Buffett Partnership

The Buffett Partnership was the private investment vehicle managed by Warren Buffett from 1956 to 1969, before he began using Berkshire Hathaway as his primary investment company. Operating much like an early Hedge Fund, the partnership was a collection of pooled money from a small group of investors—whom Buffett called his “partners”—including his family, friends, and a few savvy businesspeople. Over its 13-year existence, the partnership served as the crucible where Buffett honed his investment philosophy, blending the deep Value Investing principles learned from his mentor, Benjamin Graham, with his own evolving strategies. It was through the partnership's spectacular success that Buffett built his initial fortune and reputation as an investment prodigy. The partnership's structure, strategy, and eventual dissolution provide a masterclass in disciplined investing and ethical alignment between a fund manager and his clients.

After leaving his job at Graham-Newman Corp. in New York, a 25-year-old Warren Buffett returned to his hometown of Omaha, Nebraska, in 1956. He had no intention of retiring; instead, he launched his first investment partnership with just over $100,000 pooled from a handful of family members and friends. He famously ran the entire operation from a study in his home. Over the next few years, he consolidated several partnerships into a single entity, the Buffett Partnership, Ltd. His pitch was simple: he would manage their money alongside his own, applying the rigorous analytical principles of Security Analysis to find undervalued securities. This humble operation would ultimately generate returns that dwarfed the general market, laying the financial and philosophical groundwork for the global conglomerate Berkshire Hathaway would become.

Buffett's fee structure was radically different from today's “2 and 20” model and perfectly illustrates his commitment to his partners. He truly put his money where his mouth was, ensuring he only profited when his investors did first. The arrangement was simple, fair, and brilliant:

• Zero Management Fee: Buffett took no annual fee based on the size of the assets. His partners' capital was not slowly eroded by fees regardless of performance.
• A 6% Hurdle Rate: Partners kept 100% of the profits up to an annual return of 6%. Buffett saw this as a fair return they could likely get elsewhere with less risk, so he didn't feel he deserved a cut of it.
• A Share in the Excess: Buffett's compensation came from taking 25% of all annual profits above the 6% hurdle. For example, if the partnership returned 16% in a year, partners would get the first 6%, plus 75% of the remaining 10%, for a total return of 13.5%. Buffett would get the other 2.5%.
• The High-Water Mark: If the partnership had a losing year, Buffett would receive no fees until all prior losses were recovered and the 6% hurdle for the new year was met.

This structure perfectly aligned his interests with his investors. He only made significant money if they did, a powerful lesson in shareholder-friendly management.

In his famous annual letters to partners, Buffett clearly explained his three-pronged investment approach. This strategy allowed him to find opportunities in any market environment.

This was the bedrock of his strategy, straight from the Benjamin Graham playbook. “The Generals” were publicly traded stocks that were simply cheap based on a conservative valuation of their business. This often involved Cigar-Butt Investing, which Buffett described as finding a discarded cigar butt on the street with one free puff left in it. The businesses weren't always great, but they were so cheap that a small rise in price toward their actual value offered a quick and easy profit. He often looked for companies trading below their Net-Net Working Capital, a rock-bottom valuation metric that offered an immense Margin of Safety.

“The Workouts” were what we today call Arbitrage. These were investments in companies undergoing major corporate events like mergers, spin-offs, or liquidations. The profit in a “workout” didn't depend on the whims of the stock market, but on the successful completion of the announced event. For example, if Company A announced it was buying Company B for $50 per share, and Company B's stock was trading at $45, Buffett could buy shares and lock in a $5 profit if the deal went through. These investments provided steady, market-independent returns.

The final category involved buying a controlling stake in a company to directly influence its management and capital allocation decisions. This was a major evolution from Graham's more passive approach. By taking control of undervalued but mismanaged businesses, like Dempster Mill Manufacturing, Buffett could personally step in to unlock the company's true value. His most famous “control” investment was, of course, a struggling textile mill named Berkshire Hathaway.

In 1969, at the height of his success, Buffett did something unthinkable: he closed the partnership. In a letter to his partners, he explained that the “speculative frenzy” of the late 1960s bull market had made it nearly impossible to find the kinds of undervalued opportunities his strategy required. His discipline wouldn't allow him to chase lower-quality investments just to stay in the game. He liquidated the partnership and gave his partners two options: take their profits in cash or exchange their partnership interest for shares in Berkshire Hathaway, the textile company the partnership now controlled. Most partners chose the shares. Over its lifetime, the Buffett Partnership achieved a compounded annual return of 29.5%, absolutely crushing the Dow Jones Industrial Average's 7.4% over the same period. A $10,000 investment in 1957 would have grown to over $260,000. The partnership was more than just a successful fund; it was the foundation of the Buffett legend and a timeless model for intelligent, ethical, and disciplined investing.