Siegmund Warburg and Investment Management

One of the intriguing issues raised by Niall Ferguson’s absorbing new biography of Siegmund Warburg is why someone regarded, rightly, as “the most important City figure of the postwar period” should have had such an apparent blind spot about the growth and profit potential of investment management as a business.

Peter Stormonth Darling, the chairman of Mercury Asset Management, the business that grew out of S.G.Warburg’s Investment Department, records in his memoirs how his first instruction on being told to take charge of this backwater in the bank was to “get rid of it”. In 1979 the business was offered, says Ferguson, to two rival banks, Flemings and Lazards, at a giveaway price of £10m. They were, he concludes, “foolish not to buy at the absurdly low price Warburg asked”.

(Editor's subsequent note: In fact they were even more foolish than the book implies. According to the information I received from Mr Darling after this article appeared, the business was in fact offered to Flemings for just £1 and to Lazards for £100,000).

Even allowing for inflation, the asking price stands in striking contrast to the £3.1 billion for which the business was eventually sold to Merrill Lynch 18 years later. (A few years after failing to offload it, Warburgs floated the business on the London market as a largely independent business). More extraordinary still is that MAM’s exit price in 1997 was more than three and a half times that at which S.G. Warburg had itself been sold, somewhat ignominiously, just three years earlier.

As blind spots go, this therefore was something of a corker. Because shareholders in Warburgs retained a holding in MAM, to their eventual considerable benefit, the opportunity cost was nothing like as high as it would have been if the decision to sell had gone ahead. Yet Warburg’s decision was, as Ferguson makes clear, entirely consistent both with his own temperament and aspirations in business, and with the prevailing attitude in the City at the time towards investment management.

Warburg died in 1982, just as the great late 20th century bull market was getting under way, and four years before Big Bang changed the rules of the game in the City for good. While others, including Stormonth Darling, could see the way that investment management was already developing into a profitable business in its own right on the far side of the Atlantic, Warburg never seems to have deviated from his lifelong view that investment management was a second rate activity barely worthy of a high-minded financier’s time.

A number of factors can be detected behind this reluctance. One was Warburg’s strongly held conviction that what he wanted his business to be was an “haute banque” in the grand Continental tradition, a private bank which delivered first class advice and services to its corporate clients and acted throughout with the highest possible standards of efficiency and integrity. Relationship building with big hitters in business and Government, in his vision, was a high calling that invariably took precedence, in both social and moral terms, over the grubbier business of generating transactions for short term profit.

Managing client investment portfolios, an activity which absorbed a fair deal of management time and little (in those days) of profit, was an even lower priority. It did not help that Warburg himself had virtually no interest in accumulating personal wealth and retained an inveterate distaste for the stock market. Those who spent their time in market speculation, in his view, were among the lowest forms of business life, right down there with journalists and economists. There was no deeper insult in the Warburg vocabulary than to describe someone as a “Boersianer”.

As one of his colleagues observed, Warburg was a “capitalist by fate” who “despised money making for its own sake”. His own record as an investor was, perhaps unsurprisingly, mediocre. Deeply risk-averse, and ascetic in his personal habits, he lived well, but without ostentation, and died a much less wealthy man than many of his more money-oriented colleagues and contemporaries.

When he gave investment advice to others, the results, says Ferguson, were sometimes “wholly inadequate”, as in the early 1970s, when despite identifying the roots of the inflation that was about to plunge the Western world into a deep recession, he could come up with nothing better as an investment strategy than a 50-50 allocation to equities and Government bonds. Yet this was also the man whose brilliant mind just a few years later helped to pioneer the index-linked Government bond, a simple but invaluable innovation which has benefited millions since (as even Paul Volcker, scourge of the innovations of investment banks, would surely readily concede).

Another of Warburg's besetting personal characteristic was a lifelong inclination to pessimism. His own experience, he noted once, was “that if one expects miraculous results from investment management, this is the best way to do badly...In the long run the most favourable achievements are obtained on the basis of modest anticipations and by way of policies which rather err on the side of being solid and pedestrian than original”.

Ironically, of course, there is a lot of wisdom in that observation, although it has taken three decades of academic research to confirm quite how soundly based it is. Is investment management a high calling? Not self-evidently. There is plenty of money to be made in it, as history has shown, but at the aggregate level it is by definition a zero sum game. To succeed at it, it definitely helps to believe in the triumph of hope over experience. Siegmund Warburg, a Jew who had fled from the Nazis in 1934, was neither temperamentally nor intellectually inclined to think that way.

High Financier; The Lives and Times of Siegmund Warburg, by Niall Ferguson, is published by Allen Lane. You can search for and buy a copy at a competitive price in the Independent Investor bookshop.


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John Kay: Why The Customers Have No Yachts

Having dissected the way that markets work, and before that how companies should, in his latest book the economist John Kay has turned his laser-like attention to the subject of personal investing. One of his themes, the need for investors to minimise the take (in fees and charges) that providers and advisers slice off their returns, was summarised in an article in the Financial Times yesterday.

The book itself, entitled The Long and The Short of It, can be thoroughly recommended to anyone who wants to look after their own money in an intelligent way (although as someone who read the book in draft, and has worked with John Kay in the past, I must declare a personal interest). He puts the Efficient Markets Hypothesis, rational excpectations and all the other influential outpourings of academia firmly in their place - "illuminating but not true", in his words.

Here is an extract from the article:

"Over the 42 years that Warren Buffett has been in charge of Berkshire Hathaway, the company has earned an average compound rate of return of 20 per cent per year. For himself. But also for his investors. The lucky people who have been his fellow shareholders through all that time have enjoyed just the same rate of return as he has. The fortune he has accumulated is the result of the rise in the value of his share of the collective fund".

"But suppose that Buffett had deducted from the returns on his own investment – his own, not that of his fellow shareholders – a notional investment management fee, based on the standard 2 per cent annual charge and 20 per cent of gains formula of the hedge fund and private equity business. There would then be two pots: one created by reinvestment of the fees Buffett was charging himself; and one created by the growth in the value of Buffett’s own original investment. Call the first pot the wealth of Buffett Investment Management, the second pot the wealth of the Buffett Foundation".

"How much of Buffett’s $62bn would be the property of Buffett Investment Management and how much the property of the Buffett Foundation? The – completely astonishing – answer is that Buffett Investment Management would have $57bn and the Buffett Foundation $5bn. The cumulative effect of “two and twenty” over 42 years is so large that the earnings of the investment manager completely overshadow the earnings of the investor. That sum tells you why it was the giants of the financial services industry, not the customers, who owned the yachts".

"So the least risky way to increase returns from investments is to minimise agency costs – to ensure that the return on the underlying investments goes into your pocket rather than someone else’s". The message is the same one that Jack Bogle, the founder of Vanguard, has done more than anyone else to promote over the years. There is lots more in the same challenging vein. Anyone who has enjoyed John Kay's weekly FT column will know what to expect.
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