When Warren Buffett offers you investing advice, take it. That may not qualify as a revelatory insight. But a decision to do just that more than three decades ago means the Washington Post Co.’s pension fund now has $2.4 billion in assets — and only $1.4 billion in obligations. That billion-dollar surplus trounces the average corporate pension plan, which can meet 90% of its commitments, according to actuarial firm Milliman.
In 1975, Buffett, who had recently joined the company’s board, wrote a 19-page memo to then chairman and CEO Katharine Graham. He argued that most companies were largely ignoring their pension accounts, even though those assets equaled half the net worth of some big U.S. firms. “If a company had $100 million invested in its engine division earning 12% by managerial zeal and ingenuity,” he wrote, “why tolerate $100 million in its pension fund ‘division’ poking along at only 4%?” (You can read the full letter here.)
The missive is fascinating for Buffettologists. There’s an early version of his critique of chasing hot managers. (If you give 1,000 “coin managers” a quarter to flip, some will inevitably land on heads five times in a row.) And value investing, he explains, is more than just buying cheap shares. Stock ownership should be like “business ownership with the corresponding adjustment in mental set.”
Buffett’s advice: Ditch the company’s adviser, Morgan Guaranty, which then managed nearly half of all corporate plans, and allocate relatively little to bonds. Buffett argued that Morgan had grown so big that it effectively was the market. He recommended investing with equity managers at two small firms: Bill Ruane of Ruane Cunniff & Goldfarb (which runs the Sequoia Fund) and David “Sandy” Gottesman of First Manhattan. Buffett knew both well. Ruane, who died in 2005, was a former classmate at Columbia Business School. Gottesman was part of Buffett’s coterie of value investors. The Post transferred most of its money to the two firms in 1977. (James Gipson, who ran the successful Clipper Fund, also briefly managed some of the assets.)
It was a wise choice. Investing in the sorts of mainstream stocks that Buffett himself might have favored (including at various times R.J. Reynolds, Capital Cities, Heinz, and eventually his own Berkshire Hathaway), Ruane and Gottesman produced stellar returns. The fund, still managed by the two firms, has soundly beaten the market over the past 36 years, with an annualized return of 13.9%, vs. 11.5% for the S&P 500 and 8% for bonds, according to Barclays. It has been so successful that the company hasn’t had to contribute since 1991.
Buffett says Kay Graham deserves the credit. Some Post directors feared that switching to smaller fund managers might expose them to liability. Graham took Buffett’s advice anyway. “She was a smart woman who wanted to learn,” Buffett says, “and she controlled the board.”
The lore of Buffett’s 1975 letter has grown over time, says former Post CFO and director Martin Cohen. The board was already considering a change, he contends, when Buffett sent his letter. (Buffett recalls it as unsolicited.) The company heavily contributed to the plan in the early years, Cohen adds. That, he says, is as much the source of the overfunding as the investment returns.
The lion’s share of the pension fund will remain with the company as it sells off its newspaper division to Amazon.com founder Jeff Bezos for $250 million. (The company is keeping the Kaplan educational operation and other assets.) Bezos will receive $333 million in pension assets (including $50 million in surplus funding). Buffett, alas, has no plans to open a pension advisory business.
This story is from the September 2, 2013 issue of Fortune.