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By Dan Werner and Jeremy Glaser | 04-30-2016 12:00 PM

Buffett: Only a Handful of Large Banks Worth Your Investment

Against the backdrop of increased regulation and other concerns, Buffett's caution on banks is warranted, says Morningstar's Dan Werner.

Jeremy Glaser: For Morningstar I'm Jeremy Glaser. We’re here at the Berkshire Hathaway Annual Meeting at the lunch break. I'm joined by Dan Werner, he's a senior analyst, he's been blogging with me so far this morning. We're going to get his take on the meeting.

Dan thanks for joining me.

Dan Werner: Thanks for having me Jeremy.

Glaser: So we're seeing that there has been a lot of really good questions this year compared to past ones.

Werner: Very pointed questions about their energy business, about ESG type of investing, how that affects their companies. Really good, solid questions. I've been very impressed with the quality so far from all the panelists.

Glaser: There were few different questions that touched on banks, which I know is your specialty. About derivative exposure, about if banks are too big at the moment. How do you think about their responses to these. Do you still see why they see value in these big banks?

Werner: I do, because they do have--big banks generally do have a cost funding advantage. But with respect to the derivatives I think they were little less enthused about banks that did those types of businesses. Having said that, they had a big gain in derivatives themselves on their balance sheet. So it was kind of interesting. I thought one of the parts that was interesting was the auto leasing business. They said we can't compete on that, there is no way, it's too big for us. And they commented on investment banking in general and specifically with their investment in Wells, and Wells has been growing their investment banking business, but not to the degree...it's not going to achieve the type of magnitude that they are uncomfortable with.

Glaser: They said 45 out of 50 of the biggest banks probably are "univestable." What does that mean for your average retail investor? Should they only be looking at those two or three or five big names.

Werner: I think, for a long-term bank investment you probably only look at those two or three, five names. I think specifically for U.S. banks you may want to think about some regionals just because consolidation is continuing and is going to continue for the foreseeable future.

Glaser: One of the most pointed questions was about Sequoia Fund, which has lot of connection with Berkshire; they used to be a Berkshire holder. About their Valeant stake and then obviously the issues going on there. What do you think about their response? They didn’t seem to be that concerned about the concentration of the fund necessarily.

Werner: I don’t think it was necessarily concentration of the fund. I think it was just more the characters that run those types of the investments for Sequoia. I think they questioned more of the, maybe not necessarily due diligence of Sequoia I think it was more of the management of Valeant and that it's hard to assess character like that on a long-term basis. And sometimes you miss on one.

Glaser: Both Warren and Charlie said that they are pleased with the direction Sequoia is moving now, kind of maybe a defensive active management. There was a long discussion about how indexing is probably the way to go--that because of the fees and expenses with active management, it's going to be very difficult as a group for active people to outperform. How do you hold those two things together?

Werner: I mean Warren basically said the best place to be is American business, and over the long term if you own a bunch of businesses you'll do much better than something that’s actively managed just because of the active management fees and incentives that those managers have to find the best investment, supposedly to try and achieve alpha. That you are better off doing nothing and just buying an index.

Glaser: You mentioned that ESG, the sustainability factors were a topic of conversation. We heard concerns about health and Coke, and on the energy business. What do you think of the responses? It's something that they care about as much as, it seems, the shareholders and journalists do this time?

Werner: They were a bit dismissive, especially on the Coke answer. They said, look, people are going to continue to do what they want. People have free will and they are going to consume sugary drinks, if they want to consume sugary drinks. We just happen to be in a position to own a company that sells a lot of sugary drinks. Ultimately it's people's responsibility to act accordingly and not be governed to act by some outside authority.

Glaser: Finally one of the things that didn’t come up was succession planning. I think that means that they've really put this to rest. The people are comfortable with what the company will look like after they are gone.

Werner: I was surprised that there wasn’t a succession question. I think they have put it to bed. I think the chain of command or the bench, so to speak, has been largely established and so far I don’t think...I really don’t think we're going to get a question on that this year.

Glaser: Well Dan, thanks for your midday update, and we'll catch up with you later.

Werner: All right, thank you.

Werner: For Morningstar I'm Jeremy Glaser. Thanks for watching.

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