Warren Buffett is looking for a successor

Every March, Warren Buffett (Chairman of Berkshire Hathaway) comes out with his annual letter to shareholders. For any true devotee of value investing, this is required and eagerly anticipated reading.

The letter came out last Thursday, and I poured over it with green pen in hand to underline important sections. One section in particular was particularly interesting to me. Buffett is going to pick a much younger successor to take over investing operations when he retires.

Buffett said,

"...I intend to hire a younger man or woman with the potential to manage a very large portfolio, who we hope will succeed me as Berkshire's chief investment officer when the need for someone to do that arises. As part of the selection process, we may in fact take on several candidates."

How will the greatest investor in the world go about picking the right person? Paying attention to how he looks for a money manager reveals important criteria we can all use in picking investment managers or even specific investments.

He goes on to say,

"Picking the right person(s) will not be an easy task. It's not hard to find, of course, smart people, among them individuals who have impressive investment records. But there is far more to successful long-term investing than brains and performance that has recently been good."

Right off, he highlights that a smart person with a good record isn't enough. He's emphasizing that brains and a nice 3 year record are insufficient criteria for choosing a money manager.

He continues,

"Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions."

He's highlighting the irrational behavior of markets, and how big, wrong bets can tank a recently good-looking record. He's looking for someone who avoids risks, not someone who can shoot out the lights. In avoiding risks, he wants a successor who doesn't assume risk solely by looking in the rear view mirror at either past events or, even worse, statistical data which doesn't capture and cannot capture future risks.

Some managers have great records because they've taken great risks. You don't want to find out they were taking huge risks after your portfolio has been mauled. As Buffett puts it, you can't tell who is swimming naked until the tide goes out.

Next, he says,

"Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I've seen a lot of very smart people who have lacked these virtues."

He's looking for someone with the right temperament for investing, someone who is independent-minded, level-headed, and understands both individual and herd psychology.

Look at his criteria:

1) intelligence and a good record aren't enough
2) he wants someone who avoids risks, not just a manager trying to shoot out the lights
3) he's looking for someone who doesn't just look at the past or statistical models in making decisions
4) he wants someone who is independent, level-headed, and understands human and group psychology

Is this the criteria that most financial planners or investment books and periodicals advise? Not in my experience. But, I think Buffett clearly understands what works, and most sellers of investment advice don't.

What I think he's saying is that it's more important to pick a manager with the right attitude, process and temperament than a manager who is brilliant, seemingly confident and can show a stellar record. Now, that's advice we can all use.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.