buffett's outperformance

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buffett's outperformance

Postby rgb73 » Sat Sep 29, 2012 6:17 am

Hi all,

Here is an article in the economist that refers to a paper that explains the outperformance of Berkshire Hathaway as compared to the market:

http://www.economist.com/node/21563735

Its interesting, it seems that the outperformance comes largely because his insurance vehicles provide a very cheap, stable source of leverage of approximately 60% on its capital.

A great businessman, perhaps not as good a stockpicker as one might think.
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Re: buffett's outperformance

Postby ks289 » Sat Sep 29, 2012 6:37 am

Thanks for the interesting link.

Buffett amplifies his returns using leverage to buy stocks, and on a much smaller scale this reminds me of the pay down mortgage versus invest for retirement debate.
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Re: buffett's outperformance

Postby dbcoop » Sat Sep 29, 2012 7:37 am

My understanding of this subject is growing. However Warren Buffet seems to be a very "patient and opportunistic" investor, as everyone says buying low and holding or selling high, as I understand it.
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Re: buffett's outperformance

Postby Call_Me_Op » Sat Sep 29, 2012 7:44 am

rgb73 wrote:A great businessman, perhaps not as good a stockpicker as one might think.


Not sure who thinks that.
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Re: buffett's outperformance

Postby Rodc » Sat Sep 29, 2012 9:51 am

I think it is pretty well known that Buffet is not simply a stock picker (as a fund manager might be).

Not only what the OP mentions, but he often buys and has BRK run business or buys a controlling interest and gets heavily involved in management.

He is as much a businessman as a stock picker.

His brilliance is he comes at money making from several complimentary angles.
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Re: buffett's outperformance

Postby nisiprius » Sat Sep 29, 2012 12:24 pm

Nobody thinks Buffett is a stock picker, except people who are selling stock-picking methodologies who set him up as proof that successful stock-picking is possible. The syllogism is:

a) I am a stock picker.
b) Warren Buffett is a stock picker.
c) Ergo, I am Warren Buffett.

To define Warren Buffett as a "stock picker" is like calling Cartier-Bresson a "Leica photographer," or Elvis Presley a "sideburn wearer," or the Wright brothers "bicycle mechanics." Factually accurate, not quite capturing the essence.
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Re: buffett's outperformance

Postby VennData » Sat Sep 29, 2012 1:11 pm

nisiprius wrote:To define Warren Buffett as a "stock picker" is like calling Cartier-Bresson a "Leica photographer," or Elvis Presley a "sideburn wearer," or the Wright brothers "bicycle mechanics." Factually accurate, not quite capturing the essence.


or like saying nisiprius is an "Internet User" :D
Last edited by VennData on Sat Sep 29, 2012 1:24 pm, edited 1 time in total.
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Re: buffett's outperformance

Postby DRiP Guy » Sat Sep 29, 2012 1:20 pm

VennData wrote:
nisiprius wrote:To define Warren Buffett as a "stock picker" is like calling Cartier-Bresson a "Leica photographer," or Elvis Presley a "sideburn wearer," or the Wright brothers "bicycle mechanics." Factually accurate, not quite capturing the essence.


or like saying nisiprius is an "internet User"


Hear-hear!
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Re: buffett's outperformance

Postby larryswedroe » Sat Sep 29, 2012 1:37 pm

I had preview of the paper and have written a piece on it that will eventually appear on my blog.
The article misses some key points in the paper,
For example the study compared the performance of the public holdings of BRK with its "private" holdings and found no value added as a manager as some would have guessed--of course the private companies got the benefit of the leverage and the very low cost of funding provided by the float of his insurance companies--below Treasury rates. Another minor factor was the low cost of funding provided by accelerated depreciation rules.

The paper is quite interesting

Hope that is helpful

Larry
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Re: buffett's outperformance

Postby fisher_man89 » Sat Sep 29, 2012 1:37 pm

ks289 wrote:Buffett amplifies his returns using leverage to buy stocks, and on a much smaller scale this reminds me of the pay down mortgage versus invest for retirement debate.


That's not true.
Buffett claims to never have used debt in any significant way personally in the biography The Snowball.
He doesn't care for it in business either, since he is into fundamental analysis.
He works with large amounts of cash, float from his insurance businesses, but it's not borrowed money.
Berkshire Hathaway has around $40 billion in cash right now.
http://ycharts.com/companies/BRK.A/cash_on_hand
So he has little reason to borrow money and pay interest.

Warren Buffett does not like debt and does not like to invest in companies that have too much debt, particularly long-term debt.

from: http://www.buffettsecrets.com/warren-buffett-debt.htm
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Re: buffett's outperformance

Postby yobria » Sat Sep 29, 2012 2:14 pm

fisher_man89 wrote:
ks289 wrote:Buffett amplifies his returns using leverage to buy stocks, and on a much smaller scale this reminds me of the pay down mortgage versus invest for retirement debate.


That's not true.
Buffett claims to never have used debt in any significant way personally in the biography The Snowball.
He doesn't care for it in business either, since he is into fundamental analysis.
He works with large amounts of cash, float from his insurance businesses, but it's not borrowed money.
Berkshire Hathaway has around $40 billion in cash right now.
http://ycharts.com/companies/BRK.A/cash_on_hand
So he has little reason to borrow money and pay interest.

Warren Buffett does not like debt and does not like to invest in companies that have too much debt, particularly long-term debt.

from: http://www.buffettsecrets.com/warren-buffett-debt.htm


That's what he's doing, however, just like owning stocks and a mortgage, as ks289 says:

The researchers estimate that Berkshire, on average, leveraged its capital by 60%, significantly boosting the company’s return. Better still, the firm has been able to borrow at a low cost; its debt was AAA-rated from 1989 to 2009.
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Re: buffett's outperformance

Postby rgb73 » Sat Sep 29, 2012 7:26 pm

That's not true.
Buffett claims to never have used debt in any significant way personally in the biography The Snowball.
He doesn't care for it in business either, since he is into fundamental analysis.
He works with large amounts of cash, float from his insurance businesses, but it's not borrowed money.
Berkshire Hathaway has around $40 billion in cash right now.
http://ycharts.com/companies/BRK.A/cash_on_hand
So he has little reason to borrow money and pay interest.

Warren Buffett does not like debt and does not like to invest in companies that have too much debt, particularly long-term debt.

from: http://www.buffettsecrets.com/warren-buffett-debt.htm


In a way, insurance float is another form of debt; it is money that is "loaned" to BRK that the lender will want back if there is an insurance event; e.g., a hurricane/earthquake etc. It's simply that the terms of the 'loan' are different.
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Re: buffett's outperformance

Postby rgb73 » Sat Sep 29, 2012 7:29 pm

I had preview of the paper and have written a piece on it that will eventually appear on my blog.
The article misses some key points in the paper,
For example the study compared the performance of the public holdings of BRK with its "private" holdings and found no value added as a manager as some would have guessed--of course the private companies got the benefit of the leverage and the very low cost of funding provided by the float of his insurance companies--below Treasury rates. Another minor factor was the low cost of funding provided by accelerated depreciation rules.

The paper is quite interesting

Hope that is helpful

Larry


Great, do let us know when you post it Larry.
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Re: buffett's outperformance

Postby MarkNYC » Sat Sep 29, 2012 8:58 pm

Rodc wrote:.. he often buys and has BRK run business or buys a controlling interest and gets heavily involved in management.

I don't think this is accurate. For years, Buffett has stated that he rarely gets involved at all in the management of the companies Berkshire buys. In the 2010 annual report, he states "At Berkshire, managers can focus on running their business...They simply get a letter from me every two years and call me when they wish. A "hire well, manage little" code suits both them and me." Also in that year's annual report, he reproduced the 2-page letter he sent to all Berkshire Hathaway Managers, dated July 26, 2010. In that letter, he tells them "...talk to me about what is going on as little or as much as you wish. Each of you does a first-class job of running your operations with your own individual style and you don't need me to help."

I would assume he's being truthful, and rarely gets involved.
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Re: buffett's outperformance

Postby bhmlurker » Sat Sep 29, 2012 11:44 pm

Buffett not being a micromanager means just that. Simply having the authority to fire Berkshire or its subsidiary's employee means more power than held by shareholders or investors of most companies. Even the president of the US of A can't fire a federal govt employee that easily. That's why investors who try to invest like Buffett can't duplicate his success. When the number of shares held is too low, one can only be along for the ride instead of acting like a owner of a real company.
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Re: buffett's outperformance

Postby larryswedroe » Sun Sep 30, 2012 12:42 pm

bhmurkler
But the whole thrust of the paper says otherwise. They can replicate the investment strategy, what they cannot replicate is the leverage at below treasury rates! That is where the source of most of the alpha is. That takes nothing away from the kudos he deserves for figuring out the right strategy 50 years before the authors did.
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Re: buffett's outperformance

Postby abuss368 » Sun Sep 30, 2012 12:58 pm

rgb73 wrote:Hi all,

Here is an article in the economist that refers to a paper that explains the outperformance of Berkshire Hathaway as compared to the market:

http://www.economist.com/node/21563735

Its interesting, it seems that the outperformance comes largely because his insurance vehicles provide a very cheap, stable source of leverage of approximately 60% on its capital.

A great businessman, perhaps not as good a stockpicker as one might think.


Thank you.
Last edited by abuss368 on Sun Sep 30, 2012 7:34 pm, edited 1 time in total.
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Re: buffett's outperformance

Postby savermike » Sun Sep 30, 2012 2:56 pm

A version of the paper from 2012-08-29: http://www.econ.yale.edu/~af227/pdf/Buf ... dersen.pdf
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Re: buffett's outperformance

Postby larryswedroe » Sun Sep 30, 2012 3:12 pm

abuss
I didn't see any criticism.
The paper shows that it was Buffett's STRATEGY that was the key to his success, not his stock picking. He bought the right kind of stocks with certain attributes and that led to his alpha (that and the leverage and low cost funding and his discipline and few other things).

Best wishes
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Re: buffett's outperformance

Postby abuss368 » Sun Sep 30, 2012 7:34 pm

larryswedroe wrote:abuss
I didn't see any criticism.
The paper shows that it was Buffett's STRATEGY that was the key to his success, not his stock picking. He bought the right kind of stocks with certain attributes and that led to his alpha (that and the leverage and low cost funding and his discipline and few other things).

Best wishes
Larry


Hi Larry,

You are correct and I have edited my previous response.

Thank you.
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Re: buffett's outperformance

Postby bhmlurker » Sun Sep 30, 2012 10:48 pm

Larry, Your point is well taken re: cheap cost funding and leverage. However, he also had access to GE and GS' preferred shares with 10% dividend that was never offered to us peons. I suppose that we can conclude he has multiple insurmountable advantages over mom-and-pop investors.
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Re: buffett's outperformance

Postby wamfan » Mon Oct 01, 2012 1:17 am

This paper completely ignores his early days where he ran his hedge fund from him house. At the time, he did not own any insurance companies, or have any other access to leverage that wasn't available to others, but his outperformance was off the charts.
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Re: buffett's outperformance

Postby yobria » Mon Oct 01, 2012 1:45 am

wamfan wrote:This paper completely ignores his early days where he ran his hedge fund from him house. At the time, he did not own any insurance companies, or have any other access to leverage that wasn't available to others, but his outperformance was off the charts.


Seems insurance was his forte:

In 1962 [the year Buffett became a millionaire], Warren Buffett began buying stock in Berkshire Hathaway after noticing a pattern in the price direction of its stock whenever the company closed a mill...In 2010, Buffett claimed that purchasing Berkshire Hathaway was the biggest investment mistake he had ever made, and claimed that it had denied him compounded investment returns of about $200 billion over the previous 45 years.[7] Buffett claimed that had he invested that money directly in insurance businesses instead of buying out Berkshire Hathaway (due to what he perceived as a slight by an individual), those investments would have paid off several hundredfold.

Buffett initially maintained Berkshire's core business of textiles, but by 1967, he was expanding into the insurance industry and other investments.

http://en.wikipedia.org/wiki/Berkshire_Hathaway
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Re: buffett's outperformance

Postby larryswedroe » Mon Oct 01, 2012 9:27 am

bhmlurker
Yes that ability to make investment in 24 hours gives him huge advantage in structuring deals such as the Goldman one--and they are willing to pay also to get Buffett to put his name on the deal as that alone might help the stock.

Wamfam
You don't know that what you say is true. It might be. But have you adjusted his returns for the factors listed in the paper?
But even if it is so, then how do you know it wasn't luck? If it was skill did it suddenly disappear when the paper's study begins?
Or was he simply then swamped with too much money which ultimately kills almost any skill based alpha

Larry
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Re: buffett's outperformance

Postby wamfan » Sun Nov 25, 2012 12:29 pm

larryswedroe wrote:bhmlurker
Yes that ability to make investment in 24 hours gives him huge advantage in structuring deals such as the Goldman one--and they are willing to pay also to get Buffett to put his name on the deal as that alone might help the stock.

Wamfam
You don't know that what you say is true. It might be. But have you adjusted his returns for the factors listed in the paper?
But even if it is so, then how do you know it wasn't luck? If it was skill did it suddenly disappear when the paper's study begins?
Or was he simply then swamped with too much money which ultimately kills almost any skill based alpha

Larry


I just noticed this response to me and I never responded. Anyway...

Buffett's hedge fund performance is out there for anyone to see. In fact, his fund performance is included in copies of The Intelligent Investor, where you can see how he performed against the S&P by year. Of note, when risk is defined as standard deviation, he outperformed the S&P massively during his fund years, and did it with less volatility. Also during this time, he never purchased entire businesses, but did take large stakes in some companies and pressured management. It is widely known that in the late 60's, he could not find any decent investments, so he wound up his hedge fund and gave investors the option of taking cash or shares in Berkshire Hathaway, which he had recently gained control of.
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Re: buffett's outperformance

Postby noyopacific » Sun Nov 25, 2012 11:12 pm

If I understood it correctly, the referenced article in The Economist suggests that:
Buffett may have been able to exploit an anomaly that occurred during a period when low-beta (less-volatile) stocks performed better than high-beta (more-volatile) stocks . . . and it may have been possible for Buffett to exploit this anomaly by buying low-beta stocks.

I wonder if The Economist may be putting the cart ahead of the horse. It appears to me that both the size of Berkshire's typical stake and Buffett’s willingness to add to a position when share prices dropped sufficiently might help to explain at least some of the reduction in volatility. The idea that Buffett’s "anomalous" purchase of low-beta, high-performing stocks was a factor in his success as a stock-picker seems unlikely.

I’d also like to take this opportunity to whine :annoyed
Maybe I'm a simpleton but I've never been comfortable with the use of the term “hedge fund” when hedging is not an integral part of a fund’s strategy. I don’t see that hedging strategies were a significant factor in any of Buffett's earlier private investment partnerships or for Berkshire Hathaway. I do realize that by the common definition for “hedge fund,” the term is technically acceptable.
Perhaps I am being unreasonable about this.
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Re: buffett's outperformance

Postby nisiprius » Mon Nov 26, 2012 12:59 pm

"Buffett’s willingness to add to a position when share prices dropped sufficiently..."

When a "value investor" is succeeding, his success is attributed to his willingness to continue buying when share prices fall:

Image

When a value investor is failing, his failure is attributed to exactly the same behavior, except that now it is called "doubling down" or "failing to cut losses":

Image

Image

Image
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Re: buffett's outperformance

Postby tetractys » Mon Nov 26, 2012 4:09 pm

The more I read about Buffett, the more I recognize he's a smart guy that got lucky. -- Tet
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Re: buffett's outperformance

Postby huntertheory » Mon Nov 26, 2012 5:26 pm

Buffett is easily caricatured and misunderstood: when an "investor" -- broadly defined -- ends up as the richest guy in the world, everyone wants to use him to make their points (and the investor himself is not above using himself to make his own points).

The article is a good one, but it strikes me as a little too divorced from what he does on a day-to-day basis. What makes Buffett unique is that he is basically the only person I can think of who is as comfortable being a "stock picker" as he is being a buyout person as he is being a businessman/manager. He got his start with Ben Graham doing fundamental analysis, and, while Bogleheads can disagree about whether that will win the day in the public markets, those tools are the ones used by managers of existing businesses to identify good "investments," i.e. products to invest extra cash flows in *within* a company. He also, basically unique of all buyout types, was and remains willing to buy entire companies and *not* replace management but nevertheless to provide oversight. He is not a micromanager but he also is not out to lunch. He considers himself the Capital Allocator in Chief, and is happy to re-route cash flows from one business to another. I think his track record on this has been excellent, and is not as susceptible to the random walk of the market analysis -- this is just good old fashioned business.

Which is the other unique element, which is that he does not run a *hedge fund* or a private equity fund, instead he runs a full blown corporation with lots of operating subsidiaries and so on. There's an investment aspect to this, but it's not the kind of pass through vehicle you typically see. Lastly, the insurance float is clearly a big advantage, but to appreciate what he's done you have to understand the insurance business. If it was purely a free lunch, all the richest people and companies would be insurance companies. The float does provide them with cheap, permanent capital, though he achieves that by being disciplined with the rest of their investments (all insurance companies invest the float and collect the spread), particularly by not being yield hungry with the supposedly "safe" assets. (Also, as Larry points out, sometimes being awash in capital can be a drag on returns though.)

Add to it a series of good (i.e. maybe lucky) moves early on, the leverage from float, and 30+ years of economic stability in the United States for him to operate under, and you have Warren Buffett. Defining the guy is difficult. I think there's lessons you can learn but they aren't simple ones, and I think you learn more by studying what he's done than what he says in public these days.
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