Charlie Munger was a true polymath: EquityCompass’ Robert Hagstrom

Today marks the centennial anniversary of Charlie Munger, born on January 1, 1924. Though he passed away on November 28, 2023, Munger's legacy as a titan of investment and as a beacon of wisdom continues to resonate powerfully in the world of finance and beyond. Munger, best known for his role as the vice-chairman of Berkshire Hathaway alongside Warren Buffett, was more than just an investment genius; he was a philosopher of the business and investing world. His approach to investment, characterised by an interdisciplinary perspective and a focus on long-term value creation, has left an indelible mark in the world of investing. As we commemorate his centennial today, Fortune India presents an exclusive interaction with Robert Hagstrom, chief investment officer and senior portfolio manager at EquityCompass Investment Management, a prominent Baltimore-based advisor overseeing over $5 billion in assets. Prior to EquityCompass, Hagstrom was chief investment strategist at Legg Mason Investment Counsel, and before that, the portfolio manager of the Growth Equity Strategy at Legg Mason Capital Management for 14 years where he managed $7 billion in assets. Hagstrom, also the author of ten influential investment books including "The Warren Buffett Way" — a seminal work on Buffett's investment strategies — offers his insights into Munger's impactful investing principles.

What was the cornerstone of Munger’s investment philosophy, and how does it set him apart from other value investors?

Although Warren Buffett is the face of Berkshire Hathaway, those that have studied Berkshire are acutely aware of the enormous contribution Munger made to the long-term success of Berkshire. To understand Munger’s investment philosophy and appreciate how his thinking sets him apart from other value investors is to understand he was a multi-discipline thinker – a true polymath. The scope of his knowledge is staggering. Recognising this, it would be incomplete to reference only one aspect of his approach when his overall philosophy towards investing encompasses so many important ideas.

If we were to investigate the deep well -- that is Munger’s knowledge -- we would pull-up three distinct buckets: the pursuit of worldly wisdom, the study of failure, and the moral imperative to embrace rationality.

Yes, he was a great investor, but his overall success was greatly enhanced by being a multi-discipline thinker, undertaking a deep examination of his mistakes, and most of all his dedication to the pursuit of rationalism. Munger was once asked what is that one quality that accounts for his success. He answered, “I’m rational. People who say they are rational should know how things work.” It’s not a passing idea. It’s fundamental to him. Munger added, “It’s a moral duty to be as rational as you can make yourself.”

How did Munger’s approach differ from Graham’s undervalued asset focus and its broader perception of value investing?

Ben Graham’s value investing was based on buying a stock that was selling at a cheap price to current earnings, book value, and dividends. He spent no time thinking about the quality of the business or the quality of management. Indeed, Graham thought trying to measure these two factors was difficult. And that which was difficult could be calculated wrongly.

Munger favoured the approach used by Phil Fisher. We discussed Phil Fisher and his contribution to investing and to Warren Buffett in The Warren Buffett Way. Fisher emphasised the need to understand what made for a great company and the characteristics that made for great managers.

If you are a long-term investor, the quality of the company and the quality of management are critically important to the future value of the stock (business).

How did Munger reconcile the differences between Graham’s deep value approach and his focus on high-quality businesses at fair prices?

Munger was certainly aware of Graham’s deep value approach to buying cheap stocks, but he was not fully convinced this was the right approach. Particularly, for long-term investors. Munger knew that if you bought and held cheap, mediocre companies you would get paid for buying the asset at a discount. But once the stock reached fair value, the investor was left with economic returns of the company and if the company didn’t generate above-average returns, the investor would be left with the average return or perhaps even below average returns of the business. For long-term investors it is better to buy and hold above-average economic returns that work to grow the intrinsic value of the investment at an above-average rate.

How does Munger’s emphasis on “elementary worldly wisdom” impact decision making, and what practices can individual investors adopt for a similar mindset?

Munger once said, “He who only owns a hammer every problem looks like a nail.” Better said, if you only attack an investment idea from the singular silo of finance and accounting, you have hobbled yourself in fully understanding the problem. Munger likened it to “a one-legged man in an a**-kicking contest.” You don’t get very far. According to Munger, you do not need to be an expert in every discipline to reach worldly wisdom; all that is needed is a basic understanding of the major mental models within each discipline. You would then have, in effect, a liberal arts education in investing, and you would be well on the way to enjoying what he called “the lollapalooza impact” of worldly wisdom.

How did 'latticework of mental models' influence Munger’s investing philosophy, particularly in physics and biology, and how can it be applied to understanding economics and investing?

A brief example for readers is the study of physics and the contribution of Isaac Newton. In Principia Mathematica, Newton outlines the three laws of motion, the third of which – for every action there is an equal and opposite direction. – connects directly to the principles of economics, primarily the principles of supply and demand. When they are in balance, we can say the economy is in equilibrium. But if this equilibrium becomes displaced by accidents in production and consumption, then the economy will react with countervailing forces of comparable strength that will restore equilibrium balance. Disequilibrium cannot survive long. Studying physics and Newton helps us absorb this immutable truth.

However, there are many who do not see an economy and a stock market from a physics point of view. Perhaps they are more naturally drawn to biology, in which case Munger would recommend reading On the Origin of Species by Charles Darwin who taught us that living systems learn, evolve, adapt, and change unexpectedly. There is no doubt that markets are living, breathing systems. That makes them the exact opposite of atomic physical systems, which are highly predictable and repeat the same action thousands of times with near precision. Biological systems, in contrast, exhibit non-equilibrium traits, whereby small effects can sometimes have large consequences, while large effects can have small consequences. In physics, negative feedback loops can push the system into new and unforeseen directions – just like the stock market.

What role did the disciplines of sociology, mathematics, and philosophy play in enhancing Munger’s investment approach?

Studying sociology gives us another mental model: the most optimal and efficient societal body is one that is most diverse. It is referred to as the wisdom of the crowd’s effect. But once diversity collapses, when agents become of one mindset, the system becomes unstable, leading to booms and busts – again, just like the stock market.

From mathematics we learn about probability theory, formulated by Blaise Pascal and Pierre de Fermat. We would take additional note of the 18^th century Presbyterian minister Thomas Bayes, whose theorem gave us a mathematical procedure for updating our original beliefs and thus changing the relevant odds. Taken together, Pascal, Fermat, and Bayes gave us an outline to properly estimate the future free cash flows of companies, which in turn makes it possible to determine the intrinsic value of our investments.

In philosophy we would study the modern philosopher’s Rene’ Descartes, Francis Bacon, Immanuel Kant, and David Hume and their collective contributions to the study of rationalism. Investors should also read Ludwig Wittgenstein, the Austrian-born philosopher whose field of study included logic, mathematics, and the philosophy of language. From Wittgenstein we learn that when we speak of “meaning,” we are referring to the words used to create a description that ultimately leads to our explanation of events. And when we fail to explain outcomes, it is often because we didn’t form the right description.

Our studies in philosophy would be incomplete without studying Ralph Waldo Emerson. His essay on Self-Reliance and its mirror image self-confidence are essential to taking a variant view of an investment which can lead to excess returns. Investors are also right to study William James, considered to be one of the founders of the unique American philosophy called pragmatism. Being a pragmatist made possible Buffett’s shift from Graham’s asset-centric valuation techniques to the future free cash flow estimates of better businesses articulated by Munger. For those readers who would like to study the concept of multiple mental models and their use in investing can refer to the book I wrote, Investing: The Last Liberal Art.

In what ways does Munger’s understanding of psychology influence investment decisions and success?

No liberal arts study of investing is complete without a deep dive into psychology. And doing so takes us into the study of failure, Munger’s second bucket of knowledge. In Munger’s mind, while it is important to study what works, it is absolutely imperative to study what doesn’t work. And getting to the root of failure starts with psychology, for almost without exception our failures, our mistakes are embedded in psychological missteps.

Munger delivered a lecture at the Cambridge Center for Behavioral Studies in 1994. Under the title of “The Psychology of Misjudgment,” he offered a list of what he called “psychology-based tendencies that often mislead along with the antidotes to errors.” Here is one example called “Social-Proof Tendency.” It describes the very common and very human tendency to adopt the beliefs and behaviors of people around us, without considering their worth. Essentially it is about self-confidence. A person’s behavior becomes oversimplified when they automatically think and act in accordance with what they observe being thought and done around them. So, by the actions of others, investors risk being pulled into misguided action. Or equally dangerous, they are lulled into inaction at times when action is precisely what is needed. Munger’s antidote is simple: “Learn how to ignore the examples of others when they are wrong. Few skills are more worth having.” For readers who want to learn more about Munger, I would recommend Poor Charlie’s Almanack, now published in its second edition (2023).

Is there a perceptible difference between the approach of Buffett’s and Munger’s investment styles? Would Berkshire or Buffett's script read differently without Munger?

The answer is no. Since Buffett bought See’s Candies, on Munger’s recommendation, Buffett learned what made for a wonderful company with wonderful economics. This led Buffett to the purchase of Coca-Cola and Apple. Since See’s Candies, Charlie’s and Warren’s investment styles have dovetailed with each other. As for the second question -- shortly after Munger’s passing away, Buffett issued this statement: “Berkshire Hathaway could not have been built to its present status without Charlie’s inspiration, wisdom, and participation.”