Nervous, Not Paralyzed
Every year I look forward to reading Warren Buffet’s Berkshire Hathaway annual letter, anticipating both the wisdom and at least one cringey innuendo. And this year’s report didn’t disappoint!
On the wisdom side, there was a fascinating discussion of property-casualty (P/C) insurance, the growth of risk, and the trade-off between float gathering and intelligent underwriting. Then for cringey innuendo you had Buffett opining that his 91-year-old sister Bertie would be “surrounded by males” at Berkshire’s upcoming annual meeting. Good times!
I mentioned a little while back that Permanent Equity would be making a somewhat bigger show of force than usual out in Omaha this May. That remains true, and we hope to see you there. I’m also excited to be attending because despite reading all of Buffett’s letters, I haven’t done so before. Further, being reminded by Buffett in his letter that he is 94 means there won’t be many more chances to do so before Greg Abel replaces him as CEO (as Buffett also notes in his letter), and I don’t want there to be three things I regret.
But back to the wisdom…
In discussing P/C insurance, Buffett notes rightly that it’s a business model with a long and inverted feedback loop. Whereas most businesses spend to make a product and then sell it to customers when they need it knowing the cost, P/C insurers sell a product (policies) to customers sometimes long before they need it without knowing the cost. Further, that “This mode of operations has the desirable effect of giving P/C insurers cash before they incur most expenses but carries with it the risk that the company can be losing money – sometimes mountains of money – before the CEO and directors realize what is happening.”
To protect against this taking place at Berkshire, Buffett says that “no optimists” are allowed. Yet while he wants his underwriters to “come to work nervous,” they also can’t be “paralyzed.” This is because an underwriter paralyzed by risk won’t write any policies at all, which is also a money-losing proposition.
I liked this paradigm of “nervous, not paralyzed” and thought that it aligned nicely with the idea of “paranoid optimism” that I talked about last season. Both are good reminders that when it comes to capital allocation, you can’t do nothing, but that you also shouldn’t do everything – or even most things. This is because in a mostly efficient market, most available opportunities will definitionally not be very attractive. That said, both private equity and public market investors plowed record amounts of capital into investments last year despite rising valuations, implying that most people are neither nervous nor paralyzed (Buffett, for his part, is sitting on record amounts of cash).
As for why that is, you’d have to ask them. But “nervous, not paralyzed” is a better approach to capital allocation for my money and also coincidentally the tack that you/Bertie/anyone should take if ever actually “surrounded by males.”
See you Friday.
– Tim
