Berkshire Investors Struggle With the Todd Combs News

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Berkshire Hathaway (BRK.A) investors had some big news to digest today. And they apparently battled against their initial skepticism about CEO Warren Buffett's hiring of a largely untested 39-year-old named Todd Anthony Combs to manage a "significant" part of Berkshire's investment portfolio. After falling precipitously for most of the day on uncertainty about the new hire, Berkshire shares recovered somewhat as investors learned more about Combs.

The Dow Jones Industrials and S&P 500 closed nearly unchanged Tuesday amid a fierce tug-of-war between buyers and sellers.

Castle Point Capital, Combs's Greenwich, Conn.-based fund, controls about $400 million in assets. It was founded in 2005 by Combs and former Goldman Sachs (GS) CEO Stephen Friedman, whose Trident Funds -- part of Friedman's Stone Point Capital -- provided Castle Point's initial capital. "In November 2005, Trident III seeded the Castle Point fund with $35 million and committed an additional $1.8 million to the management company," Stone Point said in a letter to investors today (see full letter below).

Combs was introduced to Buffett by Charlie Munger, his long-time partner at Berkshire Hathaway, according to press reports.

Friedman, of course, was also chairman of Goldman Sachs and previously served as chairman of the board of the Federal Reserve Bank of New York, chairman of the President's Intelligence Advisory Board and Intelligence Oversight Board, assistant to President George W. Bush for economic policy and director of the National Economic Council. He's currently on Goldman's board of directors.

An All-American Type

During the early stages of the Great Recession, Buffett invested $5 billion in Goldman Sachs in exchange for a 10% preferred stake, meaning Buffett earns $500 million every year the deal is in place. Factor in warrants, and Buffett will walk away with about $2 billion on his $5 billion investment after approximately three years, assuming The Oracle sells his stake back to Goldman, as has been rumored.

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Combs is an "all-American type" who isn't interested in publicity, according to Fortune's Carol Loomis, a longtime Buffett confidant. "Now a resident of Darien, Conn., Combs is by birth a Floridian who graduated in 1993 from Florida State University with majors in finance and multinational business operations," Loomis reported.

Though little known outside Wall Street, Combs is a respected money manager and obvious disciple of Buffett's value-driven, company-focused approach. "At Castle Point we like to think of ourselves as owners of businesses," Combs said in a July shareholder letter cited by Reuters.

Combs's top 10 long holdings in June included CIT Group senior secured credit, CME Group, MasterCard, US Bancorp, Western Union, State Street Corp, Amadeus IT and RenaissanceRe, according to the wire service.

Another Savvy Short-Seller

Combs made a ton of money in 2007 and 2008 by shorting financial stocks during the credit crisis, Marketwatch reported. He also reaped big returns before the financial crisis by shorting shares of the massive government-sponsored enterprise Fannie Mae, as well as reinsurer RenaissanceRe.

"Short positions, or negative bets, returned 35.56% in 2007 and 36.68% in 2008 for the Castle Point Capital Master Fund, Combs' hedge fund," Marketwatch reported. "Those gains helped the Castle Point hedge fund return 18.95% in 2007, after fees. Long positions that year lost just over 9%."

Below is the notice Castle Point has posted about Combs's departure:
Castle Point Capital, a long-short hedge fund sponsored by Trident III to focus on the financial services sector, announced earlier today that its portfolio manager, Todd Combs, has agreed to join Berkshire Hathaway as an investment manager responsible for a significant portion of Berkshire's investment portfolio.

As a result, we will be winding down the Castle Point hedge fund. A copy of the Berkshire Hathaway press release is attached for your information.

This is disappointing news for Trident III given the success that Castle Point has had in building its platform during the past five years. The fund has grown its asset base from $35 million at inception to more than $400 million at the end of last month.

The fund has also had strong relative performance during extremely challenging times in the financial services sector, outperforming its benchmark by roughly 80 percentage points since inception in November 2005 (positive 34% cumulative net return for Castle Point since launch vs. negative 46% for the XLF).

Nevertheless, we are happy for Todd, who has an incredible opportunity to work for Warren Buffett at Berkshire Hathaway. Todd is an extremely talented investor and we wish him much success in his new position.

In November 2005, Trident III seeded the Castle Point fund with $35 million and committed an additional $1.8 million to the management company. Since then, Trident III's fund investment has grown to more than $48 million. Trident III has also received $5.4 million in distributions from the management company. Accordingly, after winding up the business, we expect the total investment return of Trident III to be approximately $54 million, or 1.5x cost.

The Castle Point fund is up 1.0% net for the current month through the close of business today, and it has already liquidated approximately 90% of its positions. We expect Castle Point to close out the balance of its holdings in an orderly manner over the next few weeks, although certain positions may take longer. We should receive 90% of our capital account balance from the Castle Point fund by or before the end of November and the balance upon completion of the year end audit.

We also note that Castle Point has sufficient cash on hand to wind up the operations of the management company and the firm has informed its investors that it is suspending the accrual of management fees as underlying positions transition to cash.

Trident III remains extremely well positioned. In total, the fund has invested $1.1 billion in fourteen portfolio companies. As of September 30, 2010, Trident III had generated realized proceeds of $1.1 billion and, based on preliminary valuations, total realized proceeds and unrealized value of approximately $2.3 billion, representing 2.0x cost and a gross IRR in excess of 26%.

As always, please do not hesitate to contact us with any questions.
Sincerely,

Chuck Davis, Meryl Hartzband and Jim Carey
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