Jason Stipp: I am Jason Stipp for Morningstar. Ahead of the Berkshire Hathaway Annual Meeting, we're talking about some of the big themes that are going to be on investors' minds, and the succession issue obviously is one that springs to mind.
This is not a new topic, of course, but how should investors frame their thinking about the succession plans that will someday have to take place at Berkshire Hathaway?
Here to offer some insights is Morningstar's director of personal finance Christine Benz.
Thanks for joining me, Christine.
Christine Benz: Jason, good to be here.
Stipp: So I have this thesis that thinking about Berkshire Hathaway and the management change there, could be akin to thinking about a mutual fund and a management change there. Does it make sense to think about Berkshire in terms of being a mutual fund?
Benz: I think it's a decent analogy, Jason. You do have at Berkshire a manager running a basket of different investments, making those allocation decision just as a mutual fund manager would. So, I think it stands up from that standpoint. It’s a well diversified basket of investments.
The one thing that might be different is that when Warren Buffett does eventually decide to step away from Berkshire, you could see a price shock in Berkshire shares. That's not typically something you see when a mutual fund manager leaves, the basket of underlying investments won't change all that much, unless in a very rare situation there would be mass investor redemptions that would cause the fund to have to make some changes. But generally speaking you have a lot of stability. You really have to sit there and evaluate the new manager. With Berkshire there could be some price shocks when Buffett steps away.
Stipp: So, certainly to the extent that people have outsourced those capital allocation decisions to Warren Buffett, it is sort of similar to finding a manager that you really like on the stock mutual fund side and outsourcing those allocation decisions to that person.
So, we had spoken that there might be some ways that investors at Berkshire Hathaway might be better off than investors in a mutual fund with a similar manager change, and some ways that they might be a little worse off in evaluating a new management
Benz: Right.
Stipp: Can you run through some of those?
Benz: Well, when I think of the ways in which the Berkshire shareholders would be better off than mutual fund shareholders, oftentimes, when a mutual fund manager leaves, it’s a big shock. It's not something the fund company has prepared for in advance. Maybe the manager has some ill will toward the company he is leaving, so he has really no interest in making sure that things go smoothly. That's a big negative for mutual fund shareholders. This happens quite a bit.
In Berkshire's case, while shareholders would certainly want to see as much communication as possible, and some who wanted more, there has been a decent flow of communication around this succession issue. Obviously, Buffett has been very involved in helping choose his successor and is very involved in continuing to see Berkshire be a thriving company. So, in that respect, Berkshire shareholders are much better off than mutual fund shareholders.
Stipp: On the flip side, Christine, if you were going to compare Berkshire shareholders to mutual fund shareholders in a similar situation, what disadvantages might the Berkshire shareholders have?
Benz: Well, I think the biggie right now, Jason, is that all of the successors who have been discussed so far for Warren Buffett have not had public track records. So, it's hard to get your arms around exactly what strategy they use to managing money, and also how their execution has been.
So, in contrast with a lot of mutual funds, they really want to name someone with a public track record that shareholders can gain confidence in. At least from what we know, it's not going to be the case with Berkshire.
Stipp: So, if you were going to look at it from the standpoint of it being similar to a mutual fund and the things that you might assess in a management change of a mutual fund, what things might you want to think about as a Berkshire shareholder when this transition of power happens?
Benz: Right. So I mentioned that there could be a shock in Berkshire's share price when Buffett decides to step down definitively, but generally speaking, the value of those businesses, the true intrinsic value of those businesses, is not going to change overnight.
So, if you are concerned about the succession issue, I think it's not too early to start thinking, "Well, am I comfortable with this basket of investments? Do I like this group of companies for the next few years at least?" Because the true value of those companies will not change even when there's a change at the helm.
So that's something to keep in mind that you actually have a little bit of time to evaluate the successor or successors, when those people are finally announced.
Stipp: And it's quite possible, like you said, that we will see a lot of volatility around this change. There could be some noise around this change. So likely, during that period of succession that we won't really see a good intrinsic value on the stock price because of all the potential uncertainty and the knee-jerk reactions that could happen.
Benz: So that's another thing I would say, don’t focus on the short-term performance noise in the share price. Really do stay anchored on, "what does this portfolio of companies look like? Do I like its future prospects?" And then spend a little time getting comfortable with what changes may be coming down the pipe, but definitely don’t focus on that short-term performance noise.
Stipp: And I know that Morningstar's Paul Larson also mentioned that Berkshire is a wide-moat company right now, certainly we like to look to wide-moat companies for investment opportunities.
He said that even after Buffett leaves, the groundwork that he's laid with the businesses right now, that competitive advantage should endure for a while even if ultimately the next management team does not have the same acumen that Warren Buffett has, and maybe someday down the line Berkshire is narrow-moat.
Benz: That seems like a really valuable insight, Jason.
Stipp: So, last question for you, Christine, I think this is more a practical issue. The tax considerations: Probably a lot of people who are Berkshire shareholders, especially before it became a member of the S&P, have been longtime shareholders. What things should they keep in mind if they are considering that they might want to make a change at some point after the management change happens?
Benz: Right, so this is yet another reason not to act rashly. You really need to take stock of your tax position, think about the capital gains that you may unlock if you sell your shares, and really make sure that the investment that you might swap into instead will pay you back in terms of those capital gains taxes that you may have to pay or make a switch.
So it's a really important consideration, and this is one that would be true for Berkshire shareholders, any fundholder who is thinking about leaving simply because of a manager change, and you hold the fund in a taxable account--make sure that you think through "well, what is this going to cost me come tax time."
Stipp: And a very important point, too, you might not be able to invest with Warren Buffett anymore, but where will you put that money? Who will invest it for you next? So, it's something may be people don’t consider right away, but certainly an important point to remember.
Christine, thanks so much for joining me for the insights today.
Benz: Thank you, Jason.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.
