One of Charlie Munger (Trades, Portfolio)'s earliest investments was the so-called Fund of Letters. Munger teamed up with one of his closest investment partners at the time, Rick Guerin, to buy shares in this enterprise, which appeared to be deeply undervalued in 1972.
Deep value fund
In the go-go years of the 1960s, so-called "letter stocks" became popular. These were securities sold without an SEC registration, and therefore, not saleable for an extended period in ordinary stock market transactions. Under the securities laws, it was necessary to put a rider on the stock saying that the investor could not sell until an SF3C registration or some other key event had occurred.
The Fund of Letters was essentially a venture capital fund that its founders created in a highly touted initial public offering, which provided exceptional commissions to brokers. The fund raised $60 million, but only $54 million remained for investment purposes when the fees were paid.
It could not raise additional capital from the market as a closed-end investment vehicle. The only way the fund could increase net asset value was with sensible investments. That task was only made more difficult because it was launched with such huge expenses to take into account.
Surprisingly, it soon traded well below its net asset value. Munger and Guerin took advantage of this to acquire the business, and as soon as they did, they changed everything about it.
In Janet Lowe's book, "Damn Right! Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger," the author explained the changes the investors bought in almost immediately:
"They renamed it the New America Fund, reorganized the board, and redirected the investment style to a value approach. They quickly liquidated assets chosen by former managers. Guerin was the chairman, but Munger's investment philosophy was written all over the New America Fund and, as might be expected, the philosophy ran against the pack."
The book noted that in 1979, Business Week published an article entitled "Shareholder Heaven at New America Fund." It noted that in the fund's most recent financial year, remuneration for all officers and directors came only to $54,950. The article also highlighted the fact that net asset value per share increased from $9.28 in October 1974 to $29.28 on Sept. 30, 1979. Lowe's book went on to highlight some of the fund's holdings at the time:
"Among New America Fund's holdings were Capital Cities Communications and 100% of the Daily Journal Corporation (DJCO, Financial), publisher of a Los Angeles legal newspaper."
The holdings also included Blue Chip Stamps, which accounted for about 25% of assets under management.
Other people's money
The Fund of Letters is an example of a trend that repeated itself throughout Munger and Warren Buffett (Trades, Portfolio)'s early careers. These two investors spent their early years finding businesses they could acquire at knockdown prices, but these weren't just any old businesses. They were companies that provided access to capital.
Munger and Buffett became adept at finding businesses they could break up or take over and invest the money more effectively. To put it another way, they were able to use other people's money to leverage their investment skills, and that's something these billionaires are still doing to this day.
Buffett frequently refers to Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) insurance float, which has the same qualities. The float is the value of the insurance premiums customers have paid to the business, but the business has not yet paid out in claims. Buffett has been investing this money for years, effectively borrowing the money from policyholders to invest in the market. This has been one of the key pillars of Munger and Buffett's wealth creation strategy for over seven decades.
Disclosure: The author does not own any share mentioned.
Read more here:
- Why Relying on the P/E Ratio Can Be Dangerous
- How to Analyze Stock Buybacks According to Warren Buffett
- Charlie Munger: The Factors to Consider When Valuing a Business
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