I recently found a classic article published in Fortune in November 1999. It was written by Warren Buffet, as the market was being carried to new heights by the internet bubble. I include excerpts here, with a little editing by me for clarity or brevity. There are many great points in it, which I discuss briefly after these excerpts. Most fundamentally, it reminds us of why CornerCap is in business in the first place.
Buffett on the Market, November 22, 1999:
Bear in mind--this is a critical fact often ignored--that investors as a whole cannot get anything out of their businesses except what the businesses earn. Sure, you and I can sell each other stocks at higher and higher prices. Let’s say the [market] was just one business and that the people in this room each owned a piece of it. In that case, we could sit here and sell each other pieces at ever-ascending prices. You personally might outsmart the next fellow by buying low and selling high. But no money would leave the game when that happened: You’d simply take out what he put in. Meanwhile, the experience of the group wouldn’t have been affected a whit, because its fate would still be tied to profits. The absolute most that the owners of a business, in aggregate, can get out of it in the end--between now and Judgment Day--is what that business earns over time.
And there’s still another major qualification to be considered. If you and I were trading pieces of our business in this room, we could escape transactional costs because there would be no brokers around to take a bite out of every trade we made. But in the real world investors have a habit of wanting to change chairs, or of at least getting advice as to whether they should, and that costs money--big money. The expenses they bear--I call them frictional costs--are for a wide range of items. There’s the market maker’s spread, and commissions, and sales loads, and 12b-1 fees, and management fees, and custodial fees, and wrap fees, and even subscriptions to financial publications. And what do they come to? Investors are dissipating almost a third of everything that their companies are earning for them—by handing it over to various types of chair-changing and chair-advisory “helpers.” In my view, that’s slim pickings [for investors].
There are hefty charges for little guys who have wrap accounts; management fees for big guys; and, looming very large, a raft of expenses for the holders of domestic equity mutual funds. You have to conclude that the annual cost of these to their investors--counting management fees, sales loads, 12b-1 fees, general operating costs--runs to at least 1%. And none of the damage I’ve so far described counts the commissions and spreads on options and futures, or the costs borne by holders of variable annuities, or the myriad other charges that the “helpers” manage to think up. In short, frictional costs for the owners of stocks--which is 1% of the 500’s market value--looks to me quite possibly on the low side. It also looks like a horrendous cost.
And don’t brush these expenses off as irrelevancies. . . stock market investors who are figuring their returns must face up to the frictional costs they bear.
As I read Buffett’s analysis, two points struck me. First that the aggregate return will be ONLY the profits of the companies that make up the market. Second, that such a large portion of that profit will be eroded away by people who are as Warren Buffett puts it, “moving chairs around or getting advice on whether they should.” He obviously takes a very dim view of all the “helpers,” and I agree with him.
But if I agree, then what is CornerCap doing in an industry that provides less than NO value in aggregate? Are our clients somehow being cheated? I often challenge myself as to whether our clients are getting their money’s worth from us. This shouldn’t be just a passing thought. Every business should continually examine its model to be sure it adds real value. If it does not, it will eventually cease to exist.
Here is what I believe. There is no disputing Warren Buffett’s thesis that, in total, shareholders can get no more than the net profits from the business they own. CornerCap’s first task is to work toward seeing that our clients get their share of those profits. Our research and stock selection in our portfolios, using Fundametrics, has over time provided a return that has allowed clients to do better than a passive benchmark, after our fees are paid. We would like to think that we add value by “moving the chairs around.” But there is no guarantee that this added performance will continue in the future. We believe that it will, but there can be NO guarantee.
So, absent assured great performance, what do we offer our clients that justifies their using us? Our second task, and the one I believe most valuable to our clients is to bring order to a process that is often rooted in chaos when left to the clients themselves. Many of them have never created a personal balance sheet, cash flow statement, or even done a projection of how their assets and income balance against their retirement plans. Also, many have been totally ignorant of estate tax issues that can potentially cost their heirs thousands or millions of dollars in totally avoidable taxes. Our job is to help these people make tax efficient investments and direct their lives toward attainable financial goals. Our success in accomplishing this is not really measurable – since we would have to measure what we accomplish for the client against what would have happened if we weren’t there, something that can never be known, since we ARE there for them.
But anecdotally, we have seen enough case histories to know what a poor job most people do on their own. This is a point on which I take issue with two of my real heroes in the investment world – Warren Buffett and John Bogle. Both explain that all one has to do is pick some good sound investments, and then leave them alone. The point they both miss is that very few people are emotionally capable of following that advice. Especially in times of great change in the markets, emotion usually overrules rationality. I agree with Warren Buffet’s alter ego Charles Munger, the vice Chairman of Berkshire Hathaway who often adds cynical zingers to Buffett’s comments. During one of their famous annual meetings, at one point Buffett was talking about his shareholders investing on their own, which, he said would work out just fine for many of them. To which Charlie followed up, “Many of you won’t do fine.”* I believe Munger understated the case – MOST of them won’t do fine on their own.
Yes, we move the chairs when we believe it will help our clients. We make no money by shifting the chairs. We have no incentive to do so, and we only put money in motion when we think it will benefit the client. We do our best to protect the clients from others who do charge extra fees for moving the chairs, sometimes exorbitant fees and in investments that are often little understood by the client and highly illiquid, tied up for years.
We greatly limit the chair switching. Each such move costs money in transaction costs. But for many individuals bad timing costs four times as much as fees and transaction costs. Evidence suggests that average investor buys high, sells low, and by doing so, loses about 1% a quarter on average; if the market does 7% a year, the average investor does 3%. For example, many investors bought in 1999-2000 and lost 80%. Then they came back in 2008 and lost 50%. That leaves them down 80% over the last 13 years, a decline of -16% annually. A conservative, disciplined approach could have made 2.3% a year with the S&P 500.
CornerCap’s mission can be summed up – we provide investments and advice that is relatively low cost, transparent, and liquid. Our roots are anchored in investment research and institutional investing. That fuels our investment passion. However the really significant value that we will always add is with our stubborn investment discipline and strong handholding.
*Carol J. Loomis, “Tap Dancing to Work Warren Buffett on Practically Everything, 1966-2012.” p. 253.