Warren Buffett: Closet Trend Follower or Leverage Master?

Warren Buffett has achieved his Holy Grail, and his success is severely saluted. But, can you achieve what he has done? Doubtful. He is the unobtainable exception to every rule. Buffett is complex with a complex firm. He has been positioned as the buy and hold/value guy and has not done much to counter that view, but it is dead wrong. Buffett has traded serious size in currencies.

Many times he has bet against the dollar. There is nothing wrong with that, but the thousands who attend his annual shareholder meetings do not know that, that is part of the real legend. Buffett has also traded derivatives, but at one time he was once squarely against derivatives:

“We have more money than ideas…one place the money certainly wont go is to derivatives. There’s no place with as much potential for phony numbers as derivatives.”

His billionaire vice chairman, Charlie Munger, added:

“To say that derivative accounting is a sewer is an insult to sewage.”

Shortly after those statements, Buffet’s firm sold $400 million of a new type of derivative security in a private placement to qualified institutional investors (source: News Release. Berkshire Hathaway, Inc. May 22, 2002).

To confound even more, a year later Buffett declared:

“Derivatives are financial weapons of mass destruction, carrying dangers, while now latent, [but] potentially lethal. We view them as time bombs, both for the parties that deal in them and the economic system.”

Buffett’s legend of buy and hold or value as his get-rich strategy has permeated public consciousness thoroughly for decades. Dozens of books spin the yarn. Yet when he launches a new derivatives strategy against his legend, either no one notices or those who do notice refuse to criticize. (That might hurt business, after all.)

A few years back, I sat down with a trend following trader. He has a 20- year plus track record making on average more than 20 percent a year. The topic of Warren Buffett came up during our discussion. While he was very respectful of Buffett, he was bewildered how some could call his trend following trading luck, but those same people could see Buffett as skill.

This same trader pointed out the thousands of trades he has made. He noted that his trend trading peers also had thousands of trades over decades. He saw it more logical to make an argument for Buffett’s success as luck given the relatively few trades that made him so wealthy: Coke, Gillette, American Express, Goldman Sachs, and Wells Fargo to name a few. In addition to the billions in options he wrote (more derivatives), Buffett’s own portfolio and insurance business were arguably at the heart of the Great Recession. It may be a stretch to say that the solvency of Berkshire was at risk in the fall of 2008, but just imagine how things would have unfolded if Goldman Sachs had failed. The dominoes in Buffett’s portfolio and behind Berkshire would have tumbled quickly (source: Cullen Roche, “The Many Myths of Warren Buffett”).

A few years later, in 2011, Buffett was in India warning investors to avoid long-term fixed-dollar investments such as 10-year U.S. Treasury bonds. He worried that government actions were combining to dilute the value of the dollar. Buffett warned:

“If you ask me, if the U.S. Dollar is going to hold its purchasing power fully at the level of 2011, 5 years, 10 years, or 20 years from now, I would tell you it will not.”

Does that mean Buffett has been selling bonds? You bet. Amazingly, government actions he now critiques are the very ones that saved him (source: http://www.fool.com/investing/general/2011/03/28/buffett-warns-the- dollar- will-decline.aspx). However, Buffett sees it differently. He reflected on the chaotic times since 2008:

“[My techniques] are not new lessons. Never owe any money you cant pay tomorrow morning. Never let the markets dictate your actions. Always be in a position to play your own game. Never take on more risks than you can handle. But all of those were old lessons, unfortunately. Even though I didn’t see it coming, those lessons which are timeless allowed us to in effect profit from it rather than suffer from it. Good businesses, good management, plenty of liquidity, always having a loaded gun; if you play by those principles, you will do fine no matter what happens. And you don’t ever know what’s going to happen.”

It’s almost as if Buffett has become Jason Bourne, an amnesiac on the loose, without memory of how history has really unfolded. Add in his Goldman Sachs association and the David Sokol situation, a top executive of his who resigned under odd circumstances resembling insider trading, and in total over the last decade Buffett as the avuncular straight talker has become harder and harder to accept at face value. Long-time fund manager Michael Steinhardt was harsher:

“[Buffett’s] reality is that he is the greatest PR person of recent times. And he has managed to achieve a snow job that has conned virtually everyone in the press to my knowledge…and [it] is remarkable that he continues to do it.”

As someone who grew up in the Washington D.C. area, I watched politicians use and/or abuse the system to their own economic advantage on such a regular basis that it was no longer considered unethical. In the fall of 2008, Buffet received political favors and influenced government in ways that no trend following trader ever could. It was wrong. Buying into the Buffet legend is not part of my ethos. Don’t drink the Kool-Aid.