Tag Archives: Buffett

Why is Berkshire Hathaway is not on the “Too Big To Fail” list?

It appears that the Bank of England sent a letter to the U. S. Treasury asking why Berkshire Hathaway is not on the list of “too big to fail” institutions.

If you are on the list it is deemed that you are a financial institutions “whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity.”

MetLife, along with a number of other primary insurers, has sued the U.S. government about it’s designation as an SIFI (‘Systemically Important Financial Institution.”)  Being designated an SIFI brings along with it considerably more regulation.

New regulations under the Dodd-Frank legislation, mandate that financial institutions that fit SIFI qualifications, will have to meet higher capital standards and develop contingency plans for potential future failures.

But here’s something that most people are not aware of: insurance companies often take out insurance against catastrophic losses from other insurance companies.  The companies that insure the insurance companies are called “reinsurers.”  Berkshire Hathaway, run by Warren Buffett, is the largest of these reinsurers in the U.S. and the third largest in the world.

So who is more important to the financial stability of the financial system, retail insurance companies or the big global reinsurance companies that insure the insurers?  To me, the answer seems obvious.

To use your local bank as an example.  If it goes broke (and many have) it’s no big deal because your money is insured by the FDIC (Federal Deposit Insurance Corporation).  But if the FDIC went broke, that would be a BIG DEAL.  Then no one’s bank deposits would be safe.

Insurance is Berkshire’s most significant business – accounting for 27% of net earnings last year – and providing Warren Buffett with the capital to invest in stocks and acquisitions.  But Warren Buffett has friends in high places which may explain the reason he’s not on “the list.”

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Active vs. passive investing

There is a great deal of misperception about the merits of passive vs. active investing.

First, let’s define terms for people who are not familiar with investment styles. Passive investing is buying all the stocks in an index, like the S&P500. Since there is no research involved and the only time an index fund makes a change is when there’s a change in the index, costs are kept low. Active investing, on the other hand, means that a fund manager looks at the stock market and buys those stocks he thinks will go up and avoids those that he believes will go down. Obviously he won’t be right all the time, but if he’s a good manager his selection will result in a fund that will do better than average.

That’s a simple explanation. It doesn’t get into factors such as value vs. growth, risk adjusted returns and other nuances. But it’s the basic concept.

Much is made about expense ratios and average returns. A lot of this confusion is the result of marketing by John Bogle, the founder of Vanguard Funds who made a fortune by promising his clients that they would never do better than average … and that was a good thing.

So why didn’t investing legend Warren Buffett give up stock picking and put his money in an index fund? Because he’s a good stock picker who can add value and get a better return on his money than a stock index. And Buffett isn’t the only one.

There are money managers who can add value to a portfolio, a better risk-adjusted return than the market. And there are managers who do worse. Knowing the difference requires years of research and expertise. That is what we at Korving & Company provide to our clients. We create a diversified portfolio of mutual funds tailored to the needs of our clients using funds managed by individuals who have demonstrated that they can add value over and above an index.

Without that, many investors are better off being average.

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Warren Buffett and You.

An interesting, and instructive, article in Investment Advisor magazine made some great points about the Buffett legend.  Like most legends, it’s part truth and part myth.  In Buffett’s case there is more myth than truth.

Don’t get me wrong, Buffett is one of the world’s richest men, and a famous investor.  But it’s not a rags-to-riches story.  Son of a Congressman, young Warren had an elite education.  He bought a farm while in high school, not something you can do with the income from a paper route.

The legend is that he’s just a folksy stock picker with a buy-and-hold strategy.  The truth is that he made his first millions as a hedge fund manager, raking off 25% of the profits over a 6% hurdle rate.  His most famous investments came from bailing out firms in distress like GE and GEICO when they were in financial trouble.  Buffett got sweetheart deals from them because he had them by the throat and could lend them billions of dollars when they needed it fast.

That’s the edge that Buffett has that none of my other readers have. (Hi Warren)

One observer of Buffett wrote:

By oversimplifying this glorified investor named Buffett the general public gets the false perception that portfolio management is so easy a caveman can do it. And so we see commercials with babies trading from their cribs and middle aged men trading an account in their free time.

If you’re not Warren Buffett, what should your objective be with your investments?  Think about your goals.  See if they are reasonable.  Determine what it will take to get you there.  If you need help with this, get the advice of a professional.  If you are fortunate enough to have already reached your financial goals, decide what it takes to make sure you don’t lose it.

And then, unless you are determined to make a career out of investment management, hire a competent, credentialed, experienced, fee-only Registered Investment Advisor to manage your portfolio for you.  In other words, call Korving & Company – today – and make an appointment.

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