Fee Structure of Buffett's First Investment Partnership, Buffett Associates?

[SCMessina]

Hi guys,

 

I wanted to see if others had thoughts on whether this is the correct interpretation of Buffett's fee structure for his first investment partnership:

https://www.scmessina.com/2015/03/what-was-the-fee-structure-of-warren-buffetts-first-investment-partnership-started-in-1956/

 

I know the fee structure changed subsequently for following partnerships (25% above 6% hurdle rate with other variations), but for the first group of investors, close family and friends, would be interesting to hear feedback on whether this interpretation is correct or not. Appreciate any color or insight.

[100 Shares]

I am pretty sure it was 6% hurdle rate and he took 25% of profits above that hurdle.

[benhacker]

I believe the link is correct. 

 

I think this is covered in Snowball...  He compensated original partners at 4%... so basically he was on the hook for that + fund expenses regardless.  The 6% / 25% was later when he consolidated the partnerships, or maybe just later on, I can't remember.

[Tim Eriksen]

Remember he had five partnerships by mid 1957 so the generous terms on the first probably did not apply to all.  My notes related to 1957 show three options. 6% hurdle with 33% profit interest, 4% hurdle with 25% profit interest, and 0% hurdle with 16.67% profit interest.  His 1957 letter also notes that two partnerships started during the year finished minus 12% with no mention of any clawback. 

 

I don't know when the law changed but I believe it is illegal now to structure it the way he did.   

[bookie71]

I have a lawyer friend, from Omaha,  whose parents had a chance to invest in the first partnership, but decided it was better to put the money in savings for his college.  As he says, "They could have bought the college"

[original mungerville]

Remember he had five partnerships by mid 1957 so the generous terms on the first probably did not apply to all.  My notes related to 1957 show three options. 6% hurdle with 33% profit interest, 4% hurdle with 25% profit interest, and 0% hurdle with 16.67% profit interest.  His 1957 letter also notes that two partnerships started during the year finished minus 12% with no mention of any clawback. 

 

I don't know when the law changed but I believe it is illegal now to structure it the way he did. 

 

Based on those three fee structures, it looks like his business plan expected 12% returns on partnership assets. 12% returns provides Buffett with 2% on assets as a management fee under all three fee scenarios.

[InvestingOnSale]

Remember he had five partnerships by mid 1957 so the generous terms on the first probably did not apply to all.  My notes related to 1957 show three options. 6% hurdle with 33% profit interest, 4% hurdle with 25% profit interest, and 0% hurdle with 16.67% profit interest.  His 1957 letter also notes that two partnerships started during the year finished minus 12% with no mention of any clawback. 

 

I don't know when the law changed but I believe it is illegal now to structure it the way he did. 

 

Based on those three fee structures, it looks like his business plan expected 12% returns on partnership assets. 12% returns provides Buffett with 2% on assets as a management fee under all three fee scenarios.

 

Looks like the 3 options for limited partners comes from Buffett's 1960 letter when he was trying to combine all the partnerships into one.

http://www.bengrahaminvesting.ca/Resources/Buffett-Partnership-Letters.pdf

 

As of 1968, his gross compounded returns were an annualized 31.6% and net returns were 25.3%. So, I take the fact that the three fee structures break even to the partners at a 12% annual return as Buffett being consistent in keeping expectations low. With the benefit of hindsight and after reading all the letters, one can't help but be amused at the high outperformance, yet constant downplaying of expectations.

[Guest Schwab711]

Remember he had five partnerships by mid 1957 so the generous terms on the first probably did not apply to all.  My notes related to 1957 show three options. 6% hurdle with 33% profit interest, 4% hurdle with 25% profit interest, and 0% hurdle with 16.67% profit interest.  His 1957 letter also notes that two partnerships started during the year finished minus 12% with no mention of any clawback. 

 

I don't know when the law changed but I believe it is illegal now to structure it the way he did. 

 

I'm pretty sure it was illegal then :) I'm studying for the 65' right now and this is all covered in the Investment Advisers Act of 1940. I'm not sure what the benchmark for 'qualifying investors' was at the time and if he had under 5 investors he would have been exempt as well (probably why there's so many partnerships). Either way, it was likely illegal in spirit even if technically legal, assuming no clawback.

[Sionnach]

This is an old thread - but recently started reading the book "Warren's Ground Rules", which I highly recommend thus far.

 

Regarding the fee structure - is there a reason why Buffett chose to do a 6% hurdle rather than use the DJIA as a hurdle? He says he expected 5-7% returns for the dow, and this is where the 6% hurdle come from. Why wouldn't he just use the DJ as a hurdle?

 

He does this now for setting Todd and Teds compensation.

 

Also - was Buffett so confident that he would return >6% that he was not worried about having returns of, say, 4% three years in a row and making no fees for three years?

[Mephistopheles]

I think it's because he likes to focus on absolute returns rather than comparing to the market in every single time period.

 

This is to prevent a total reliance on the market. For instance if the Dow drops 20% and he loses 18%, that would mean he takes compensation for beating the market even though clients lost money.

[jmp8822]

Also - was Buffett so confident that he would return >6% that he was not worried about having returns of, say, 4% three years in a row and making no fees for three years?

 

I believe he already had enough money at the time that he wasn't going to be in trouble if the business didn't make money.

[Sionnach]

I think it's because he likes to focus on absolute returns rather than comparing to the market in every single time period.

 

This is to prevent a total reliance on the market. For instance if the Dow drops 20% and he loses 18%, that would mean he takes compensation for beating the market even though clients lost money.

 

I'm not sure about that - in his early partnership letters he often talks about how relative performance is more important than absolute (Klarman seems to disagree). He says he'd much rather lose 10% and the dow lose 20% than have them both gain 20%, which makes intuitive sense, but to me would suggest that he should have based his compensation on performance relative to a benchmark (as he's done with T and T)