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Should investors start to consider the emergent opportunities in high yield and distressed debt? We think so. The market stress that arose in late 2015 resulted in a significant widening in credit spreads as price moves were exacerbated by severely reduced liquidity.

As the credit cycle continues to mature, we believe that stressed and distressed credit (especially in the US) could offer investors a rare opportunity to generate attractive returns in today’s low (or negative!) yield environment.

Fundamental and technical headwinds

Much of the poor performance of corporate credit in recent years has been due to losses in energy and commodity-related issuers, as weaker worldwide demand and excess supply sent oil and commodity prices down.

The other big problem has been reduced liquidity, as tighter regulations have discouraged banks from holding credit. Without the banks, there were often no willing buyers, spreads widened and the absolute price of many corporate credit securities plunged. This, in turn, exacerbated volatility, leading to dramatic swings in prices.

Number of US HY Bonds experiencing more than a 10 per cent price loss in a month

Credit fundamentals have also shown signs of deterioration as 2015 company earnings reports came in weaker alongside rising debt levels.

The low default rates of around 1 per cent to 2 per cent in recent years may be due to low interest rates masking the weakness of many company balance sheets. In this environment, idiosyncratic risk is heightened and dispersion in performance at the security level more likely.

The proportion of corporate credit trading at distressed prices now surpasses the levels set in 2011. The illiquidity in credit markets has had a disproportionate effect on lower-rated credits which have significantly underperformed higher-rated credits. The ratio of spreads on global CCC-rated debt to B-rated debt (a measure of stress in credit markets) has become wider than at the worst point in 2008.

Many macro risks are likely to persist, and the stability of capital markets depends on effective management by central banks. Geopolitical risks abound and China’s gradual slowdown will continue to place pressure on emerging markets. Default rates will eventually rise and volatility is unlikely to abate.

The opportunity for investors

It is often at the darkest hour that opportunities present themselves. We therefore believe that it is now time to consider how to take advantage of the structural changes and dislocations arising in credit markets.

Having highlighted many of the negatives in the current environment, it is worth noting that we believe we are unlikely to be in a 2008-style scenario.

Leverage is manageable and although some industries are stressed, it is likely that access to capital will remain relatively accommodative.

Federal Reserve policy along with easier underwriting may extend the cycle and postpone the uptick in defaults. It is now, more than ever, a “market of credits” rather than a “credit market”, affording those with rigorous research coupled with patience, capital and flexibility the potential to generate attractive returns.

Any further deterioration in economic conditions, combined with rising default rates as the credit cycle matures, could create significant opportunities for investors willing to tolerate a degree of volatility and illiquidity.

While investors will need to take into account their own specific return objectives, liquidity constraints, time horizon and risk tolerance, options worth considering include:

Long-only credit opportunities funds. These strategies could be thought of as sitting further up the risk–return spectrum and with less liquidity than traditional multi-asset credit funds.
Credit-oriented hedge funds. These strategies would have the flexibility to invest both long and short and will rely to a greater extent on manager skill than market beta when compared with long-only credit opportunities funds.
Private markets vehicles. These typically focus on opportunities at the higher end of the risk–return spectrum and tend to offer the least liquidity to the end investor.

While the opportunity may not yet be upon us, investors would do well to heed the military maxim that “time spent in reconnaissance is seldom wasted”.

Phil Edwards, European director of strategic research, and Diane Miller, senior manager researcher, Mercer

No longer can analysts use the excuse there is inadequate data for incorporating ESG into investment decisions.

The Sustainability Accounting Standards Board (SASB), a not-for-profit chaired by Michael Bloomberg with Mary Schapiro as vice chair, was formed to set market standards for disclosure of material sustainability information to investors. With “material” defined as likely to affect financial performance.

The organisation – founded by Jean Rogers and made financially viable through donors including Bloomberg Philanthropies; foundations such as Ford, Rockefeller, PwC and Deloitte – is predicated on a belief that ESG factors can impact company financial performance and drive long-term value.

The fact there is a now a broader range of risks and resource constraints beyond just access to capital makes the use of standardised financial reporting to investors insufficient. This means that a new, standardised language is needed to articulate the material, non-financial risks and opportunities facing companies that affect their long-term value creation.

Bloomberg has put its money where its mouth is and was the first company to use the voluntary SASB standards; and a number of investors, including CalSTRS are behind the initiative, with chief executive Jack Ehnes on the board.

“SASB will help forge the link between ESG and how to put it into practice,” Chris Ailman, chief investment officer of CalSTRS, says. “Our board has said they want us to integrate ESG, and our managers are saying how do we do that? ESG is all about looking at not just the balance sheet, but also the footnotes. SASB is focused on that, it looks at what is material for each industry. “It is really important to us that SASB has defined material as affecting financial performance, which is right down the centre of our fiduciary duty,” Ailman says. “For over 10 years when we’ve hired managers, we grill them on whether they look at ESG. Ninety-seven per cent of our managers confirm they use ESG criteria, now the board wants us to prove it.”

Standardised comparable data a big improvement

Director of capital markets policy and outreach at SASB, Janine Guillot – formerly chief operating investment officer at CalPERS – says the standards can be used to incorporate data into investment strategies; for corporate engagement to improve sustainability issues; or at the total portfolio level.

Standardised, comparable data will improve all of those tools and enable them to be more metric-focused.

“I’m so excited about SASB, it’s a tool for investors to integrate sustainability across the entire portfolio,” she says. “The standards are firmly focused on what will impact a company’s financial performance. Whatever type of investor you are, you will have the right access to comparable data on sustainability. We are a piece of market infrastructure.”

In a presentation to the CalPERS investment committee, Guillot said her view has moved from being a sceptic about whether ESG factors should be incorporated into decision-making, to seeing that they must be incorporated into investment decision-making for long term investors.

But this, says Guillot, is still aspirational because incorporating ESG into investment decision-making in a rigorous and scalable way requires data – data that’s reliable, relevant and comparable.

“That’s the gap that SASB aspires to close,” she says.

SASB was formed to set market standards for disclosure of sustainability information to investors, with a focus on identifying sustainability topics and metrics that are material, decision-useful and cost-effective for companies to provide. It has now developed provisional sustainability accounting standards across 11 sectors and 79 industries, and is conducting industry consultation with companies and investors.

“This will enable companies to report comparable information so performance can be benchmarked. We hope companies will compete to improve performance on sustainability metrics, just like they do on financial metrics today,” Guillot says. “Existing sustainability reporting is not standard and they don’t have industry-specific performance metrics. The SASB accounting standards are the first that allow comparison of peer performance and benchmarking within an industry,” she says.

Companies hit by ‘survey fatigue’

As an investor, Chris Ailman says he would like companies to report on a more consistent basis.

“Companies are dealing with survey fatigue: they are hit with surveys from lots of directions. SASB will provide consolidation and a consistent format, and then other groups can use it as a data feed. It means comparisons are now possible, and a financial analyst wants a quick financial analysis on who’s better or worse,” he says. “ESG is such a broad topic it is begging for a definition, and we are 100 per cent behind it. We will integrate it into our process and work with investment managers on how they pick stocks.”

Guillot says within a corporate, the SASB standards should be incorporated into regular financial reporting and be the responsibility of the CFO. If these internal controls and frameworks exist then investors know it is reliable, and it also gives a framework for CEOs and boards to benchmark performance.

“Our vision is that companies will compete on sustainability information, like they do with financial information,” Guillot says. “The standards will also allow investors to understand the sustainability risks they are exposed to given their asset allocation and ensure companies they invest in are sustainable.”

“Widespread adoption of these standards would give a common language for talking about sustainability performance. It would enable integration of ESG into investment decision-making with rigour and at scale. This would be a better outcome for society, and long term investors.”

As a sign of the momentum in the industry, the SEC’s has included a discussion around sustainability disclosure in its recent Regulation S-K concept release, looking for comment on modernising certain business and financial disclosure requirements.

It says: “We are interested in receiving feedback on the importance of sustainability and public policy matters to informed investment and voting decisions. In particular, we seek feedback on which, if any, sustainability and public policy disclosures are important to an understanding of a registrant’s business and financial condition and whether there are other considerations that make these disclosures important to investment and voting decisions. We also seek feedback on the potential challenges and costs associated with compiling and disclosing this information.”

It is asking for comment.

Pension funds need investment strategies with attractive risk and return characteristics to fund their liabilities.

Hedge funds are increasingly popular investments which purport to fill this need, as witnessed by a 25-fold increase in hedge fund use in the CEM global database between 2000 and 2014.

But have hedge fund portfolios delivered these benefits? New CEM research indicates that some did but most did not.

The reality is most hedge fund portfolios behaved like simple blends of equity and debt with unattractive returns and no risk-reducing characteristics.

The primary objective of the research was to better understand how funds are investing in hedge funds by examining their portfolio structure, benchmarks, performance and costs.

Results are based on a one-time survey completed by 27 leading global funds, and 15 years of CEM hedge fund data from more than 300 funds.

Rationale for investing in hedge funds

The top reasons given for investing in hedge funds were the potential for improved returns; diversification benefits; knowledge-sharing and learning; and access to asset classes that are otherwise hard to source and manage.

Funds not investing in or divesting their hedge fund portfolios cited difficulty in scaling holdings to fund size; an unjustifiable increase in fund complexity; the extreme difficulty of achieving and sustaining alpha; and high costs.

Benchmarking hedge funds

CEM believes the following principles should be used in selecting benchmarks for all investment programs:

The benchmark should be investable. An investable benchmark is “what you could have had”, a real alternative that was possible, and ideally implementable at low cost.
It should fairly reflect available returns. Benchmarks that are too easy or too hard to beat may give undue credit for investment skill, or not give credit where it is due.
The benchmark should have similar risks to the investment program.
It should be correlated to the assets it is being used to assess. A high degree of correlation indicates that the benchmark is both fair and a useful risk proxy.

Self-reported hedge fund benchmarks

Two primary types of hedge fund portfolio benchmarks were used by funds in 2014 – cash-based indexes and specialty hedge fund indexes – and both types of benchmarks suffer flaws.

Cash-based indexes were used by 33 per cent of the CEM universe, and a common example is libor + 4 per cent.

Cash-based benchmarks are seriously flawed: the average correlation with hedge fund returns is 2 per cent, the premiums are not investable, and worst of all they are very easy to beat (funds that use cash benchmarks outperform them by an average of 4.8 per cent per year).

Cash-based benchmarks only serve to generate random noise about performance while serving to perpetuate the myth that hedge fund portfolios are uncorrelated and have no (simple) market beta.

Indeed, for funds that used cash-based benchmarks, the average correlation to simple equity/debt blends is actually 87 per cent (the median is 95 per cent; and the beta is one).

Specialty hedge fund indexes were used by 44 per cent of the CEM universe.

These are commercial indexes based on either self-reported hedge fund returns that are not investable, or synthetic hedge fund replication which is easily outperformed.

While specialty hedge fund indexes had a reasonable correlation of 71 per cent to hedge funds, simple equity/debt blends make superior, easy to understand hedge fund benchmarks.

CEM constructed benchmarks

In order to improve and standardise performance comparisons, CEM constructed simple, investable benchmarks consisting of customised blends of equity and debt for all CEM participants with 5+ years of hedge fund data.

These custom benchmarks are specifically designed to have betas of one, and are highly correlated to hedge fund returns; the average correlation was 84 per cent and the median was 90 per cent.

The average equity/debt split was 44 per cent/56 per cent and the average duration of the debt component was 5.6 years.

Histograms of the correlations and equity/debt splits for the CEM universe are shown below.

graph1

graph2

Hedge fund performance

Hedge fund net value added based on self-reported benchmarks averaged -0.08 per cent over the 15 years ending in 2014.

This value added is, however, largely a mix of outperformance and underperformance caused by differences in benchmark choices.

Average net value added based on CEM’s customised, investable equity/debt blends, was -1.88 per cent over the same period.

The database universe net value added versus the custom benchmarks histogram is shown below.

graph3

While the average result is obviously disappointing, 30 per cent of funds did outperform their CEM custom benchmarks over 15 years.

Three characteristics shared by these outperforming funds included a long history of investing in hedge funds, hedge fund portfolios with lower correlation to CEM custom benchmarks, and implementation via lower cost direct hedge funds rather than higher cost fund of funds.

Cost impact

Costs matter, and high costs are the main reason why hedge funds performed poorly.

Before costs, hedge funds had positive value added of 0.97 per cent; after costs, value added was reduced to -1.88 per cent (see table).

On average, hedge fund costs in 2014 were 2.85 per cent for all implementation styles, 2.31 per cent for direct investing in hedge funds, and 3.56 per cent for fund of funds.

Fund of funds performed worse than direct hedge fund investing (-2.17 per cent versus -1.66 per cent) because they were higher cost.

Hedge fund value added before and after costs, 2000–2014

	All hedge funds	Direct	Fund of fund
Gross value added (A)	0.97%	0.65%	1.39%
Cost (B)	2.85%	2.31%	3.56%
Net value added (A-B)	-1.88%	-1.66%	-2.17%

Hedge funds and risk mitigation

Risk mitigation is an important performance attribute implied in the very name “hedge” funds.

Unfortunately, hedge fund portfolios did not provide protection when it was needed during extreme market turmoil – the 2008 global financial crisis.

The chart below shows annual average hedge fund returns, benchmark returns, and net value added since 2000.

2008 shows the worst result over the entire period, with average net value added of -5.6 per cent for hedge funds.

The average global hedge fund 2008 return was -17.6 per cent, only slightly better than the average global total fund return of -21.3 per cent.

graph4
† Annual returns and net value added are expressed in local currency.

Key implications for pension funds

Hedge fund portfolio benchmarks used by most funds are flawed.
Cash-based benchmarks generate noise, not signal.
Specialty benchmarks are somewhat better, but simple portfolios of equity and debt are superior.
Most hedge fund portfolios behave like simple pension funds – correlations with customised equity/debt benchmarks averaged 84 per cent.
The average equity/debt blend was 44 per cent/56 per cent.
Costs matter: average hedge fund portfolio value added before costs over 15 years was 0.97 per cent.
Average value added net of costs was -1.88 per cent.
It is hard to justify typical hedge fund fees if simple equity/debt blends correlate highly and outperform them.
Hedge fund portfolios do not appear to provide significant risk mitigation benefits, based on their poor performance in the 2008 global financial crisis.
Only 30 per cent of hedge fund portfolios outperformed simple equity/debt blends.
These pension funds generally had long histories with hedge funds, portfolios with lower correlation to equity/debt blends, and lower cost direct hedge funds.

Funds may not wish to apply the CEM benchmarks used in this research study; however, we believe this approach would help funds to better understand the actual risk and return characteristics of their hedge fund portfolios.

Innovation in search of new investment opportunities has never been more important for pension funds facing today’s low growth and low returns. It is something one of Canada’s largest pension funds, the C$112 billion ($89.2 billion) Montréal-based Public Sector Pension Investment Board, PSP Investments, believes it is getting right.

Two innovative themes are apparent in recent strategy at the fund, explains Daniel Garant, executive vice president and chief investment officer. The fund’s recent acquisition of a portfolio of hydroelectric assets illustrates one ongoing strategy to build industry specialised platforms, he says.

The lights all went on in Massachusetts

The $1.2 billion purchase of attractive hydro facilities located on rivers in Massachusetts and Connecticut will be run by hydro company H20 Power, itself majority-owned by PSP Investments as a result of a previous acquisition.

“Buying a company with a management team with operational know-how and expertise in a particular industry is a way for us to find interesting growth opportunities,” observes Garant. “These platform companies bring assets and expertise, giving us access to specific experience that we can leverage to further grow our asset base. Platforms are a way to get an edge on the competition.”

It’s a competition that is particularly fierce in infrastructure where PSP Investments has a target weighting of 13 per cent of its total portfolio.

Pension fund demand for long-dated, inflation proof investments outstrips supply and is weighing on returns in the asset class and demanding innovation, says Garant.

PSP Investments put its platform strategy into action in 2013 when it bought airport specialist investor and manager AviAlliance with stakes in various airports in Europe, including Düsseldorf and Hamburg. Other platform businesses include one with an expertise in US agriculture.

The fund’s latest hydro-electric purchase also reflects Garant’s enthusiasm for renewable energy assets, a sector he became expert in at Hydro-Québec, which he left in 2008 to join PSP Investments to head up the fund’s public markets division before being appointed chief investment officer in 2015.

“Given our long-dated liabilities, we are an investor with time on our side. We see increasing opportunities in renewables over time, particularly with efforts to control global warming in the wake of the recent Paris Agreement,” he says in reference to last year’s Paris Agreement on climate change that aims to restrict global warming to 2 degrees.

Private debt a trillion dollar market

Another illustration of innovation Garant highlights is the fund’s push into private debt, a relatively new asset class for PSP Investments and one which has opened up as banks have withdrawn from the market.

“Private debt is a trillion dollar market. The fact that banks have been forced to adjust their business model because of international regulations that do not affect us as asset managers, created an attractive opportunity for us. Our private debt strategy is one that has worked well for us.”

Last year PSP Investments opened its first foreign office, in New York, to build a local presence at the heart of the private debt talent and transaction pool.

The fund has already committed $3 billion in private debt transactions and although it isn’t alone, or the first to see private debt opportunity knocking, the fund prides itself on its ability to seize the moment. Other offices in London and Asia will follow, similarly aiming to build local knowledge and get closer to partners in private debt, but also private equity, infrastructure and real estate.

Like infrastructure, real estate has a target weighting of 13 per cent in the fund’s 33 per cent long-term target allocation to real return assets.

The diversified real estate portfolio spans sectors and geographies in a strategy that favours direct ownership and co-investment through joint ventures.

Real estate diversified in emerging markets

A notable characteristic is the allocation to real estate in emerging markets, with eight per cent of the real estate portfolio now invested in markets such as China, Brazil, Mexico and Columbia.

“In emerging markets, we look for local partners to invest alongside us. Finding the right partner is critical to invest in these markets. It takes a great deal of research and discussion to make sure our interests are aligned, something which is essential for a project to be successful,” he says.

“While country risk in real estate is asset specific, we are very careful when investing in real estate in emerging markets. We always have a specific plan for each asset, both with respect to value creation and our exit strategy.” In Colombia, the fund has direct residential real estate exposure via a partnership. In China, PSP Investments invests in real estate through funds. “Direct ownership in China isn’t easy,” says Garant.

Active management is another pillar in PSP’s current strategy, and 69 per cent of the fund’s total assets are actively managed, including all private markets allocations and some public markets investments. Garant remains convinced that active management is essential in the current climate.

He says 20 years ago, 10-year Canadian government bonds offered a risk-free, real rate of return of around six per cent, today those same 10-year bonds offer a real return of only 0 to 0.5 per cent.

“In the current environment of low growth and low returns, basis points from active management are even more significant, especially in absolute return strategies within public markets,” says Garant.

The public market allocation amounts to $59 billion and is composed of Canadian and foreign equity, fixed income and world inflation-linked bonds.

One of Garant’s many remits as CIO is to develop a strategy that focuses on the absolute return of the entire portfolio: the idea being to build investments that make business sense at the total portfolio level, but are too large for, or do not fit well in a single asset class.

It will offer another investment seam at the fund where the need to deploy capital looms ever larger.

Net inflows are increasing every year with assets under management projected to reach $116 billion by 2020, and $154 billion by 2024. Rewind to 2000, when PSP Investments began life with just $1.9 billion in passive, public market allocations run by a handful of employees compared to today’s 600-odd, and 2024 seems just around the corner.

“Good Morning. I’m Warren Buffett and this is Charlie Munger. I’m the young one.”

So began the Berkshire Hathaway AGM, a seven hour adventure through the American economy as Buffett, 85, fielded shareholder questions with his vice chairman and right-hand man Charlie Munger, 92, from Berkshire headquarters in Omaha, Nebraska.

Warren Buffett’s journey to becoming America’s best-loved investor began back in 1962 when he bought a struggling textile business. Since then he’s built up a $360 billion conglomerate that spans insurance, rail, energy, furniture and food, by sticking to his basic principles of value investing: he only invests in businesses he understands, with managers he trusts, at low prices. It’s a formula that saw Berkshire’s net profits climb 21 per cent to $24 billion last year.

Berkshire’s shareholders have never been shy about voicing their opinion at the annual AGM, and this year Buffett’s answers drilled deep into the workings of his company from the gloomy outlook for rail freight and reinsurance, to his steadfast investment in Coca-Cola that left one health conscious shareholder more likely to successfully prise the can of Cherry Coke out of his hand than persuade him to sell his 9 per cent stake in the sugary stuff.

Tough questions on capital intensive investment

Questions kicked off with an inquiry into why the company was pouring money into capital intensive companies when Buffett has always sought businesses that required little, or no capital investment.

Freight railway group BNSF and Berkshire Hathaway Energy, about to receive $3.5 billion to boost wind generation, are typical culprits.

“The ideal business is the type that takes no capital and grows,” acknowledged Buffett.

He talked of the “double barrelled effect” of owning a business that grew without requiring “lots of money” allowing earnings to be used to purchase other businesses. But times have changed, and given the kind of capital Berkshire now needs to deploy, capital-intensive businesses like renewables and railroads are the norm.

“The alternative would be to go back to working with tiny sums of money and that really hasn’t gotten a lot of serious discussion between Charlie and me.”

Berkshire showed the extent of its firepower in a recent $32.4 billion acquisition of Precision Castparts, a high end manufacturer of aircraft and engine components.

Of Berkshire’s many insurance businesses, the biggest are reinsurance giant General Re and GEICO, America’s second biggest auto insurer which collects $18 billion in premiums annually. Buffett, who sold Berkshire’s entire stakes in reinsurance groups Munich Re and Swiss Re last year, believes the sector is in for a rougher ride over the next 10 years.

The reinsurance market is suffering from supply outstripping demand, but the biggest challenges are low interest rates and the limited investment options for the float, from where a significant proportion of insurers’ earnings come. “It is no fun running a traditional reinsurance company, having money come in – particularly if you’re in Europe – and looking around for investment choices, to find out that a great many of the things that you were buying a few years ago now have negative yields. The whole idea of ‘float’ is that it’s supposed to deliver a fairly substantial investor-positive rate. That game has been over for a while,” said Buffett.

Climate change insurance risks get short shrift

A shareholder motion from climate activists demanding a report into the risk of climate change on Berkshire’s insurance business got short shrift.

The vote attracted little more than 10 per cent support with a large majority accepting Buffett’s proposal set out at length in his annual report in February – that Berkshire could simply raise insurance premiums if climate risks turn out to be significant.

“We’re not denying climate change is an incredibly important subject, we’re not denying its existence. But it will not hurt our insurance business,” he said.

So to renewables, where Berkshire has one of the largest energy portfolios in the US, spanning wind, solar, hydro and geothermal.

It’s a subsidy-dependent industry that faces regulatory headwinds from contrasting policy, coming from the different US jurisdictions, said Buffett.

“We would hope we have the capital and are in an advantageous position to be a big player, but government policy is the major driver.”

In his opinion, given that society benefits from the reduction of greenhouse gasses, it should be society that picks up the tab. But who subsidizes renewables, and by how much, will be a “political question for a long time to come.”

Falling demand for coal has hit BNSF’s freight railroad business. Commodities are being hauled less because of the mild winter and buyers over-ordering. But he defended BNSF as a “very good company” that just “wouldn’t earn as much as it earned last year.”

Buffet says he avoids ’45 of the top 50’ banks

“Tougher capital requirements makes large banks less profitable than smaller banks,” he acknowledged adding that new capital requirements have transformed banking.

“It hasn’t turned it into a bad business but just a less attractive business,” he said adding that he would avoid 45 of the top 50 banks. A particular worry is the mismarking and misunderstanding of derivatives positions, widespread across the financial system.

“I know one that is so mismarked it would blow your mind,” he threw in.

Berkshire’s leasing businesses have done well, although here, he says, banks do have an advantage. He reported “huge activity” in freight train repair field.

“Aircraft leasing doesn’t interest me. That’s a scary business. Some people have done well using short term money to finance long term assets, but this isn’t for us.”

In answer to a shareholder’s inquiry, asking if he thought the US property market was “frothy” and reminiscent of 2007, he reassured that he saw no nationwide bubble in real estate.

“We are not paying bubble prices for residential real estate.” Good news for the Berkshire shareholders cruising the exhibition hall showcasing Berkshire companies, including a Clayton Homes modular home, on sale for $78,000, reduced for shareholders.

Such is Berkshire’s reach, the conglomerate’s health has become a proxy for the health of the American economy as a whole. Buffett may not be bullish, but he’s measured and for the long-term.

“Over time American businesses are going to do fine,” he said.

Avoid derivatives, diversify, hire good managers and don’t reward just profit. These were Warren Buffett’s key investment tips for his 40,000 shareholders packed into Omaha’s CenturyLink Centre and the devoted hoard of global followers, tapping into the Berkshire AGM online in an inaugural livestreaming of the event – also broadcast in Mandarin.

Speaking alongside his business partner Charlie Munger, 92, who peered through thick glasses with the same combination of hard-headed capitalism and humour as the Berkshire chairman, it was the investment fees paid by endowments and pension funds to consultants and managers that most riled him.

Back in 2008 in a charity bet “he hopes is an example,” Buffett invested $1 million in a low cost index tracker, wagering his investment would fare better than the same investment in five hedge funds.

Eight years and several hundred hedge funds later, the S&P 500 index fund is beating a portfolio of funds assembled by hedge fund manager Protégé Partners, by 44 percentage points.

“That’s a terrible result for hedge funds but not for their managers,” he observed, in reference to the two and twenty fee structure paid to hedge fund managers – comprising a fee of two per cent of the assets they manage and 20 per cent of all gains.

“The net result of hiring professional management is a huge minus,” he said, adding: “no consultant in the world is going to tell you, ‘Just buy an S&P index fund and sit for the next 50 years’. You don’t get to be a consultant that way, and you certainly don’t get an annual fee that way. Far more money is made by people in Wall Street through salesmanship than investment abilities. That’s my message.”

Good managers ‘feel about Berkshire how we feel’

Buffett also eulogised about the importance of good managers in a business. Berkshire relies on its managers to run its 80-odd subsidiary companies. Independent of Buffett, they are the people who produce the money for him to invest and his ability to spot managerial talent has been crucial to his success.

“Outstanding managers are invaluable. We want to align ourselves with them and have them feel about Berkshire how we feel about it,” he said. Their strategy for finding the best is to look for patterns in evaluating humans, and businesses; beware that “very smart people” can do “really stupid things” risking what’s “important to them” for something that’s not; avoid “self-destructive behaviour,” and choose people with patience and opportunism.

Amazon founder Jeff Bezos was singled out for glowing praise in an endorsement that included Buffett’s insight into the impact of the internet on traditional business models.

He said the “Amazon effect” – whereby online shopping and quick delivery are now the norm – is a huge economic trend that wasn’t on the radar 20 years ago and the ramifications of which are just as difficult to predict going forward.

“If I owned a bunch of shopping malls, I would be thinking plenty hard about what they might look like 10 or 20 years from now,” he said.

IBM-aside, Buffett has tended to avoid investing in the technology sector, preferring to own stock in companies whose business he better understands.

His advice in a fast changing world? Hold onto a diversified portfolio of companies.

“We went into department stores but we didn’t think about ourselves as department store guys. We didn’t think of ourselves as steel guys or tyre guys, or anything of that sort. We’ve thought of ourselves as having capital to allocate.”

Derivatives still ‘Weapons of Mass Destruction’

And Buffett added that diversification’s best friend was long-termism. Defending his struggling allocation to American Express, and tougher climes elsewhere in the portfolio like Berkshire’s packaged goods companies, he said: “The world changes and we can’t make a portfolio change every time something is a little less advantageous than it used to be.”

A lot of “great companies” are weaker than they used to be at their peak, he said.

Buffett has beaten the derivatives drum before, once calling the financial instruments “weapons of mass destruction”.

This year he reiterated his warnings despite Berkshire’s own substantial derivative exposure. He expressed doubts at auditors’ ability to effectively police derivative use and “hold behaviour in check;” arguing that derivatives make it difficult to value companies, and that they exacerbate turmoil in a crisis when markets are shut, like after the 9/11 attacks.

“If there is a major discontinuity you will have a lot of problems. When you open back up you have large gaps in the positions.”

And the inevitability of another major attack is something very much on his mind.

“Being in the insurance business, you know someday somebody will pull off something that will be harmful,” he said, calling the likelihood of a cyber, nuclear, biological or chemical attack “one disadvantage to innovation.”

Buffett refused to predict where oil prices – or any other commodity values for that matter – were headed, but said declining oil prices should be good for the US overall as a net oil importer.

“It will ultimately benefit consumers,” he said, although it would be “very bad for some businesses,” particularly hurting capital values.

The duo gave a glimpse into the Berkshire culture where there are no regular meetings, or standard corporate speak.

“We don’t have any committees. We might go to a baseball game together. I’ve seen the other type of operation and I like ours better,” he said.

He also explained Berkshire’s remuneration system which rewards profits alongside growing the business.

“I don’t want people to be worried about the profit that might be impaired by growing the business,” he said.

Buffett has come out in favour of Clinton in the US Presidential race, but he didn’t think America’s next President would dramatically impact Berkshire Hathaway in a pragmatism that encapsulated his overarching message of business as usual for 2016.

“The system works well. It will keep working. No presidential candidate or president will end this.”