Most of the time nobody will explain the game to you

In many areas of life, the sharpest people in a given field often won’t explain the tricks of the trade to the general public.  Sometimes it’s the case that the publicly-available information on a subject is second-rate.  Take Warren Buffett for example.  His derivatives deals are brilliant because he is getting paid to borrow money.  Of course, he does not fully explain his deals because he doesn’t want others copying his trades. In shareholder letters, he does not explain how his counterparties were inappropriately modeling equity-equity correlations.  He only discussed the trades on a superficial level because GAAP accounting of the derivatives were causing people to misunderstand Berkshire’s intrinsic value.  Buffett likely avoids explaining Berkshire’s credit default contracts for similar reasons.

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Who did dumb deals with Warren Buffett?

Previously, I wrote about Buffett’s brilliant derivatives deals.  He will be paid to borrow money.  The deals are structured so that Berkshire Hathaway avoids counterparty risk (people who make dumb deals have a very high chance of blowing up).  So who are the counterparties?

According to this 2010 news article, two of the counterparties are Lehman Brothers and Goldman Sachs.  Buffett knows who all of his counterparties are.  Presumably, he had somebody shop around Wall Street to figure out who would give him the best pricing on these derivatives deals.  He should know which companies were and weren’t willing to make dumb derivatives deals.  He knows that Goldman Sachs was willing to do a dumb deal with him.  So I find it incredibly interesting that he decided to invest $5B into Goldman Sachs for preferred shares and warrants.  On the preferred shares, Buffett is exposed to any other number of dumb things that Goldman Sachs may have done.  If Goldman was essentially giving him free money, it was likely that it was giving away free money to other people.

Warren Buffett’s playbook and derivatives deals

Here’s a look at part of Warren Buffett’s ‘playbook’ of investment strategies that he has experimented with.

For-profit dialysis: an unethical industry / DaVita (DVA)

I’ve been researching the dialysis industry because Berkshire Hathaway owns DaVita (DVA), one of the largest dialysis providers in the US.  However, I’m not quite sure why Berkshire Hathaway owns this stock.  The for-profits are rarely rewarded for creating value while there are large financial rewards for unethical behaviour.  Buffett has been vocal about not owning Lorillard (a tobacco company) so I don’t see why he would be ok with owning DaVita.  It is possible that Buffett hasn’t researched the company much as Ted Weschler (probably) made the decision to buy it.

Historically, DaVita has been very rewarding for shareholders ever since Kent Thiry saved it from bankruptcy and turned it around.  However, his integrity strikes me as questionable and I’m of the opinion that entrusting your money with unethical people is not a good idea.

Berkshire Hathaway’s 1989 letter to shareholders

In my opinion, Warren Buffett’s 1989 shareholder letter is one of his most significant ones as it has his greatest insights buried in there.