Top 5 Tips for Starting a Hedge Fund (Part 2 of 2)

Starting a Hedge Fund

Tips on Starting a Hedge Fund (Part 2 of 2)

Top 5 Tips for Starting a Hedge Fund (Part 2 of 2)The post below is part of a 2 part series on starting a hedge fund. To read part 1 now please click here.

4. Focus on risk management
and your investment process more than high performance returns. Yes, investors want to see strong returns but a top 5 sign of a green hedge fund manager is someone who constantly pushes their extremely high returns found within back-testing or their first 4 months of operating. Doing so ruins much chance of serious consideration as it gives off the impression that your fund will reach for those returns at any cost or risk. Speaking about returns too much takes away from confidence within your fund’s investment process and risk management controls.

5. Invest in yourself. Choose high quality service providers, build a team, break down your investment process into concrete steps, and spend 50 hours creating a solid PowerPoint presentation/pitch book for your fund and don’t show it to a single investor until you have completed 5 drafts of it. Too many times I see hedge funds looking to raise capital who have not yet taken the time to organize their own thoughts, plans or marketing materials. If your hedge fund is not worth your own investment of time, why should any invest their time and possibly capital into it? Investors look for signs of a manager having skin in the game in multiple ways.

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Prime Brokerage Services and Products

Prime Brokerage Q & A

Prime Brokerage Services

Prime Brokerage Products - Q & A | Services QuestionQuestion: What Services do Prime Brokerage Firms Provide?

Answer: I recently found an detailed answer to this question within the Preqin Global Hedge Fund Investor book. Here it is:

Prime brokers provide trading and financing services to hedge funds. Prime brokerage is the common name for the package of services offered by investment banks and securities firms to hedge fund and other investors allowing them to borrow securities and cash to be able to invest on a leveraged basis and achieve an absolute return. The prime broker is able to provide a centralized securities clearing facility for the hedge fund and then benefits by earning fees on financing the client’s long and short cash and security positions and by charging fees for clearing and other services. It also earns money by hypothecating the portfolios of the hedge funds it services.

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The Hedge Fund Transparency Act | Hedge Fund Registration

HF Transparency Act

The Hedge Fund Transparency Act

The Hedge Fund Transparency Act  Hedge Fund RegistrationJust about to jump on a plane so I don't have must time to write up much of a summary here but two senators have propsed new legislature which would force hedge funds to register with federal securities regulators. There is a 90% chance that this quickly be approved:

The Hedge Fund Transparency Act, sponsored by Senators Carl Levin, a Michigan
Democrat, and Charles Grassley, an Iowa Republican, would require hedge funds to
file an annual disclosure form with the U.S. Securities and Exchange Commission,
comply with the agency’s record-keeping standards and cooperate with its

“The problem is that hedge funds have gotten so big and
are so entrenched in U.S. financial markets that their actions can now
significantly impact market prices, damage other market participants and can
even endanger the U.S. financial system and economy as a whole,” Levin said...

“A major cause of the current crisis is a lack of transparency. The
wizards on Wall Street figured out a million clever ways to avoid the
transparency sought by the securities regulations adopted during the 1930s,”
said Grassley, who introduced a similar bill in 2007. read more

To read additional articles on hedge fund regulation and compliance please visit our Hedge Fund Regulation Corner Compliance & Law Notes.

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Chicago Hedge Fund Group Event a Success

Chicago HFG Event

Chicago Hedge Fund Group (HFG) Event

Last night was the first event for the Hedge Fund Group (HFG) in Chicago, it went well. We had over 130 professionals register to attend the event and attendees included $1B+ and medium sized hedge fund managers, consultants, traders looking to start hedge funds, exchange professionals, and service providers. Over 100 professionals attended the event, a strong enough response that we will be holding another event like this in Chicago sometime again over the next 6 months.

Thank you to everyone who came and helped make it a success. Specifically thank you again to the three sponsors of this Hedge Fund Group (HFG) event. These three groups made the event possible:

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Hedge Fund Ethics | A Larger Conversation Needed?

Hedge Fund Ethics

Hedge Fund Industry Ethics

Hedge Fund Ethics | A Larger Conversation Needed?A few weeks ago I posted a note hoping to create a conversation around hedge fund industry ethics and best practices. Just this morning I found an interesting article on hedge fund ethics, again it appears that the most challenging part of setting any code of ethics for the industry is that hedge fund manager are so diverse, their operations, investments, and even scheduled lifespans are often drastically different from one fund to the next. As hedge funds are forced to innovate to produce returns in 2009 while also securing capital for distressed assets I believe this diversity will only increase over the next few years. Here is the article on hedge fund ethics:

Hedge funds took a battering 2008 - and as they have been battered by the storm two questions of "right" and "wrong" have been coming up that show that there are ethical codes at work here, but no agreement on what the "right" answer is.

And here's where the "ethical" questions come up:

If your fund is down and you know it is going to take years to recoup the losses and get paid at 20% of profits again do you:

a) stay with the fund until you have recouped the losses and made your investors whole - working for "psychic income" as Kenneth Griffin of Citadel fame told the New York Times or
b) leave - retire, switch to a new fund, start a few fund - basically start again? If you had many years of excellent performance before this one terrible year you may well be able to raise another fund.

In the first case there's a moral high ground to climbing back out and keeping your commitments to your investors, but maybe the second case makes sense if you can't climb back out from that fund. Maybe you can't keep your key players or your strategy no longer works and your investors are better off with you closing the fund and returning their money.

The second question is whether to allow investors to take money out of the hedge fund. Again hedge funds are not acting consistently. One of your investors wants to pull his money out - do you

a) allow him to knowing that doing so could hurt the remaining investors that are staying in because you'll be forced to selling into a falling market? Much of the volatility in November and December was redemption selling as hedge funds were force to liquidate equities and debt so investors could withdraw funds. Or do you
b) tell investors they can't take their money out and you are going to hold it until it is a more stable time to sell?

Again this is a current raging debate in the hedge fund world that takes on the ethical language of right and wrong. I know I'd want to be able to get my money out if I'd lost faith in a fund! source

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Family Office Business Development Job Opening

Family Office Business Development Job

Below is a marketing / business development job listing which has just been opened for professionals with family office or wealth management business development experience.

View additional Hedge Fund Job Listings

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Capital Introduction Services for Funds

Capital Introduction Q & A

Capital Introduction Services for Funds

Capital Introduction Services for FundsQuestion: What are capital introductions services? Should our firm be using them? We are based in Miami, any help would be appreciated.

Answer: I recently found a detailed answer to this question within the Preqin Global Hedge Fund Investor book:
Capital introduction is the service whereby the prime broker attempts to introduce its hedge fund clients to qualified hedge fund investors who have an interest in exploring new opportunities to make hedge fund investments. Some prime brokers will offer a physical capital introduction service arranging meetings and events where the managers are able to meet investors. Others will apartner with a third party marketer or offer a particular marketing plan to hedge fund managers who have not attempted to raise assets before. This service is popular with hedge fund managers and can lead to new business for the prime brokerage firm.
My background is in capital raising and I am now associated with a prime brokerage firm which offers capital introduction services. If you are looking for prime brokerage or capital introduction services please get in touch with our team and we will help as we can.

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Chicago Hedge Fund Managers Invited

Chicago Hedge Fund Managers

Chicago Hedge Fund Managers InvitedThis evening the Hedge Fund Group (HFG) is hosting a networking event for hedge fund managers located in and around Chicago. The event runs from 5-8PM CST on January 29th at the Hyatt Regency Chicago on Wacker Drive.

For complete details and registration (free) please click here.

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Online Investment Job Listings | Hedge Fund Jobs

Investment Jobs

Online Investment Job Listings

Question: Does your site provide job listings? I am 4 years into my career working within analyst roles for a family office and large hedge fund. Any help would be appreciated.

Answer: Yes, we do offer job listings on our site. To view these now please see this page: Hedge Fund Job Listings. We are working with a few groups to add additional hedge fund jobs to this page in the next 4 weeks.

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Mark Fuchs Interview on Hedge Funds

Mark Fuchs Interview

Mark Fuchs Interview on Hedge Funds

Here is a video interview with Mark Fuchs on hedge funds and how the time for them may be during these periods of low confidence in traditional asset classes. If you are reading this article over email please click here to watch this video now.

Watch over 100 hedge fund videos online within our Hedge Fund Video Library

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What is a Ponzi Scheme? Charles Ponzi

What is a Ponzi Scheme?

What is a Ponzi Scheme? Charles Ponzi

Many professionals are now asking what exactly is a ponzi scheme? How do you define what a ponzi scheme is and how do they work? Here is a video on ponzi schemes and how they work. If you are reading this article over email through our daily hedge fund newsletter please click here now to view the embedded video below.

More on the definition of a ponzi scheme:

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Hedge Fund Losses and Closures in 2008 2009

Hedge Fund Losses

Hedge Fund Losses in 2008 2009

Here is a video below on hedge fund asset losses and closures. While there is a small set of institutional investors investing in a number of opportunistic hedge funds most are still loosing assets each quarter. Many firms were profitable just 2-3 years ago and now have less assets to manage and little if any performance fees to collect. If you are reading this article over email through our daily hedge fund newsletter please click here to watch the embedded video below.

View over 100 additional hedge fund videos within our Hedge Fund Video Library

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Obama Hedge Fund Regulation 2009 2010 2011

Obama Regulations

Obama Hedge Fund Regulation 2009

Here is a short video interview with Dan Alpert from Westwood Capital on hedge fund regulations which may come through Obama. The discussion revolves around forcing some hedge funds to be more transparent to regulators, hopefully in a way which does not expose hedge fund investment strategies to the general public. The video talks about how most people think regulation is in place to protect consumers, in this case most of the new regulation will be around protecting the financial system. The financial system needs protection from certain firms or funds which use leverage to the point of damaging the whole system should liquidity or capital ever dry up. If you are viewing this article over email please click here now to watch the video.

FinAlternatives wrote on this same topic earlier this week: ess than a week into his administration, the outlines of President Barack Obama’s plan to overhaul America’s financial regulatory systems are coming into focus. And it is becoming increasingly clear that the plan will involve some sort of mandatory hedge fund registration and surveillance.

Although most of his top economic advisers are still awaiting confirmation by the Senate—including Treasury Secretary-designate Timothy Geithner and Securities and Exchange Commission Chairman-designate Mary Schapiro—Obama is expected to offer details of his plans before traveling to London on April 2 for a Group of 20 meeting. The Obama administration is also laboring under an April 30 deadline—set by last year’s Emergency Economic Stabilization Act—to offer his regulatory recommendations to Congress. source

Review dozens of additional resources within our Hedge Fund Regulation Corner | Compliance & Law Notes or watch over a 100 hedge fund videos within our Hedge Fund Video Library.

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Top 5 Tips for Starting a Hedge Fund (Part 1 of 2)

Starting a Hedge Fund

Top 5 Tips for Starting a Hedge Fund

Top 5 Tips for Starting a Hedge FundThis is a 2 part series on starting a hedge fund. I had a 45 minute conversation with a hedge fund startup Friday related to capital raising, seed capital, prime brokerage and building a team around your hedge fund during the first few years of operation. After hanging up the phone with this professional I thought it may help to publish a list of tips for those starting hedge funds:

Top 5 Tips for Starting a Hedge Fund

1. Starting a hedge fund is not a get rich scheme, in 99.9% of all cases it takes 2-4 years before the hedge fund becomes profitable and stable as a business. I’ve worked with a client in the past which had been running a fund for 7 years and still had not raised enough capital to be self-sustaining

2. Complete due diligence on your service providers. I heard of a hedge fund last month who was quoted at over $80,000 for their legal formation costs, which is at least $35k above what most other firms charge for this same service. If you don’t shop around you could end up paying twice as much to service providers as you need to. No, you should not select service providers based on price but you should always sit down or have conference calls at least with three prime brokerage firms, three auditors, and three administration firms before deciding who to work with.

3. Always be growing relationships. This is different than always be selling. Selling can be spotted from 5 suits away and a networking event, and felt by how someone asks what company you work. It is always best to take the high road, the long-term approach yet always be looking out for those individuals who you should invest a significant portion of your time getting to know. The benefits of doing so could be valuable advice, leads or an allocation. If you are always looking to close than no professionals along the way will want to give you feedback on your marketing materials or suggest an alternative path to raising assets.

Read Part 2 of this Article by Clicking Here.

Take advantage of over $3,000 worth of consulting advice on how to start a hedge fund for just $17 within our e-book which may be found at

Read over 25 articles on starting hedge fund companies within our Hedge Fund Startup Guide.

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Hedge Funds in Sao Paulo Brazil | Investments

Sao Paulo, Brazil

Hedge Funds & Family Offices in Brazil

Hedge Funds in Sao Paulo Brazil | InvestmentsStarting on February 13th, 2009 I will be starting to work out of Sao Paolo, Brazil for several weeks. While in town I will be meeting with hedge funds, private equity firms and family offices.

If you are based in Sao Paulo and would like to meet while I am in Brazil please do send me an email at If there are enough professionals in the city interested in networking we will put on a 30-50 person networking event in downtown Sao Paolo.

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Why Use a Third Party Marketing Firm?

Third Party Marketing

Why Use a Third Party Marketing Firm?

Question: Why should our hedge fund startup consider hiring a third party marketing professional over growing our own marketing skills internally.

Answer: While growing your own knowledge and skills relating to hedge fund marketing and sales is always important there are many reasons to consider employing a third party marketing firm. Below is an explanation from the Preqin Hedge Fund Investor Guide.

“Hedge fund managers primarily hire third party marketers as the hedge fund manager specializes in managing the investment portfolio, not creating relationships with investors and increasing assets under management. Some managers can employ more than one third party marketer at any one point in time, and can hire specific firms to focus on specific geographic regions or investor groups.”

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Market Values of US Banks 2009

Bank Market Values

Market Values of US Banks 2009

A trader on the west just sent me the picture below. Click on the picture below to enlarge it, pretty interesting to see the differences between JPM and Citi.

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The 5 Pillars of OTC Processing

The 5 Pillars of OTC Processing

Ron Tannenbaum, co-founder, GlobeOp Financial Services

As the OTC derivatives market expands in volume, complexity and sector interest, many funds face equally complex post-trade processing challenges in terms of operational processes & efficiencies. Can the key elements of a successful operational infrastructure to support a competitive OTC strategy be defined?

As a significant opportunity for alpha, the growing attraction of OTC derivatives is confirmed both at the industry level and on the “production floor”. Supplementing Morse’s recent focus group confirmation that 64% of firms increased derivative contracts volume in the last 6 months, new trades by GlobeOp's OTC clients in the same period increased 100%; monthly open positions increased 18%.

GlobeOp: Daily Average OTC Trade Volume

GlobeOp Monthly OTC open positions by Product Type, August 2008

In addition to traditional hedge fund activity, mutual funds liberated by the UCITS III directive are also increasingly including OTC derivatives in their trading strategies. Exponential OTC volume growth, combined with the current market turbulence, is challenging in-house operational systems as never before. Legacy and “bolt-on” software systems struggle to communicate with each other. Spreadsheets strain to handle volumes and complexity they were never designed for, increasing the risk of error with each update. In parallel with portfolios becoming more complex, funds are facing increased investor pressure to demonstrate enhanced operational control, independent valuation, higher levels of disclosure and more transparent performance reporting. For many funds, processing derivatives internally quickly becomes cumbersome, inefficient and error-prone, increasing operational risk instead of delivering competitive advantage.

Is a water-tight process for OTC trade processing possible and if so what would it look like?

Eight years of daily OTC processing has provided GlobeOp with a crystallized perspective of the elements essential to a fund’s requirement for effective OTC derivative post-trade processing. Five core, integrated processes are needed to manage, track and report on trades end–to-end throughout their lifecycle:

o Trade capture
o Operations
o Valuations
o Collateral management
o Documentation

Rigorous, reliable, daily reconciliation underpins much of the process, while scalability in terms of people and technology is needed to respond nimbly and promptly to trade volume growth, new products or unexpected market events.

The 5 Pillars

Trade capture - real-time, cross-product
Trade data entry sounds such a basic process that it is often underestimated as the cause of many issues further along the process. Incomplete and/or inaccurate detail risks being created when data is aggregated into an internal system from disparate silos or when bolt-on software is unable to communicate completely with front office configurations or legacy systems.

Also, due to their bilateral nature, derivative instruments do not always have established identifier codes, making them more difficult to process than securities with their standard ISIN, CUSIP or Bloomberg reference codes.

A real-time, cross-product, electronic trade capture environment can support the trading desk in developing and trading new OTC products. Trades should only ever be recorded once, to eliminate the risk of errors associated with manual entry and spreadsheets.

Operations - the litmus test
Trade operations are the ‘litmus test’ of the entire process, encompassing the settlement of trades and reconciliation of cash and securities positions associated with individual derivatives transactions. Having cash and securities obligations in position at the time of settlement are essential to efficiently transferring ownership and moving funds.

Valuations - transparency, independence
The challenge of accurate, independent valuation can be addressed by pricing models that can adapt to new and complex instruments, and that are tolerance-checked against counterparty prices and other external industry and data sources.

Depending only on counterparty prices due to either insufficient valuation expertise or technology can increase the risk of a domino of delays to timely and reliable trade reconciliation, NAVs and investor reporting or returns.

Mutual funds face an additional regulatory dimension to their valuation challenges. In exchange for reducing mutual fund barriers to OTC derivative trading, the February 2007 UCITS III directive placed a high premium on transparent and independent valuation and risk management.

The requirement for mutual funds to demonstrate their ability to provide fully independent daily valuations and risk analytics can affect both mutual funds and their custodian bank. A mutual fund’s back office is often well-equipped to manage the long-only investments the fund traditionally makes. Operational knowledge, systems, models and capacity for complex derivatives is, however, either absent or insufficient. This is compounded when, as we have seen repeatedly, most mutual funds also initially tend to significantly underestimate their derivative trading volume,

Thus challenged, and to meet the UCITS lll independence criteria, the mutual fund turns to its custodian bank, its historic provider of a wide range of support services. While willing in spirit, most custodian banks quickly recognize that complex OTC trade processing, valuation and risk analytics exceed both their expertise and spreadsheet-based systems.

Collateral management – exposure management
Current market turbulence has sharpened the spotlight on the value of real-time, online collateral management to accurate trading and exposure management. What collateral is on the books, with whom, at what rate, for how long? What pledges are held vs. outstanding? Accurate, transparent collateral reporting will remain vital to the front office for months to come.

Effective collateral management usually includes ensuring the fund is net present value collateralised with each of its counterparties on a daily basis. In addition, an integrated facility should ensure appropriate movement of cash and securities to support revaluations and margin calls.

Documentation - integrated STP
According to recent ISDA statistics, approximately 60% of the hedge fund industry’s OTC instruments are still confirmed manually. This is not only time-consuming, but it also increases the incidence of error and leaves funds vulnerable to compliance risk, due to the high level of positions which remain based on verbal agreements. Integrated, straight-through-processing (STP) for managing, exchanging and storing trade documentation better enables both trade partners to reconcile economic terms with counterparties and meet auditor and regulatory compliance obligations.

A successful OTC trading strategy requires underpinning by an integrated platform of people, processes and technology that deliver post-trade processing and reporting that enables the fund to focus on its core objective of generating investor returns and expanding the capital base.

Informal industry estimates indicate that building an internal OTC processing infrastructure involves significant fund investment in cost and time -- up to $50 million and five years of testing and development. Often unspoken are the risks that continued market and fund strategy evolution may result in a design neither suitable or scalable for long-term requirements, or able to deliver sufficient economy of scale.

The attraction of OTC derivative instrument strategies remains robust. As funds consider their future strategies, recent market events have only served to reinforce the need for post-trade processing and infrastructures whose key deliverables are:

• Data and document management across the lifecycle of the trade that is timely, transparent, accurate, reconciled and real-time
• Robust, scalable, online support
• Independent, risk-based valuation that is tolerance-checked within well defined limits.

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Hedge Fund Tracker Updates

Tracker Updates

Hedge Fund Tracker Tool

Our team has recently updated the following Hedge Fund Tracker profiles:

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Third Party Marketer Definition | What is a 3PM?

Third Party Marketer Definition

Third Party Marketer Definition | What is a 3PM?I often get questions from hedge fund startups and career-seeking professionals on what a third party marketer is, and how their businesses operate. Today I was reading through the Preqin Hedge Fund Investor Review book and found this definition which may be helpful:
Third party marketers provide consulting services to hedge fund managers who need assistance from experienced marketing professionals. These third party marketing firms, also known as third party distributors, will employ seasoned marketing and sales professionals who look to raise assets for hedge funds through their relationships with investor channels. This will include groups such as institutional investors, brokers, financial advisors and high-net-worth individuals.

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Where are Prime Brokerage Firms Located?

Where are Prime Brokers Located?

Where are Prime Brokers Located?Question: I am looking to work with a local prime brokerage firm, do you know where most of them are located?

Answer: Within a recent survey of prime brokerage firms I found some interesting statistics on prime brokerage firms. Here are the numbers:
  • 74% of firms were based within the United States
  • 13% in London
  • 3% in Canada
  • 2% in France
  • 2% in Poland
  • 2% in India
  • 2% in Russia
  • 2% in Germany
I found the Russia, Germany and France numbers to be surprising. I was also surprised that Asian countries didn’t break 2-4% of this list. Perhaps this has to do with regulations and fund structures and terms used within that area of the world. These statistics were taken from the recently published 2009 Preqin Global Hedge Fund Investor Book.

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Warren Buffett Interview Transcript

Warren Buffett Interview

Warren Buffett Interview Transcript

Warren Buffett Interview Transcript Below is a short interview with Warren Buffett who was featured on the the PBS Nightly Business Report tonight.

PBS’ Nightly Business Report & Warren Buffett
Full Transcript of NBR Anchor Susie Gharib’s interview with Warren Bufffett
Airs January 22, 2009, Nightly Business Report’s 30th Anniversary

SUSIE GHARIB, ANCHOR, NIGHTLY BUSINESS REPORT: Are we overly optimistic about what President Obama can do?

WARREN BUFFETT, CHAIRMAN, BERKSHIRE HATHAWAY: Well I think if you think that he can turn things around in a month or three months or six months and there’s going to be some magical transformation since he took office on the 20th that can’t happen and wouldn’t happen. So you don’t want to get into Superman-type expectations. On the other hand, I don’t think there’s anybody better than you could have had; have in the presidency than Barack Obama at this time. He understands economics. He’s a very smart guy. He’s a cool rational-type thinker. He will work with the right kind of people. So you’ve got the right person in the operating room, but it doesn’t mean the patient is going to leave the hospital tomorrow.

SG: Mr. Buffett, I know that you’re close to President Obama, what are you advising him?

WB: Well I’m not advising him really, but if I were I wouldn’t be able to talk about it. I am available any time. But he’s got all kinds of talent right back there with him in Washington. Plus he’s a talent himself so if I never contributed anything for him, fine.

SG: But I know that during the election that you were one of his economic advisors, what were you telling him?

WB: I was telling him business was going to be awful during the election period and that we were coming up in November to a terrible economic scene which would be even worse probably when he got inaugurated. So far I’ve been either lucky or right on that. But he’s got the right ideas. He believes in the same things I believe in. America’s best days are ahead and that we’ve got a great economic machine, its sputtering now. And he believes there could be a more equitable job done in distributing the rewards of this great machine. But he doesn’t need my advice on anything.

SG: How often do you talk to him?

WB: Not often, not often... no no and it will be less often now that he’s in the office. He’s got a lot of talent around him.

SG: What’s the most important thing you think he needs to fix?

WB: Well the most important thing to fix right now is the economy. We have a business slowdown particularly after October 1st it was sort of on a glide path downward up til roughly October 1st and then it went into a real nosedive. In fact in September I said we were in an economic Pearl Harbor and I’ve never used that phrase before. So he really has a tough economic situation and that’s his number one job. Now his number one job always is to keep America safe that goes without saying.

SG: But when you look at the economy, what do you think is the most important thing he needs to fix in the economy?

WB: Well we’ve had to get the credit system partially fixed in order for the economy to have a chance of starting to turn around. But there’s no magic bullet on this. They’re going to throw everything from the government they can in. As I said, the Treasury is going all in, the Fed and they have to and that isn’t necessarily going to produce anything dramatic in the short term at all. Over time the American economy is going to work fine.

SG: There is considerable debate as you know about whether President Obama is taking the right steps so we don’t get in this kind of economic mess again, where do you stand on that debate?

WB: Well I don’t think the worry right now should be about the next one, the worry should be about the present one. Let’s get this fire out and then we’ll figure out fire prevention for the future. But really the important thing to do now is to figure out how we get the American economy restarted and that’s not going to be easy and its not going to be soon, but its going to get done.

SG: But there is debate about whether there should be fiscal stimulus, whether tax cuts work or not. There is all of this academic debate among economists. What do you think? Is that the right way to go with stimulus and tax cuts?

WB: The answer is nobody knows. The economists don’t know. All you know is you throw everything at it and whether it’s more effective if you’re fighting a fire to be concentrating the water flow on this part or that part. You’re going to use every weapon you have in fighting it. And people, they do not know exactly what the effects are. Economists like to talk about it, but in the end they’ve been very, very wrong and most of them in recent years on this. We don’t know the perfect answers on it. What we do know is to stand by and do nothing is a terrible mistake or to follow Hoover-like policies would be a mistake and we don’t know how effective in the short run we don’t know how effective this will be and how quickly things will right themselves. We do know over time the American machine works wonderfully and it will work wonderfully again.

SG: But are we creating new problems?

WB: Always

SG: How worried are you about these multi-trillion dollar deficits?

WB: You can’t just do one thing in economics. Anytime somebody says they’re going to do this and then what? And there is no free lunch so if you pour money at this problem you do have after effects. You create certain problems. I mean you are giving a medicine dosage to the patient on a scale that we haven’t seen in this country. And there will be after effects and they can’t be predicted exactly. But certainly the potential is there for inflationary consequences that would be significant.

SG: We all know that in the long run everything is going to work out, but as you analyze President Obama’s economic plan, what do you think are the trade-offs? What are the consequences?

WB: Well the trade-off… the trade-off basically is that you risk setting in motion forces that will be very hard to stop in terms of inflation down the road and you are creating an imbalance between revenues and expenses in the government that is a lot easier to create than it will be to correct later on, but those are problems worth taking on, but you don’t get a free lunch.

SG: What about the regulatory system, is it a matter of making new rules or simply doing a better job at enforcing the rules we already have?

WB: Well there are probably some new rules needed, but the regulatory system I don’t think could have stopped this. Once you get the bubble going... once the American public, the U.S. Congress, all the commentators, the media, everybody else started thinking house prices could go nothing up, you were creating a bubble that would have huge consequences because the asset class was so big. I mean you had 22 trillion dollars probably worth of homes. It was the biggest asset of most American families and you let them borrow 100% in many cases of the price of those and you let them refi up to where they kept taking out more and more and treating it as an ATM machine.. the bubble was going to happen.

SG: But everybody is saying we need more rules, we have to enforce them, we need to go after every institution, every financial market. Do you think that new rules will do the trick or do we have enough rules that we just need to enforce them?

WB: Well you can have a rule for example to prevent another real estate bubble; you just require that anybody bought a house to put 20% down and make sure that the payments were not more than a third of their income. Now we would not have a big bust ever in real estate again, but we would also have people screaming that you’re denying home ownership to all these people that you got a home yourself and now you’re saying a guy with a 5% down payment shouldn’t get one. So I think it’s very tough to put rules out... I mean I can design rules that will prevent it but it will have other consequences. It’s like I say in economics you can’t just do one thing and where the balance is struck on that will be a political question. My guess is that it won’t be struck particularly well, but that’s just the nature of politics.

SG: You’ve said that we’re in an economic Pearl Harbor, so how bad are things really?

WB: They’re bad, they’re bad. The credit situation is getting a little better now. Things have loosened up from a month ago in the corporate debt market. But the rate of business descent is at a pretty alarming pace, I mean there is no question things have really slowed down.

Peoples’ buying habits have changed. Fear has taken over and fear is a tough thing to fight because you can’t go on television and say don’t be afraid, that doesn’t work. People will get over it, they got greedy and they got over being greedy. But it took a while to get over being greedy and now the pendulum has swung way over to the fear side. They’ll get over that and we just hope that they don’t go too far back to the greed side.

SG: What’s your view on the recession? How much longer is it going to last?

WB: I don’t know. I don’t know. I don’t know the answer to these things. The only thing is I know that I don’t know. Maybe other people think they know, but I have no idea.

SG: The last time we talked, you said back in the Spring, you said the recession is not going to be a short-haul thing. What is your feel for it right now?

WB: It isn’t going to be short, but I just don’t know Susie. There’s no way of knowing.

SG: Berkshire Hathaway is in a lot of businesses that are economically sensitive, like furniture, paint, bricks. Do you see any signs of a pick up?

WB: No. No. The businesses that are either construction or housing related, or that are just plain consumer businesses, they’re doing very, very poorly. The American consumer has stepped back big time and it’s contagious and there’s a feedback mechanism because once you hear about this then you get fearful and then don’t do things at all. And that will end at a point, but it hasn’t ended at this point. Now fortunately our two biggest businesses are not really tied that way- in insurance and in our utility business we don’t feel that, but everything that’s consumer related feels it big time.

SG: Do you think that the psyche of the American consumer has changed, becoming more savers than spenders?

WB: Well it certainly has at this point and my guess is that continues for quite a while. What it will be five years from now, I have no idea. I mean the American consumer when they’re confident they spend and they’re not confident now and they’ve cut it back but who knows whether.. I doubt that that’s a permanent reset of behavior, but I think it’s more than a one day or one week or one month wonder in that case.

SG: Is that a bad thing?

WB: Well it just depends who the consumer is. I mean consumer debt within reason makes sense. It makes sense to take out a mortgage on a home particularly if you aren’t buying during a bubble. You are normally going to see house price appreciation if you don’t buy during a time when people are all excited about it. So I don’t have any moral feelings about debt as to how people should.. I think people should only take on what they can handle though and that gets to their income level…

SG: Let me ask it this way, with Americans saving more may be good for consumers, but is that bad for business?

WB: Well it’s certainly bad for business in the short term. Now whether it’s better for business over a 10 or 20 year period... if the American public gets itself in better shape financially that presumably is good for business down the road, but while they’re getting themselves in better shape, its not much fun for the merchant on Main street.

SG: One thing that Americans aren’t buying these days is stocks. Should they be buying?

WB: Well just as many people buy a stock everyday as sell one so there are people buying stocks everyday and we’re buying stocks as we go along. If they’re buying into a business that they understand at a sensible price they should be buying them. That’s true at any time. There are a lot more things selling at sensible prices now than they were two years ago. So clearly it’s a better time to buying stocks than a couple of years ago. Is it better than tomorrow? I have no idea.

SG: This financial crisis has been extraordinary in so many ways, how has it changed your approach to investing?

WB: Doesn’t change my approach at all. My approach to investing I learned in 1949 or ‘50 from a book by Ben Graham and it’s never changed.

SG: So many people I have talked to this past year say this was unprecedented… the unthinkable happened. And that hasn’t at all impacted your philosophy on this?

WB: No and if I were buying a farm, I wouldn’t change my ideas about how to buy a farm or an apartment house or a business and that’s all a stock is. It’s part of a business so if I were going to buy stock in a private business here in Omaha, I’d look at it just like I would have looked at it two years ago and I’ll look at it the same way two years from now. I look at how much I am getting for my money, how good the management is, how the competitive position of that business compares to others, how durable it is and just fundamental questions. The stock market is... you can forget about that. Any stock I buy I will be happy owning it if they close the stock market for five years tomorrow. In other words I am buying a business. I’m not buying a stock. I’m buying a little piece of a business, just like I buy a farm. And that doesn’t change. And all the newspapers headlines of the world don’t change that. It doesn’t mean you can’t buy it cheaper tomorrow. It may turn out that way. But the real question is did I get my money’s worth when I bought it?

SG: One of your famous investing principals is, “be fearful when others are greedy and greedy when others are fearful.” So is this the time to be greedy, right?

WB: Yeah. My greed quotient has risen as stocks have gone down. There’s no question about that. The cheaper something gets that you’re going to buy, the happier you feel, right? You’re going to buy groceries the rest of your life; you want grocery prices to go up or down? You want them to go down. And if they go down you don’t think gee I got all those groceries sitting in my cabinet at home and I’ve lost money on those. You think I am buying my groceries cheaper, I am going to keep buying groceries. Now if you’re a seller, obviously prices are higher. But most people listening to this program, certainly I, myself, and Berkshire Hathaway, we’re going to be buying businesses over time. We like the idea of businesses getting cheaper.

SG: So where do you see the opportunities in the stock market right now?

WB: That one I wouldn’t tell you about.

SG: Let me throw out some sectors and you just tell me quickly how you feel about these sectors.

WB: Susie, I am not going to recommend anything…

SG: Even in general, for example a lot of people now are looking at infrastructure companies, is that a sector that you find attractive?

WB: I wouldn’t have any comment. What they ought to do is look at businesses they understand. They‘d be happy owning for years if there was never a quote on the stock. Just like they buy in privately into a business in their hometown... They ought to forget all about what somebody says is going to be hot next year or the year after, whatever… because what’s going to be hot you may be paying twice as much for as something that’s not going to be hot. You don’t want to think in terms of what’s going to be good next year, you want to think of what’s a good business to be in and then buy it at an attractive price. And then you can’t lose.

SG: Do you see more opportunities in the U.S. compared to overseas?

WB: Well I am more familiar with the U.S. We have such a big market. I see lots of opportunities here and I see lots of opportunities around the world.

SG: Investor confidence was so shattered last year, what do you think its going to take to restore confidence?

WB: If people were dependent on the stock market going up to be confident they’re in the wrong business. They ought to be confident because they look at a business and think I got my money’s worth. They ought to be confident if they buy a farm, not on whether they get a quote the next day on the farm, but they ought to look at what the farm produces, how many bushels an acre do they get out of their corn or soybeans and what prices do they bring. So they ought to look to-the business as to whether to be confident compared to the price that they paid and they ought to forget about what anybody is saying, including me on television, or what they’re reading in the paper. That’s got nothing to do with whether they made a good decision or not. What’s got to do with whether they made a good decision, what kind of business they bought and what they paid for it.

SG: People are reeling from this whole Bernie Madoff scandal. What would you say to people who have lost trust in the financial system?

WB: They shouldn’t have lost... you don’t need to lose trust in the American system. If you decide to buy a farm and you pay the right price for it, you don’t need to lose faith in American agriculture you know because the prices of farms go down…

SG: But you know what I’m saying. People lost money last year in companies that they thought were rock solid. As I said the unthinkable happened and then on top of it, this whole Bernie Madoff scandal. It has undermined people’s sense of well being about our system. So what do you say to people who have lost trust?

WB: Well they may be better off not being in equities. If they’re really depending on somebody else and they don’t know anything about the somebody else, they’ve got a problem. They shouldn’t do that. I mean there are going to be crooks out there and this guy was a crook on a scale that we’ve never seen before. But you ought to know who you’re dealing with. But if you’re going to buy a stock in some business that’s been around for a 100 years and will be around for 100 more years and it’s not a leveraged company and it sells some important product and it’s got a strong competitive position and you buy it at a reasonable multiple of earnings, you don’t have to worry about crooks, you’re going to do fine.

SG: Is there any take away lessons from the Bernie Madoff story?

WB: Well he was a special case. I mean here is a guy who had a good reputation for 30 years or something, and the trust of a lot of people around him. So it’s very easy to draw assurances from the fact that if fifty other people that are prominent and intelligent trust the guy, that maybe you should trust him too. But I wouldn’t put my trust in a single individual like that. I would put my trust in a very good business. I would want a business that was so good that if a social guy was running it, it would still certainly do well and there are plenty of businesses that are like that.

SG: So are you saying that investing has gotten so complicated that investors should stick to what they know? Is that the take-away lesson?

WB: You should always stick to what you know. I say the “know-nothing investor” and there’s nothing wrong with being a “know-nothing investor”. I spend 60 hours a week, thinking about investments and most people have got jobs and other things to do. They can buy index funds. And they’re not going to do better then an index fund if they go around and trust some guy who’s promising them very high returns. If you buy a cross section of American business and you don’t buy it during a period when everybody is all enthused about stock, you’re going to do fine over 10 or 20 years. If you buy something with the idea that you’re going to do fine over 10 months, you may or may not. I do not know what stock is going be up 10 months from now, and I never will.

SG: What about Berkshire Hathaway stock? Were you surprised that it took such a hit last year, given that Berkshire shareholders are such buy and hold investors?

WB: Well most of them are. But in the end our price is figured relative to everything else so the whole stock market goes down 50 percent we ought to go down a lot because you can buy other things cheaper. I‘ve had three times in my lifetime since I took over Berkshire when Berkshire stock’s gone down 50 percent. In 1974 it went from $90 to $40. Did I feel badly? No I loved it! I bought more stock. So I don’t judge how Berkshire is doing by its market price, I judge it by how our businesses are doing.

SG: Is there a price at which you would buy back shares of Berkshire? $85,000? $80,000?

WB: I wouldn’t name a number. If I ever name a number I’ll name it publicly. I mean if we ever get to the point where we’re contemplating doing it, I would make a public announcement.

SG: But would you ever be interested in buying back shares?

WB: I think if your stock is undervalued, significantly undervalued, management should look at that as an alternative to every other activity. That used to be the way people bought back stocks, but in recent years, companies have bought back stocks at high prices. They’ve done it because they like supporting the stock…

SG: What are your feelings with Berkshire. The stock is down a lot. It was up to $147 thousand last year. Would you ever be opposed to buying back stock?

WB: I’m not opposed to buying back stock.

SG: Everyone wants to know your plans. What you’re going to do with all of Berkshire Hathaway’s cash, some 30 billion dollars? Is this now the right time to do a big acquisition?

WB: Well we’ve spent a lot of money in the last 4 months. We spent $5 billion on Goldman Sachs, $3 billion on GE, $6.6 billion on Wrigley, we’ve got $3 billion committed on Dow. We’ve spent a lot of money. We’ve got money left, but I love spending money. Cash makes me very unhappy. I like to always have enough and never way more than enough, but I always want to have enough. So we would never go below $10 billion of cash at Berkshire. We’re in the insurance business - we got a lot of things. We’re never going to depend on the kindness of strangers. But anything excess in that, I love the idea of buying things and the cheaper they get the better I like it.

SG: You’ve been talking about doing a big acquisition for a while now, what are you waiting for?

WB: Well we’ve spent $20 billion dollars... that might not be.

SG: I mean in terms of a company…

WB: Well we’ll wait for the right deal. We had a deal to buy Constellation for roughly $5 billion and then events with the French coming in meant we didn’t do it. But I was delighted to commit to that $5 billion dollars for Constellation Energy. And it could happen tomorrow. That one happened on a Tuesday afternoon I mean it happened like that. Constellation was in big trouble and we flew back that day, talked to the people at MidAmerican that Tuesday and made them an offer that night.

SG: It seems that you’re pretty optimistic about the long term future of the American economy and stock market, but a little pessimistic about the short term... is that a fair assessment of where your head is right now?

WB: I am unquestionably optimistic about the long term. I’m more than a little pessimistic about the short term, but that doesn’t mean I am pessimistic about the stock market. We bought stocks today. If you tell me the economy is going to be terrible for 12 months, pick a number, and then if I find something that is attractive today, I am going to buy it today. I am not going to wait and hope that it sells cheaper 6 months from now. Because who knows when stocks will hit a low or a high? Nobody knows that. All you know is whether you’re getting enough for your money or not.

SG: As you know it’s the 30th anniversary of Nightly Business Report. As you look back on the past three decades, what would you say is the most important lesson that you’ve learned about investing?

WB: Well I’ve learned my lessons before that. I read a book what is it, almost 60 years ago roughly, called The Intelligent Investor and I really learned all I needed to know about investing from that book, in particular chapters 8 and 20 so I haven’t changed anything since.

SG: Graham and Dodd?

WB: Well that was Ben Grahams’ book The Intelligent Investor. Graham and Dodd goes back even before that which was important, very important. But you know you don’t change your philosophy assuming you think have a sound one and I picked up I didn’t figure it out myself, I learned it from Ben Graham, but I got a framework for investing that I put in place back in 1950 roughly and that framework is the framework I use now. I see different ways to apply it from time to time but that is the framework.

SG: Can you describe what it is? I mean what is your most important investment lesson?

WB: The most important investment lesson is to look at a stock as a piece of business not just some thing that jiggles up and down or that people recommend or people talk about earnings being up next quarter, something like that, but to look at it as a business and evaluate it as a business. If you don’t know enough to evaluate it as a business you don’t know enough to buy it. And if you do know enough to evaluate it as a business and its selling cheap, you buy it and don’t worry about what its doing next week, next month or next year.

SG: So if we asked for your investment advice back in 1979 back when Nightly Business Report first got started, would it be any different than what you would say today?

WB: Not at all. If you’d ask the same questions, you’ve gotten the same answers.

SG: Thank you so much Mr. Buffett … Thank you so much, always a pleasure talking to you.

WB: Thank you, been a real pleasure.

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