Berkshire versus Blackstone

A lot of pixels have been lit up here at Invest-Notes discussing Warren Buffett, Charlie Munger and their amazing enterprise, Berkshire Hathaway (BRK.A and BRK.B).  While the B-shares have been added over time to most of the portfolios I manage since their creation in 1996, the case to be made for adding shares now is more uncertain than usual. There is no doubt BRK will continue as a viable entity after Buffett and Munger have left this mortal coil. Still, even Buffett has suggested that at this time a better option for smaller investors might be an indexed fund of the S&P 500 instead of BRK.

There are two reasons for considering this advice. First, Buffett and Munger have yet to announce a formal succession plan despite their respective ages (87 and 93), so when the inevitable occurs we should expect a knee-jerk sell-off by the public. Which, following Buffett’s own advice, would likely mark the next really good buying opportunity of BRK shares. Second, BRK pays no dividend (though it prefers to own stocks that do), which typically account for a significant portion of total long-term returns for most equity investors. That the A-shares cost $256,000 each and the B-shares around $170 can also be intimidating for individual investors.

The benefit of having BRK in an investment account – beyond being associated with one of the best investing minds ever known – is that the size and breadth of its holdings allow for meaningful diversification. BRK functions more like a mutual fund or ETF than a typical publicly traded stock, offering the opportunity for individual investors to participate in ownership of asset classes not available through equity or bond holdings.

One alternative investment worth considering is Blackstone Group LP (BX), which I have been adding in modest increments to a couple of accounts since the beginning of the year. Uncommon among other publicly traded asset managers because BX also invests across four primary asset areas; real estate, credit, private equity deals and hedge fund-like investments. Interestingly, this means BX doesn’t just invest on behalf of its clients (mostly institutional) and collect management fees. BX participates as an investor with its own profits creating additional revenue streams. And like the Berkshire Boys, senior managers are major owners of BX shares. The recent dividend yield of over 6% is also compelling, though due to the quirky nature of many BX deals the annual yield over the last few years has vacillated between 3% and 9%.

If all this sounds complicated, it is. Most investors know of BX only tangently through the controversial cofounder and CEO, Stephen Schwarzman. Unjustly in my opinion but a potential positive for investors, BX has suffered from Schwarzman’s reputation as much as BRK has benefited from Buffett’s.  Started in 1985 and taken public in 2007, during the financial mayhem of 2008-2009 BX executed on Buffett’s dictum to buy when blood was in the streets brilliantly. Today, BX employs some investment strategies pretty much unknown a decade ago. This makes some investments hard to understand and others potentially requiring decades for a payout.

Additionally, there is another important reason the stock has remained so long under the radar. BX is structured as a limited partnership that brings tax complications and accounting issues such as K-1s. This also makes owners of the stock unitholders instead of shareholders, giving senior management pretty much complete control of the company. Though this lack of investor influence applies equally to owners of B-class Berkshire shares.

A final reminder however that this is uncommon fare and BX is probably not appropriate for most individual investors. There’s quite a bit of risk and much of it is not easily discernable. Yet the concept is important because we tend to think of stock and bond investments in fairly narrow terms. With stock, we own a piece of a business, while with bonds we are lenders to a business. ETFs, indexed and mutual funds tend to own a variety of assets, but almost always in the form of equities and fixed income instruments.

Equities like BRK and BX own stock in other companies (like a mutual fund or ETF) but also own many businesses outright (privately held companies not publicly traded). They both make direct loans and provide variable financing mechanisms while simultaneously owning traditional bond portfolios. BRK is a major player in the insurance industry, BX is an innovator in real estate investments. In summary, BRK and BX offer a unique and typically overlooked opportunity for the adventurous investor.

Note: I attended the annual meeting of BRK a few years ago and wrote a two-part article on my experience and impressions, links below. There’s new stuff in Art-Notes, too.

http://www.invest-notes.com/2011/05/02/money-talks-part-1/

http://www.invest-notes.com/2011/05/27/money-talks-part-2/

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