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Following in Buffett's Footsteps

If you're a fan of Warren Buffett but think the premium on Berkshire Hathaway (BRK.B) shares is too rich because of the Oracle of Omaha's wide following, Douglas Davenport believes he has the right investment vehicle for you. He runs the Wisdom Fund (WSDVX), which tries to replicate Berkshire's portfolio as closely as possible -- right down to the same holdings, sector weightings, and cash position.

The market tumble after the 1990s tech bubble shows that the Buffett touch is more important than ever, according to Davenport. Amid the current gloom, he thinks investors need to stick with Buffett's deep-value formula: Buying quality companies at good prices and staying with them as long as you can.

With the Wisdom Fund, Davenport has outpaced his large-cap value peers in recent years, helped by the insurance stocks he picked in place of Berkshire's privately owned holdings (e.g., GEICO and General Re) in the sector. For the three years through May, the fund rose an annualized 5.7%, vs. a drop of 3.7% for its peers. This year through June, Wisdom was the best-performing large-cap value fund, gaining 4%, compared with a 9.3% decline for its peers.

Bill Gerdes of Standard & Poor's Fund Advisor recently spoke with Davenport about his investing strategy, top holdings, and portfolio moves. Edited excerpts from their conversation follow:

Q: What are your fund's investment goals?

A: The fund seeks capital appreciation by emulating the investment portfolio of Berkshire Hathaway. We will own the same securities that Berkshire does, such as American Express (AXP), Gillette (G), and Coca-Cola (KO) in the same percentages that Berkshire does. Anytime that Berkshire acquires a publicly traded security, we'll buy that security at the same percentage for our portfolio.

Q: Why should someone invest in your fund rather than directly in Berkshire Hathaway?

A: We started the fund primarily because Berkshire Hathaway trades at a significant premium to its actual asset value. Along with other firms that track Berkshire, we calculate that Berkshire Hathaway has traded at a premium of 40% to 70% over the last six years. The stock has been bid up because of Warren Buffett's excellent long-term track record.

Q: What value do you add as a money manager, since you largely follow Warren Buffett's picks for Berkshire Hathaway?

A: Since our inception in February, 1999, we've outperformed Berkshire by a very wide margin. We think that's because of the value we add in the insurance and financial sectors. About 38% of the market capitalization of Berkshire Hathaway consists of privately held insurance operations, such as General Re and GEICO.

Since we can't own Berkshire's insurance holdings, we've come up with insurance companies that are excellent proxies for them. Our insurance holdings include Everest Re Group (RE), American International Group (AIG), XL Capital (XL), and ACE Limited (ACE).

Q: Do you always try to replicate Berkshire's private holdings through companies in the same sectors?

A: Yes, that's where we add value. Occasionally, Berkshire will buy 100% of company -- for example about a year ago, Shaw Industries, the world's largest carpetmaker. We then purchased Mohawk Industries (MHK), now our fourth-largest holding, because we felt it was the next good proxy for Shaw. Mohawk has more than doubled over the last 17 months.

Q: What will you do when Buffett no longer runs Berkshire Hathaway?

A: Even Berkshire shareholders worry about when he no longer manages the portfolio, but whoever controls the company will follow Buffett's philosophy. Buffett will pick a replacement to run Berkshire the way he has. The only negative we see is that Berkshire stock could drop when Buffett passes away because he's so closely tied to the company.

Q: How would you sum up Buffett's investment style?

A: He has proven that the deep-value style of [Benjamin] Graham and [David] Dodd has never gone out of style, even though it was on the back shelf during the technology and Internet boom of the 1990s. He has shown that you should buy quality companies at the right prices and hold them for as long as you can. The problem is people get nervous and sell -- it's just human nature.

Q: How would you critique Buffett in terms of his strengths and weaknesses?

A: None of us are immune from investment mistakes. Warren admits he has missed some opportunities, like the low valuations of drug stocks in 1993. A lot of people said in 1999 and 2000 that Warren Buffett had lost his touch, but we now see he avoided a bubble in technology. If you can avoid losing money, that's sometimes as important as making money.

Q: What do you think of Buffett's recent plan to invest in the telecom sector, an area he has traditionally avoided?

A: It could be a wise investment on his part. He's putting $100 million into the debt of Level 3 Communications (LVLT), which can be converted into common stock at some point. As always, he's very close to the management of the company.

Q: In following Warren Buffett's lead, what type of portfolio do you have?

A: About 60% of the portfolio is in the financial sector, and about 20% is in consumer staples, like Coca-Cola and Gillette. We also have about 25% of the fund in cash because Berkshire keeps about 25% to 33% in short-term Treasuries. We have holdings like Sherwin-Williams (SHW), a paint company, and H&R Block (HRB).

Q: Do certain Berkshire Hathaway holdings look particularly attractive now?

A: I think the energy sector will be a winner over the next several years because of dwindling supplies worldwide. Buffett bought MidAmerica Utilities and Williams Energy Partners (WEG), a natural-gas pipeline company, earlier this year. Warren has said he's looking for a very large acquisition, about $15 billion, but we have no idea where it may be.

Q: The Wisdom Fund has a good three-year record, but 2000 and 2002 so far were better years than 2001.

A: Yes, we were down about 6% in 2001. Property and casualty insurance companies had a run-up in price and then gave back a little in 2001, but they're now doing well. This year, Coca-Cola, American Express, Gillette, and Mohawk Industries are doing well.

Q: What effect will the falling dollar have on your fund?

A: We don't think the declining dollar will adversely affect our portfolio. If it keeps falling, it will help companies like Coca-Cola and Gillette, which have large overseas operations.

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