The problem i see with a call though is it is not tax efficient. If it works, you're going to, before expiration, be forced to sell and book a gain. So unless you're in a tax free account, where I believe but am not sure that you can't borrow on margin anyway, then I'm not sure a call is the best option. Maybe in a tax free account, entering a call makes sense, at the right premium of course. If you go deep-in-the money, with a long dated strike however, my gut tells me that you're paying for a put that may be pretty useless if the market doesn't agree with you in two years. Some math to illustrate may be in order, but I'm having a lazy Sat so maybe I'll re-post at a later date. ;D

ah i see what you did. you're using 50% maintenance margin (18.25 / 36.5) . However the maintenance margin requirement (for IB at least ) is 25%. https://www.interactivebrokers.com/en/?f=margin&p=overview3#margin-01

Bear with me.... I'm slow. I'm not following your math completely. So I'll just lay it out the way I think about it. If my math is wrong here, please let me know. 1) I fund $27.2k of equity 2) I borrow $25k 3) My starting assets 366 shares at $136 (=$49.8k) + 2 put contracts 120x strike, Jan 2018 = ($7 *200 = $1.4k), and $1.0k of cash for interest payments Scenario 1: (forget about puts for the moment) Brk.B tanks to $90 the very next day. 1) total assets (not including puts): (366 shares * $90 or $32.9k in stock) + $1.0k cash for interest payments 2) Total liability is still $25.k 3) so equity is worth $8.9k 4) If maintenance margin is 30%, then I'm below. Because I'm at 26%. (8.9 / 33.9 ). So I need to cough up $1.3k, otherwise they close me out. Scenario 2: (Put hedge kicks in) 1) total assets: $32.9k in stock (366 * $90 per share ), new put value = (($120 - $90) * 200 contracts) = $6.0k, cash for interest payments of $1.0k 2) total liability = $25k 3) equity = ($32.9k +$6.0k + 1.0k) - ($25k) = $15k. 4) my equity % of assets = 37.5% ($15k /$39.9k) , so in this I'm not getting called out. My put hedge counts for equity So no matter how much the stock falls below $136, I'm not going to require more margin. Without the puts, I would get a margin call at around $97 or so, but the puts become more valuable once the stock declines below $120 offsetting my equity losses. In fact, one could make the argument that i should just buy $100 strike put instead of a $120. That's something to think about as well.

I guess just to clarify, yeah don't borrow the put premium.

you're just hedging the borrowed portion so you don't ever get a margin call. You still have to be right on the thesis. So in this case, unless buffett himself is wrong on the thesis he thinks its very valuable at $124 (1.2x book).

here's a hypothetical wild idea to earn around 18-20%+ per year on your portfolio for a while without breaking a sweat. Someone please tell me why this is dumb. Why not sell everything you own to start? dump into into BRK B . Margin 2:1 and then buy the jan 18 $120 puts for the borrowed portion to hedge your downside from a margin call. put are around $7 or 5% on $136 trading price, and margin cost is around 2% per year. So you're paying a total of 2.5% plus 2% per year so 4.5% per annum pre-tax. About 3.6% (post tax rate) per year. I think from here Berkshire incrementally compounds at 10%-13%, and maybe you get a little better for buying at a slight discount today. Even if the market crashes..you're not going to get a margin call for a $120 put (especially if you have portfolio margin in IB). Just make sure to roll the put forward 6 months ahead of time so you never are going to be forced to exercise it if the market does crash. The other hedge here is that in the event of a market crash, Berkshire will buyback stock at about $124 by my math...so its unlikely it will stay low for too long. (And god forbid if it did stay low, the stock buyback should be highly valuable to remaining shareholders so that the internal compounding per share may go up another few points) So basically the stock itself say it does like 12% per year (10% internal and 2% from a slight market multiple increase to more fair level) over the next two years. by my math thats about 18.6% per year. not too shabby. just hang out at the beach and check back here once in a while. why you would do this with berkshire ONLY is quite obvious..it's the safest financial instrument you can own in the world, its undervalued, and the put is cheap because the option market knows ( I think) that the stock isn't going to fall by too much and if it does it'll come back because of the repurchase.