Sunday, December 13, 2015

Warren Buffett's 1962 Short Positions

I have collected number of article on long positions from the Buffett Partnership Limited in 1962. But that year he had also a few short positions. He explained them in his 1963 letter to shareholders:
You will note on our yearend balance sheet (part of the audit you will receive) securities sold short totaling some $340,000. Most of this occurred in conjunction with a work-out entered into late in the year. In this case, we had very little competition for a period of time and were able to create a 10% or better profit (gross, not annualized) for a few months tie-up of money. The short sales eliminated the general market risk.

The $340,000 worth of shorts were in four securities. The bulk of the amount was in Insurance Company of North America (INA) and Hartford Fire Insurance Company. INA has a long history going back to 1792 and it is known today as CIGNA. Hartford Fire still exists today and is simply known as the Hartford. The two companies were very similar. Both were large insurance companies with long unblemished histories. Both had rock solid balance sheets. Hartford traded at $68 1/8.[edit] Its liquidation value was $56 per share. It wrote about $50 of premiums per share at the company level (non-consolidated). INS traded at $94 1/2 and had $58 of equity per share. It wrote about $40 of premiums per share at the company level. Both companies consistently had combined ratios of close to 100%.

Clearly, Buffett was looking for large companies whose stocks weren't volatile and would not rise as much if the overall market climbed. But it isn't fully clear to me what he meant, especially when I don't know which workout he was referring to. There are a number of candidates. One is British Columbia Power (BCP). Another is Texas National Petroleum (TNP). Another is Lehigh Coal and Navigation. For more about these refer to my master list of Buffett Partnership Investments. And there could be others that I don't know about.

But Buffett has said that workouts are supposed to bring gains that are independent of the market overall. So, he doesn't need the exposure to market risk, be it to the downside or upside. So his shorts were positions designed to negate market movements on $340,000 of workout exposure. Plus the shorts give him leverage; he has $340,000 more to put into the workout situation. But I don't see how his workouts are exposed to market risk. Both BCP and TNP pay out fixed amounts of cash regardless of market conditions.

I will probably discover more about Buffett's workouts as I research more of his investments from 1962. And if anyone has any suggestions to add, please put them in the comment section.