This star hedge-fund manager could replace Warren Buffett

Li Lu, the hedge-fund manager who helped Berkshire Hathaway Inc. find profits in China, may push Warren Buffett’s investment company to make more deals outside the U.S. if he takes a role at the company.

“He is a person that Buffett has confidence in from a trust standpoint and who has experience from an international standpoint,” said Michael Yoshikami, who oversees about $1 billion, including Berkshire shares, at YCMNet Advisors in Walnut Creek, California. Hiring Li would mean “Buffett recognizes that the strategy that has worked in the past has to be adjusted in the new environment where more stable economies are likely to grow at slower growth rates.”

Li, 44, is in line to be hired as one of the executives who would eventually replace Buffett, the 79-year-old chief executive officer, and help manage Berkshire’s investments, the Wall Street Journal reported. Berkshire Vice Chairman Charlie Munger said “it’s a foregone conclusion” that Li would probably become a top investment official at Berkshire, the Journal reported.

Buffett is seeking more opportunities abroad after the 2008 investment in China’s BYD Co., which has jumped eightfold. Li helped arrange the deal, according to the Journal.

Buffett plans to tour Japan and India next year in search of deals. In May, he praised the prospects for economic growth in China. Omaha, Nebraska-based Berkshire, which Buffett has run for four decades, is ready to spend $10 billion on its next takeover, Buffett said this year.

Investment Soars

Berkshire’s 9.9 percent stake in BYD, the Chinese car and battery maker, soared to a market value of $1.99 billion at the end of December from a purchase price of $232 million. Li’s assistance on BYD helped Berkshire make the deal, said Thomas Russo, a partner at Gardner Russo & Gardner in Lancaster, Pennsylvania.

“He’s the person who could bridge the cultural gap with the BYD founding families,” said Russo, a Berkshire investor. Li helped Berkshire win “terms that are so different than what most Western companies have experienced” in China, Russo said.

Li started a fund with money from Munger, and he wrote the forward to the Chinese version of the Berkshire executive’s Poor Charlie’s Almanack. In the English-language collection of Munger’s quotes and ideas, Buffett wrote the forward.

Munger’s Collaborator

Li’s original fund had annual compound growth of more than 29 percent, from inception in January 1998 through the end of 2009, the manager said in Poor Charlie’s. Another fund posted an annual compound return of more than 36 percent, Li said.

Li, former president of the Student Congress on Tiananmen Square, graduated in 1993 from Columbia University, where Buffett went to business school. The money manager met Munger after college and the two exchanged thoughts on investing, according to an essay Li wrote for the China Entrepreneur Magazine in May and posted on the website of his hedge fund, Himalaya Capital.

Buffett, Munger and Li didn’t return calls and e-mails to their assistants.

In an interview with the Journal, Buffett declined to rule out the possibility that he would bring in an investment manager while still CEO at Berkshire. Buffett wouldn’t discuss succession plans specifically, the newspaper reported.

Buffett’s responsibilities will be split upon his death or retirement among at least three people, the company has said. A CEO will oversee the collection of more than 70 operating units assembled by Buffett and Munger, and one or more investment managers will allocate capital and manage Berkshire’s portfolio. Buffett’s son Howard will probably assume the position of non- executive chairman to preserve the firm’s culture.

‘High-Grade’

“I have the pleasure of knowing Li Lu and he is a brilliant and high-grade individual,” Whitney Tilson, founder of hedge fund T2 Partners LLC, said in an e-mail. “I am thrilled for him as well as for Berkshire Hathaway, which is one of our largest positions.”

Buffett said last year that he had four candidates to succeed him as chief investment officer. He didn’t publicly name them. Earlier, he’d said that he would audition managers who are “genetically programmed” to avoid large risks.

THE GREAT CIGARETTE DIVIDEND MACHINE HEADS HIGHER

Last week, we heaped abuse on the "perfectly hedged" clean energy fund. This kind of investment somehow manages to lose money in both good times and bad.

This week, we take a look at the antidote to faddish ideas like solar and wind energy: We look at the past year's price action in Altria (MO).

Altria is the world's dominant cigarette maker. It's a stock Dan Ferris and Tom Dyson have written bullishly about in DailyWealth (check out their arguments here and here). While it's easy to understand Marlboro's incredible brand power, most people don't understand the government loves it when folks buy Altria cigarettes. The government is even more addicted to the huge taxes it collects from Altria than Altria's customers are addicted to its product.

As you can see from our chart below, the cigarette business is doing well these days. Altria just struck a new 52-week high. Despite this price gain, the stock still yields over 6%. This chart proves that when it comes to making long-term investments, there's no need to chase the "next big thing"… just stick with the incredible cash flow and dividend-producing power of "World Dominators" like Altria.

CHART OF THE WEEK: GOLD AND APPLE – A GOOD PAIR

This week's chart is a tale of two "crisis-beating" assets. Gold and Apple.

In the past three years, just about every asset you can think of has either lost money or treaded water. The 2008 credit-crisis selloff was so severe, even recent rallies haven't been able to carry assets back to their levels of a few years ago. Two exceptions here are gold and shares of Apple.

Below is what's called a "performance chart." Performance charts graph the percentage returns of assets against each other. In this case, it's the past three years of gold (gold line) and Apple shares (blue line).

Amazingly, both assets have registered the same gains since mid-2007… around 80%. Gold is enjoying price strength because of its role as "real money" crisis insurance. Apple is enjoying brand dominance in phones and music players. It's a heck of a "pairs trade."

THE CLEAN ENERGY FUND? YES, STILL PERFECTLY HEDGED

Today, we take another look at one of most perfectly hedged investment funds on the market: The big "clean energy" fund, PBW.

DailyWealth readers know we believe long-term investors should focus on boring, dividend-producing businesses like Altria and Johnson & Johnson. The investor is best served by stable, dividend-paying businesses that produce "never go out of style" products like cigarettes and Band-Aids.

Yet many investors are enamored with the idea of investing in clean energy companies… most of which sport such terrible business models that we like to call them "perfectly hedged." They lose money in both good economic times and bad economic times. Their share prices are able to sink in both bull markets and bear markets.

For a picture of this hedged condition, we present the past two years of trading in the PBW. As an easy, "one click" way to go long solar, wind, and various other clean-energy companies, this fund has drawn in hundreds of millions of investor dollars over the past few years.

As you can see from today's chart, this fund managed to get smashed during the 2008 asset selloff. It also managed to not rise during the great 2009 rally… And it continues to tread water. Our advice remains: Ditch the money-losing fad stocks and get into businesses that churn out profits even when the sun is down or the wind isn't blowing.

IT'S A BEAR MARKET IN NANOTECH

Around twice a year, we check in with shares of a small company called Harris & Harris. It lets us monitor one of the biggest potential uptrends in the world: nanotechnology.

Nanotechnology is the science of manipulating matter on an extremely small scale… as small as an atom. It holds the extraordinary promise of turning lumps of coal into diamonds… building tiny machines that can clear out blood vessels… or turning toxic waste spills into pristine lakes. As investment "stories" go, nanotech is about as good as it gets.

Harris & Harris is one of the few pure stock plays on the nanotech story. H&H doesn't make nanowidgets or provide nanoservices. It simply funds start-up nanotech companies. The imaginatively named Nanosys and NanoGram are among its investment holdings. H&H even has the ticker "TINY." Thus, TINY rises and falls with how well the nanotechnology story is translating into real investment gains.

As you can see from today's chart, the nanotech story is in a bear market right now. Harris & Harris is down 31% in the past three months and just struck a new 52-week low. Folks aren't interested in paying up for nanotech innovation these days. We're sure this story will eventually be on the pages of every financial magazine you can think of, but for now, it's rough going for nanotech.

ONE OF THE MARKET'S "MUST WATCH" INVESTMENTS

It's back to moving sideways for U.S. banking stocks.

This past March, we profiled the long, sideways trading pattern in XLF. This fund is a basket of the largest financial companies in America. Major holdings include JPMorgan, Goldman Sachs, Wells Fargo, American Express, and Bank of America. These are the companies that rise and fall with America's ability to earn money, invest money, service debts, and launch new businesses.

Last year, XLF enjoyed a huge rebound off its credit-panic lows. But in October, the uptrend faltered… and turned into a long period of sideways trading action. Several months ago, XLF rallied out of this sideways pattern. But as you can see from today's chart, that rally soon gave way to weakness that took XLF back to sideways.

We recommend keeping an eye on this big $13-$15 channel… and on the direction XLF breaks out. As we said, XLF's constituents are the backbone of our banking and credit system… so its share price is a good clue to what's really happening in the economy, no matter what politicians or CNBC commentators blather on about. Money talks and you-know-what walks. You can listen in with XLF.

A Safe, Easy 45% Profit… Thanks to Bernanke

The people who set short-term interest rates in the U.S. just showed their cards last week…

Thanks to the minutes to the latest Fed meeting, we now know what Fed Chairman Ben Bernanke's playbook is.

Bernanke is making it easy for us to invest… In short, he will keep money as "easy" as possible, for as long as possible – likely beyond 2012.

Today, I'll show you the safest, easiest way to make large profits from Bernanke's easy-money deal. Our target gain is 45% in one year.

To understand what Bernanke is up to, think of it this way… He's trying to light up the U.S. economy like it's a grill. He's dousing it with rocket fuel and pumping away on the "start" button. We're just waiting on the "WOOSH!"… the big flame. He's trying so hard, we're just standing back and waiting for his eyebrows to get burned off.

But chances are, he won't see a "WOOSH." Or more specifically, he won't see the economy light up like he wants. Instead, all Bernanke's rocket fuel will do is light fires elsewhere.

He'll create asset bubbles – like tech stocks in the 1990s or housing in the 2000s – that will eventually result in spectacular busts. But Bernanke won't care about those. All he cares about is igniting the grill in front of him.

According to the minutes to the latest Federal Reserve meeting, the Fed expects the economy will grow a bit slower than it thought… Unemployment will be a bit higher… And core inflation will be lower – only around 1% through 2012.

If those guesses from the Fed are even close to correct, it will keep interest rates near zero for a very long time.

That will make money next-to-free to borrow. The obvious beneficiaries of free money are "virtual banks" like Annaly (NYSE: NLY).

If you've read my writing for any amount of time, you probably know how the story goes with these…

"Virtual banks" are essentially built to take advantage of the government's control of interest rates. These virtual banks borrow money at current (incredibly low) rates, and then buy 100% government-guaranteed mortgage bonds, which yield over 4%. So they take on no credit risk.

They make money off of the interest-rate spread, and they pay high dividends – in the 15% range. And right now, they're cheap! In addition to high dividends, we have room for 30% capital gains in Annaly…

Currently, Annaly is trading near book value. I fully believe it will rise to 1.3 times book value. Why? It's simple…

The dividend yield is just too attractive. I am certain income investors will be willing to bid up the share price of Annaly so high that the dividend yield falls to 11.5%. Think about it. Which would you prefer? Earning less than 1% in the bank? Or earning 11.5% in Annaly for a little bit more risk? An 11.5% dividend would put Annaly at 1.3 times book value.

In short, you'll collect 15% interest while you wait on a 30% capital gain. If it happens within a year, you can make 45% total returns (capital gains plus dividends) – in a totally safe investment.

We have 30% upside in Annaly – and we're getting paid 15% a year in interest. Not a bad deal.

Bernanke and the Fed have shown us their hand, and low interest rates are going to be here for a long time. Take advantage of the Fed and invest in "virtual banks," like Annaly, at today's low price.

Plan on holding for a year or taking profits at 1.3 times book value, whichever comes first.