Thinking about preserving wealth, I was wondering whether this is an art or a science. When I started my search for answers I believed that preserving wealth, and better even enlarging it, was an art rather than a science. True, there are hundreds, if not thousands, books telling you how to become and remain rich, but none of them provide a fool-proof recipe.

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I thought it best to find out how master investor Warren Buffett has been so spectacularly successful in creating, preserving and enlarging his own wealth and in making Berkshire Hathaway a success story; the company he still leads (with Charlie Munger) despite his advanced age of 91. Munger is 98, by the way. I also consulted a friend of mine who was the CEO of a very large pension fund to learn what he had to say about preserving and enlarging the pension fund’s capital. The other side of the wealth coin is how to lose wealth. This, I thought, would shed light on the question what not to do, as it unavoidably ends in disaster. I will look into this aspect as well.

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Let me start with Buffett. He studied business administration and economics and graduated at Columbia Business School, New York. His father was a stock broker, and young Warren started his own business when he was only 13 years old, selling horse racing tip sheets. What I particularly like about Buffett is that he still lives in the house he bought in the early 1950s; he is not interested in showing off his wealth. It is no surprise, therefore, that he donated his fortune to the Bill and Melinda Gates Foundation.

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Now, what are ‘the secrets of Buffett’s success’? In fact, there are no secrets as he shared his investment strategy many times over; it is quite simple discovering what this strategy is. In a nutshell, Buffett applies the so-called Benjamin Graham school of value investing. This means that Buffett looks for securities whose prices are unjustifiably low, based on their intrinsic value. Some say that Buffett is a bargain hunter. He is not as much interested in the stock market, as he is in the performance of a company as a whole – he analyses the company’s fundamentals. What is of importance in this respect is, besides its return on investment, the company’s debt (the smaller, the better) and its profit margins (good and increasing). He also looks into the legal character of a company; i.e. is it a public company having been around for at least ten years.

Buffett’s company Berkshire Hathaway holds a stake in many companies, such as Bank of America, American Express, and Coca-Cola. Remarkably, Buffett does not invest in technology companies. He says that he does not understand the mechanics behind them.

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Buffett warns potential investors to never underestimate the value of historical performance. After all, this demonstrates the company's ability to increase shareholder value. However, he adds, keep in mind that a stock's past performance does not guarantee its future performance.

In sum, Buffett investigates what an undervalued company’s long-term potential is and its capability to generate earnings.

And - not least important - how cheap the company would be to buy.

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Now, if we were to point the finger at Buffett’s secret of success, it is his extraordinary talent to determine how undervalued a company is, and what its intrinsic value as a whole would be. Indeed, this is Buffett’s most exceptional skill. Nonetheless, Berkshire Hathaway’s stockholders are getting a bit restless; they find that the time has come for Buffett (and Munger) to retire. Arguably, the fact that Berkshire Hathaway is not investing in technology shares suggests that Buffett is losing touch. Shareholders also find that the company should do better in environmental investments, in diversity and in corporate governance.

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Now, let us move from capital investment funds to pension funds. The Netherlands avails of one of the world’s best pension systems. Apart from a government-sponsored basic pension fund for all Dutch retired citizens (including members of the Royal family), the system is organised along the lines of sectors (such as health, education, and the like) and companies. Employers and employees make monthly contributions to their respective pension fund, based upon the level of income of each employee. The fund invests these contributions in a variety of assets, and – most important of all – makes sure that pensions are secured for all members of the pension fund once they retire.

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Investing the collected funds is a highly responsible and challenging job. After all, investing wrongly results in pension claims not being honoured. The victims are all the people who had contributed to their pension fund during their working life, in the expectation that they would receive a pension but are left empty-handed. So, prudently investing, while ensuring sufficient earnings is key.

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Now, what are the do’s and don’ts for fund managers of pension funds? Below are a few essential recommendations which I received from the former CEO of a large Dutch pension fund.

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1. From the outset, make sure to be clear about the objective of the capital investment. For a pension fund this objective is to absolutely ensure that the fund’s members receive a stable pension, in line with the development of the cost of living. It is also important to project future pension obligations. For a capital investment fund it is also crucial to establish in advance its objective and its risk profile.

2. Establishing the investment mix is essential, as this will to a large extent define the fund’s return on investment. Depending on the fund’s objective, the mix must be risk-averse or would allow some risk. If the fund’s objective is to honour entitlements (e.g. pensions), investment in government bonds is called for. Investment funds whose objective is an attractive return on investment, can develop a more diversified portfolio.  

3. Regarding investment in shares, the choice of country or region where the investments will take place greatly defines the return on investment. Investing in share indexes has proven to be efficient and relatively safe. Consistently achieving better returns than what share indexes provide is exceptional. Another advantage of investing in share indexes is that it is relatively simple to invest in so-called ‘sustainable investments’.

4. Investing in real estate has been undervalued so far. The attractive aspect of this investment is that rent income correlates nicely with the changing movements of inflation.

5. It is essential to maintain a hundred percent focus on control, transparency, and timely reporting on a large portfolio’s performance.
   Failing this, the credibility of management and the fund proper will be damaged when financial mishaps occur.

6. A clear ‘decision tree’ provides clarity within the institution managing the fund, who carries  ex-ante and ex-post responsibility for which particular part of the return on investment.

 

To my mind, these recommendations not just make much sense, they also help preserve and enlarge the invested capital.

 

Finally, a word about what to do in pursuit of wealth preservation. History is littered with examples of investments that went spectacularly wrong. Investing in only one activity is not advisable. Just one examples: around the beginning of the 20th century, many people exclusively invested in popular Russian railway bonds. However, after Russia’s 1917 October revolution, these bonds lost their value.

 

Ponzi schemes come to mind as well, named after Charles Ponzi. In the 1920s, he promised investors a 50% quick return for what Ponzi claimed was an investment in international mail coupons. It started as a very popular scheme but turned out to be an investment fraud that paid existing investors with funds collected from new investors. A more recent example of such a fraudulent scheme was that of Bernie Madoff, a fraudulent New York investor. His approach was the same as Ponzi’s. He paid investors in his investment fund the promised return on investment.
However, this was paid for by contributions of the fund’s new investors. In so doing year after year, Madoff embezzled $65 billion. Needless to say that Madoff, completely disgraced, died in prison. A recent scam concerns Archegos’s fraudulent investments, master-minded by Bill Hwang.

 

As I write this column, the crypto currency market is in disarray. It may turn out that crypto currencies may resemble a modern variety of a Ponzi scheme. After all, their value is based upon the demand of crypto investors, and not backed by governments and their monetary authorities.

Should demand dry up and crypto currency owners want to get rid of them, the currency’s rate will collapse.

 

At the beginning of this column I wondered whether preserving wealth would be an art or a science. My conclusion is that, indeed, it is an art; however, supported by a dose of common sense, responsible and qualified management as well as by documented practical experience.

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Peter de Haan