Warren Buffett often talks about the immense benefit of Berkshire Hathaway having permanent capital.
He also mentioned it in his February letter to shareholders and he’s right that it makes a real difference to an investor if they have permanent capital.
Let’s start with the inverse – what is non-permanent capital? It is money that investors give to managers to invest on their behalf. This will mainly consist of unit trust and hedge fund managers.
The manager has the right to allocate that money within the fund’s mandate, but that right lasts as long as the investor agrees to leave the money with them, and the investor can, with as little as a day’s notice, get their money back.
The net result for the manager is twofold. Firstly, they become beholden to their quarterly updates to investors and they are updating their minimum disclosure documents (MDDs, or formerly called fund fact sheets) on a monthly basis in which they report on the fund’s returns.
This means that any slip in returns will probably prompt investors to ask for their money back. In the current market collapse, a worried investor may, for example, decide it is too much to bear and request a withdrawal of their investment.
So, the second and bigger problem is that the long-term investment manager is always looking over their shoulder, worried about a slip against the fund’s benchmark and investors wanting their money back in the short term.
Suddenly that long-term manager is focusing a mere month or three ahead rather than on the true long term, which lasts for decades.
What is even worse is if investors want their money back amid panic like we saw during the second week of March as world markets collapsed.
Now the investment manager is required to exit positions at the worst possible time as markets tumble. They do not have the luxury of holding on because their capital is not permanent. They need to return cash to investors and subsequently need to sell the fund’s holdings down.
As private investors, our capital is largely permanent. I say ‘largely’ because we may have cash requirements in the short term, especially if you are nearing or already in retirement.
But most of us, the money we ‘manage’ is our own money and as such it is permanent capital.
This affords us the luxury of not having investors withdrawing funds, so we’re never forced to sell because of redemptions by investors.
The real benefit is that we can then truly take that very long-term view stretching over decades, whereas the investment manager is constantly having to perform or lose access to investors’ cash.
I am writing this column on Friday the 13th of March, the day after the worst local market collapse since October1987. Yet, I have not even looked at my portfolio the entire week.
I know it has fallen, likely fallen by a lot and it will look ugly.But the exact metrics of how much I have ‘lost’ is not important. I know I hold quality stocks that will recover in time. I also know I have time on my side, and I have permanent capital, so I can ride out this collapse without being a forced seller at any point.
Of course, this does not mean we can be complacent. We still need to be holding quality assets – and just because our capital is permanent does not mean we can hold “dogs” that have very little hope of ever performing.
In the 19 March edition of finweek I wrote about having a hard look at second-tier stocks in one’s portfolio and consider exiting them. So, having done that, a portfolio should consist of quality assets and while portfolios are under pressure right now, they will recover.
And that’s the point: We truly have time because we have permanent capital. Yes, the second week of March wasn’t fun. But our portfolios will grow again.