Lessons from an investment genius

Most investors will be familiar with Warren Buffett, still one of the ten richest men in the world courtesy of the investment company Berkshire Hathaway he has built and run over the past six decades. But you may be less familiar with Charlie Munger, Buffet’s right-hand man, who has just passed away at the ripe old age of 99, and who is often credited with turning Buffett into the investment genius he undoubtedly became.

For potential investors in investment companies, it’s worth finding out a little more about Munger. In today’s market environment, where shares in many investment companies are trading at significant discounts to the value of their underlying assets, Munger’s ideas seem as relevant as ever.

Before he met Munger, Buffett’s approach to investment was largely focused on finding troubled companies with assets that were worth more than their share prices implied. If such companies could put their difficulties behind them, Buffett reasoned, the share price would rise to reflect the value of their assets, and he would make a handsome profit.

It was a strategy that produced “satisfactory” results, Buffett has since said. But this approach, sometimes described as “cigar-butt investing” had a significant downside. Often, troubled companies don’t recover; Buffett might still get a return if they were broken up and their undervalued assets were sold, but there wasn’t much long-term gain to look forward to. In the worst case, they might go bust even before an asset sale.

Munger persuaded Buffett to broaden his horizons. He still wanted Buffett to look for companies priced attractively but urged him to avoid the bargain basement in favour of businesses with a real future. “He weaned me away from the idea of buying very so-so companies at very cheap prices, knowing that there was some small profit in it, and looking for some really wonderful businesses that we could buy at fair prices,” said Buffett.

That wasn’t Munger’s only contribution to Berkshire Hathaway’s success. He also identified the so-called “Lollapalooza effect”, which illustrates the significant role of investor psychology in market movements. Investors make bad decisions because they tend to follow other investors making bad decisions, Munger observed. It was this idea that underpinned the famous Buffett advice “to be fearful when others are greedy and greedy when others are fearful”.

How does this thinking apply to investment companies today? Well, first, large numbers of investment companies trading on substantial discounts are far from troubled – they are well-run funds with long track records of good performance, but prices that do not properly reflect them. Many of them are exactly the kind of businesses Munger took an interest in for so long.

Second, it’s worth thinking about why so many investment companies are on significant discounts. In many cases, it is because investors are fearful – in a tough economic climate and a geopolitically volatile world, their anxiety is informing their decisions. Perhaps a time for others to be greedy, then.

Howard Buffett, Warren Buffett’s son, once described his father as the second smartest man he had ever met. For today’s investors, it’s worth studying the work of Munger, the only man that Buffett Junior rated more highly.