Warren Buffett's Best Man

WHILE JASMINE AND wisteria scent the air on Caltech's Pasadena campus, a spillover crowd buzzes in anticipation in a roomy auditorium. Most of the people here are seasoned money managers, and they've come from all over the world to catch sight of something rarer than a Berkshire Hathaway stock split: Charlie Munger, without his famous partner, Warren Buffett.

Munger, 84 and blind in one eye, walks stiffly to the stage. A prestigious physics professor waits to interview him, but once the lanky, thick-bespectacled guest starts blaspheming some favorite targets, the prof rarely gets a word in edgewise. Munger's topic du jour is the spiraling credit crisis: He flings vitriol at bankers, saying they've been selling investors "a hapless mess of super-complexity." The accounting profession has "disgraced itself" with its lax standards, and so has academia. "The idea that we need derivatives is just so much twaddle," he says. Yet despite all this inanity and skullduggery, Munger still sees the investing world as a place where common sense can triumph -- if only because "it isn't so common."

To those who haven't heard of Munger, his musings might not seem particularly significant. But to his fans, they may as well be the Sermon on the Mount. Munger, Buffett's fellow Nebraskan, seems to be everything Buffett isn't -- cranky, reclusive, outwardly pessimistic. That hasn't stopped him from spending more than four decades as Buffett's principal sounding board, co-strategist, bad cop and muse. During their collaboration, Buffett has evolved from a successful but small-time money manager to the world's richest man, with unparalleled global influence -- and in the eyes of some admirers, he wouldn't be where he is without Munger. Indeed, it's difficult to know where Buffett's influence begins and Munger's ends. "Charlie has had a hand in all the major investments and those that they have passed on," says Lou Simpson, chief executive of insurance company Geico, a Buffett-Munger buy. The Oracle himself gives Munger enormous credit for helping Berkshire Hathaway return 21 percent annually for the past 42 years, double the Standard and Poor's 500. "He's my role model," Buffett gushed to SmartMoney.

IN CONTRAST TO THE showman-like Buffett, Munger shuns the spotlight. But he draws a smaller, more fanatical cult that seeks inspiration from his intellectual omnivorousness. "There are few people who consider acquiring knowledge their life's study -- he's an exemplar," says Chris Davis, of the $65 billion Davis Funds. "Buffett will understand something on a micro level," adds hedge fund star Mohnish Pabrai, "but Munger will understand how it fits into the world looking a decade out." Pabrai suggests that if you gave an IQ test to their respective fan clubs, Munger's would beat Buffett's "by quite a few points." Whoever would win, with the market choppy and both partners getting up in years, investing acolytes were eager to catch Munger on one of his rare public appearances -- and we were glad to catch him for an even rarer interview.

Buffett and Munger met at a dinner party in 1959, when Buffett was running a small hedge fund and Munger was an attorney in Los Angeles. The two men hit it off, and today Buffett credits Munger with a profound shift in how he approaches investing. Influenced by the statistics-driven approach of Ben Graham, his Columbia University business professor, Buffett had always sought to buy fair businesses at a great price, while Munger had become a believer in buying great businesses at fair prices. Munger's early influence can be seen in Berkshire Hathaway investments in such powerhouse names as Coca-Cola, Gillette and American Express.

But one of their most important buys together was their first, in 1965: Blue Chip Stamps. Blue Chip sold its stamps to merchants for cash; customers collected the stamps and redeemed them for items like toasters. But as customers were saving, that cash mostly sat around earning interest -- until Buffett and Munger took over. They started using the "float" to buy controlling stakes in companies like See's Candies, Buffalo News and Wesco Financial. (The complexity of the Wesco investment got Buffett and Munger in trouble with the Securities and Exchange Commission, but they emerged relatively unscathed.) Cash from those companies, in turn, gave Buffett the resources to take on large stakes in bigger corporations -- a strategy that helped fuel Berkshire Hathaway's phenomenal returns while building it into a conglomerate with more than $100 billion in annual revenue.

The adage "opposites attract" certainly applies to this partnership, where personality is concerned. Buffett will playfully speak of chicken coops and harems to illustrate his points; Munger likes to quote Cicero and Aristotle. Buffett is a coveted dinner companion; Munger sometimes has the opposite effect: "Our wives would rather not sit next to him," says Peter Kaufman, a friend and the editor of "Poor Charlie's Almanack: The Wit and Widsom of Charles T. Munger." Kaufman explains that Munger may start discoursing on fireflies or some such thing. "Charlie is set to broadcast rather than to receive," he says.

When he spoke with SmartMoney, Munger was relatively humble; he brushed aside the idea that he's the man behind Buffett, allowing only that "my utility was not zero." That utility may be more important than ever if Munger's gloomy outlook turns out to be correct. "Even with the market down, every investment class, on average, is liberally priced," Munger says, and the prospects for good returns are "modest" at best. His formula for success in a tough market (or any market) flies in the face of conventional wisdom: "Load up" by making big bets on the handful of businesses that could be winners. "People say the whole secret of investing is diversification," Munger told Berkshire investors earlier this year, but that idea is "ass-backwards."

When picking winners out of the herd, of course, it helps to have Buffett- or Munger-caliber acumen. Munger insists that involves little more than common sense -- the kind that comes from educating yourself broadly across multiple disciplines. Unlike other investors, Munger says, he and Buffett are careful not to overestimate what they know: "It's a disaster if you don't know the edge of your competency." They work hard at avoiding investing "asininities" and "possess a vast ability to dis-learn" when their assumptions prove false. And they keep enough cash on hand to act quickly -- since good investments don't swim by that often, Munger explains, "you have to be the man standing by a river with a spear." How to recognize those opportunities? That's where omnivorousness comes in. "Learn your gaps, and fill them," he says. "If you get three textbooks on a subject and skim them, it's a good start. That's what I do."

Sadly enough, that's not what most investors do, so it's little wonder that a certain world-weariness is one of Munger's hallmarks in his fifth decade at Buffett's side. "If Aristotle were alive today, he'd be a grumpy old man," Munger sighs, explaining that the Greek philosopher would be seeing the same mistakes made over and over. "Maybe that's some of the problem with me."

The Tao of Charlie Volatile markets. A rough economy. In 43 years of partnership with Buffett, Charlie Munger has seen it all. Five thoughts to help investors in today's environment. Avoid the Middleman Maybe we should think twice about our brokers and mutual funds. Munger says that due to its middling performance and high fees, the money-management industry as a whole "gives no value added" to its customers. "They are croupiers taking profits out of the system." Pick Common Sense Over Math Another knock against the pros? Their obsession with statistical analysis -- "boring gravel sifting," as Munger calls it -- obscures insights about which businesses are poised to succeed. "These people do involved computations, and they're walking right by great boulders of gold." Meanwhile, he and Buffett "just look for no-brainer decisions....We don't leap 7-foot fences." Think Like Ben Franklin Munger believes in educating himself deeply about, well, almost everything, "invading other people's territory" to develop a "mental latticework of theory" to shape his investing decisions. His poster boy for this approach: Ben Franklin. "He was a self-educated man who wandered over vast territory," Munger says. "He recognized that he needed higher math, so he went out and learned algebra....Learn your gaps, and fill them. That's what I do." Sit on Your Assets, if You Can While most investors associate Buffett and Munger with finding good stocks cheap, Munger points out that quality can trump price. "If you buy something because it's undervalued, you have to think about selling it when it approaches your calculation of its intrinsic value," he says. "That's hard. But if you buy a few great companies, then you can sit on your ass. That's a good thing." Make Way for China Munger says that China's competitive advantage over the U.S. is big and growing, but he's sanguine about it. "If the Chinese displace the Mungers, my attitude is 'bon voyage,'" he says. Of America, he adds, "our standing in the commercial world was once ridiculously high. Now it's merely high."