I’ve been a fan of Warren Buffett and Charlie Munger for many years. Indeed, I’ve lost count of the number of times I’ve been to Omaha to hear Warren Buffett and Charlie Munger speak at the Berkshire Hathaway shareholder meetings. It really is a unique event, when it comes to finance. One of the highlights has always been hearing Charlie’s humorous answers to many of the questions asked at the event over the years. In every response, Charlie would never shy away from being direct: he said what he thought, something which is comparatively rare these days. It will be very sad to see Warren on stage next year without Charlie at his side.
Much has been published about Charlie Munger, including a great article by Greg Zuckerman at WSJ (My Morning with Charlie Munger, 02 Dec 2023), who interviewed the great man himself earlier this year and a podcast was also released featuring Charlie talking about his approach to investing (A Conversation with Charlie Munger and John Collison, 05 Dec 2023). Over the years, I’ve read a number of books about both Warren Buffett and Charlie Munger. Most recently I’ve been reading Tren Griffin’s book (Charlie Munger: The Complete Investor, 2015), which intertwines quotations from Charlie Munger alongside his philosophy on investing and on life more broadly, and I’ve picked out many of the below quotations from Griffin’s great book. I’d also recommend Alice’s Schroeder’s book (The Snowball: Warren Buffett and the Business of Life, 2009), which initially triggered my interest in Berkshire Hathaway many years ago.
Who have I met at Berkshire Hathaway meetings: not quants!
I’ve met many fans of Berkshire Hathaway over years at the various shareholder meetings from all over the world. Perhaps unsurprisingly, the vast majority of these fellow conference attendees have been value investors adhering to the core philosophy of what has driven the investing style of Warren Buffett and Charlie Munger. One type of financial participant I have never met at any of the meetings I’ve attended: a fellow quant.
After all, at first glance the approach of many quants is totally at odds with a long term discretionary value investing. Indeed if I think of many of the trading strategies I’ve developed over the years, some have been very short term intraday trading strategies with holding times of a little more than a few minutes. Presently, the focus of Turnleaf Analytics, which Alexander Denev and I cofounded, has been on forecasting inflation at time horizons ranging from the next inflation print a few days away to forecast horizons of 1 month, 2 months, … and 12 months. Pretty much any of these time horizons are totally different to the ones of a long term value investor, where the duration of a trade is measured in years or even decades, where the goal is to act like a business owner, rather than to focus on short term forecasting of the market ore more broadly the economy. I could write paragraph after paragraph outlining the differences between discretionary value investing and a quant’s approach to markets… but I won’t do that here.
But Warren Buffett and Charlie Munger can still teach quants a lot!
There are numerous differences between quant and the Berkshire Hathaway approach to investing. Despite that, there are many things that Warren Buffett and Charlie Munger can teach quants, and I’ve tried to outline a few of these things below…
Knowing the limits of your knowledge
Confucius said that real knowledge is knowing the extent of one’s ignorance. Aristotle and Socrates said the same thing. Is it a skill that can be taught or learned? It probably can, if you have enough of a stake riding on the outcome. – Charlie Munger, Jason Zweig interview, 2014
Whenever, you make any decision it is going to be based on some sort of knowledge. That knowledge is never going to be complete. However, it is important to know the limits of that knowledge. Quants build models which are approximations of the real world. Mathematical models are never going to be perfect, but they can still be very useful, in particular that they can ingest appropriate data in a very systematic way. Indeed, we might want to ask questions such as:
- What data are you ingesting into your model?
- How “complete” is your dataset?
- Where are there gaps in that dataset?
- What approximations are you making in your model?
- When is the model likely to outperform or underperform?
If we can answer such questions, we can begin to think about how we can improve our accuracy, whether it is through changing the model or searching for new data. If we have no idea where the limits are in our model, it becomes more difficult not only to improve the model, but also to understand how to use the output.
The use of checklists
I’m a great believer in solving hard problems by using a checklist. You need to get all the likely and unlikely answers before you; otherwise it’s easy to miss something – Charlie Munger, Wesco Annual Meeting, 2007
If we think of creating discretionary trade ideas, one way of coming up with them is a mental checklist to see how many factors stack up for a position and how many don’t. We can look at factors like, what’s the current trend, the level of carry, what are the fundamentals saying, what is market positioning etc. As Munger suggests, a checklist can reduce the chance of missing something. This is just as true for a quant building a model. Having a checklist of the types of modelling considerations and the types of data we should look for, can be invaluable when putting together a model.
The importance of learning (including from mistakes)
I constantly see people rise in life who are not the smartest, sometimes not even the most diligent, but they are learning machines.. Nothing has served me better in my long life than continuous learning – Charlie Munger, USC Law School, 2007
In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero. You’d be amazed at how much Warren reads, at how much I read – Charlie Munger, Berkshire Hathaway Annual Meeting, 2004
You can learn to make fewer mistakes than other people – and how to fix your mistakes faster when you do make them – Charlie Munger, Harvard University, 1995
Both Warren Buffett and Charlie Munger are well known to be big fans of reading. Continuous learning is just as important for quants, as it is for discretionary investors. Learning can of course take many forms, whether from courses, books, meeting fellow investors, even browsing a Twitter feed etc. The importance of learning of mistakes is also crucial. As mentioned, a quant model will never be perfect. It will never work all the time, in particular within financial markets which is inherently noisy.
We continually model the performance of our forecasting inflation models on a live basis at Turnleaf Analytics. Even if our inflation forecasting models have managed to beat the benchmark a reasonable amount of the time in live publishing (62% of the time), there will be occasions where the model doesn’t manage to capture a surprise. On those occasions where we miss, we spend time trying to understanding why. Was it some one off factor, or was it something we could have anticipated with better data or modelling (and which type of model improvements), and also improves the general performance of the performance. You clearly don’t want to “improve” a model for just one point, which makes it less accurate pretty much anywhere else!
Putting together the pieces
You’ve got to have models in your head. And you’ve got to array your experience – both vicarious and direct – on this latticework of models. – Charlie Munger, USC Business School, 1994
As a quant, it can become easy to think that everything is about the model. However, to tackle a problem, we need to understand it, and that requires to put together multiple areas. If we are thinking about inflation and how to forecast, we need to understand first, what inflation is, and what are the likely drivers. Only once we have an idea of what the problem is, then we should think about how to model it, and what data we could use. If we truly understand the problem then it makes it much easier to model it. Domain knowledge is extremely useful in financial markets.
At first glance, Berkshire Hathaway sits at a polar opposite to how a quant may look at financial markets, long term versus short term etc. However, there are still many things that Warren Buffett and Charlie Munger can teach quants about markets. Finally, one last quotation below, which I couldn’t agree with more!
I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the Hallelujah chorus in the Buffett household. When hamburgers go up, we weep. – Warren Buffett
Saeed Amen, co-founder Turnleaf Analytics. Contact: email@example.com