C&B Notes

Minding the Boundaries of a Circle of Competence

We spend a lot of time thinking about and working on our circle of competence — we deliberately place it first among our four core investing criteria — so that we can seek to avoid permanent losses of capital (and maximize long-term returns).  This story on Morgan Stanley’s farming venture on the steppes of Ukraine is an instructive example of what can happen when investors step outside the boundaries of their circle of competence.

“Morgan Stanley’s failed gamble in Ukraine shows how Wall Street firms, in the last gasp of a debt-fueled bull market, strayed further from their traditional business of advising companies and underwriting stock sales to embrace diverse projects with unfamiliar risks.

“You don’t buy farms if you’re a brokerage,” says Richard Bove, an analyst who follows Morgan Stanley for Stamford, Connecticut-based Rochdale Securities LLC and has covered Wall Street for 30 years.  “It’s an example of stretching too hard to make a killing without thinking about the core responsibility.”

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Morgan Stanley’s misadventure in Ukraine points up risks for current-day investors lured by statistics that may seem to paint agriculture as a no-brainer. Rising wealth is changing the diets of 2.5 billion people in China and India, requiring more grain to feed cattle and pigs just as soil erosion and urbanization are limiting available farmland.  To keep food inflation under control, at least 185 million new acres – twice the area of Germany — will have to be cultivated by 2015, says Philippe de Laperouse, the St. Louis-based director of the agribusiness practice at consulting firm HighQuest Partners. LLC.

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Outsiders often struggle to appreciate the mind-set of Ukrainian workers, says Yuriy Kosyuk, CEO of Myronivsky Hliboproduct SA, a Kiev poultry and grain producer.

“We still have Soviet brains,” the shirt-sleeved Kosyuk says in a room adorned with porcelain chickens at company headquarters.  “A lot of people here don’t want a job for the salary. They want it to be able to steal something, or for some preference or way to get ahead.”

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Hedge funds, mutual funds, university endowments and others with little experience in agriculture are buying farms at an unprecedented pace, pouring at least $13 billion since the end of 2007 into land or funds that involve agriculture, according to London-based Hardman & Co.

“These investments are driven by people who put investments together; they aren’t farmers,” says Howard Buffett, the son of Berkshire Hathaway Inc. Chairman Warren Buffett.

>> Click here for the full story on Bloomberg