A Legion of Disciples
Fund managers put their own spin on Buffett's strategy
Even though Warren Buffett has been influencing investors for decades, Legg Mason portfolio manager Robert Hagstrom had never heard of him until 1984 when he was 28 years old and training to be a stockbroker. Reading Berkshire Hathaway's annual reports "was one of those episodes in life where that which was mysterious became much clearer," says Hagstrom, who has since written several investing books, including The Warren Buffett Way. "What [Buffett] did was basically put flesh on stocks which previously to me were just ticker symbols and numbers."
Hagstrom echoes the thoughts of a generation of portfolio managers who apply Buffett's philosophy to their own line of work. Some are more Buffettesque than others. You have the "purists" who load up on Berkshire stock and generally use Buffett's methods as an investment guidebook. Then you have the "tweakers" who put their own special twist on Buffett's stockpicking formula. Finally, there are the "radicals" who apply Buffett's techniques in ways he would never do.
The purists. The seeds of Buffett's wisdom took root in David Carr early, after being planted by his business partner's uncle, a Columbia University classmate of the famed investor. He gave Carr and a partner Berkshire Hathaway annual reports and news articles about Buffett when they were teens in the late 1970s. So when they set up Oak Value Capital Management in 1986, one of the first stocks the duo bought was Berkshire Hathaway, at less than $2,000 a share. Now more than 8 percent of the $142 million Oak Value fund is in Berkshire stock. Oak Value's 24 holdings also include Buffett favorites like American Express. "Buffett is a blueprint [for how] to approach our tasks on a day-to-day basis," Carr says.
Like a true Buffett disciple, Carr made visiting companies and meeting with execs a big part of his research during the fund's early days. Carr has been to Japan six times to scope out insurance company AFLAC's move there. His travel schedule has been tamed now that conference calls and corporate filings are available online. Still, Carr remains skeptical of Wall Street research—as is Buffett—preferring instead his own due diligence so that he can buy businesses at a 30 percent discount from what he thinks they are worth.
Berkshire stock also accounts for a big part—some 18 percent—of the $4.4 billion Fairholme Fund. While owning so much of one stock may seem risky, Fairholme's comanager, Bruce Berkowitz, reminds investors that the team's top pick is really an amalgam of dozens of top-rated publicly traded stocks, insurance companies, and privately held businesses. Fairholme managers seek out companies led by executives whom they regard as Buffett-like in their integrity and intelligence. "We're very much focused on the jockey as much as the horse," Berkowitz says. This is a big reason that Fairholme's second-biggest position is in Canadian Natural Resources, an oil and natural gas company in which Murray Edwards, a billionaire whom many consider the Canadian Warren Buffett, is a major investor.
The fund—which has generated average annual gains of 19.5 percent for the past five years, 5 points better than the S&P500—also adheres to Buffett's notion of concentrating one's bets. Indeed, its top three holdings and cash account for more than 60 percent of the portfolio.
The tweakers. While Warren Buffett will go down as a "buy 'em cheap" legend in value investing, people often forget how much attention he pays to the other side of the equation: earnings growth. A company doesn't have to be in the garbage bin to get Buffett's attention. The managers at the $2.3 billion Jensen Portfolio share Buffett's desire to invest only in high-quality companies, but they take it one step further. While Buffett has never set hard-and-fast rules about the level of earnings growth he demands for a potential investment, Team Jensen does. The group will consider only companies that have produced at least a 15 percent return on equity—a broad measure of profitability—for 10 straight years and trade at a 40 percent discount to their intrinsic value.
Among the fund's top 10 holdings are General Electric, McGraw-Hill, and Procter & Gamble. "We're not looking for highfliers," says comanager Robert Millen. "We're not interested in companies that grow 5o percent in one year and then go down 10 percent the next."
Jeffrey Van Harte, manager of the $375 million Delaware Select Growth Fund, has total respect for Buffett's emphasis on not overpaying for stocks. At the same time, he sees no reason not to kick it up a notch. "You should still be buying a dollar for 60 cents, but if you can get that dollar to grow to two or three dollars, it's the best of both worlds," Van Harte says. He will consider only stocks with solid earnings, which he says shows that they're competitive within their industries. Delaware Select will make bets on companies out of favor with the market, as long as they generate cash hand over fist. Van Harte says he looks for businesses undergoing either a major industry or a product change. He likes wireless company Qualcomm because it has little debt and generates plenty of cash, but it's in the midst of patent litigation with Nokia. He also thinks electronic trading network InterContinental Echange's entrepreneurial management is poised to take advantage of growing energy and agriculture trading markets.
The radicals. When Hagstrom, manager of the $1 billion Legg Mason Growth Trust fund, started managing money in 1995, he mimicked Buffett's investments by buying up shares of companies like American Express and Coca-Cola. Realizing he was missing the technology boat, he joined Legg Mason to apply Buffett's value-investing principles to a wider range of companies. Today, techs make up a quarter of his 29-stock portfolio. And these aren't cheapie "cigar butts," as Buffett might say. Hagstrom clearly doesn't place as much emphasis on valuation as his idol does. Yahoo! and Amazon, with P/Es of about 54 and 120, respectively, are the fund's top two holdings. Hagstrom thinks Yahoo! is well managed and could appreciate by 80 percent over the next 12 to 18 months.
Darren Maupin immediately took Buffettology to heart after reading a biography of the billionaire investor as a teenager. "It's an intellectual and emotional discipline," says the manager of the $731 million Fidelity Aggressive International Fund. Maupin says Buffett taught him to focus less on making a quick buck than on not losing money. Maupin applies that lesson to global businesses, an area Buffett has generally shied away from. "I don't try to predict the stock price; I try to understand the value of the company," he says.
Like many portfolio managers, Maupin won't usually invest in a company without meeting its managers. That means he spends a week or two a month on the road hunting down "unloved and cheap" companies run by talented entrepreneurs. He's keen to avoid China, which he considers a fad, and has recently favored Japan. More than a third of the fund's 65 stocks are from Japan and Canada, including Takeda Pharmaceuticals and Canadian Natural Resources.
While globe-trotting, Maupin heeds Buffett's teachings. "The longer I spend in this industry," he says, "the more I appreciate some of the things he has said."
This story appears in the August 6, 2007 print edition of U.S. News & World Report.