Warren Buffett: the world's richest index hugger?
Sarnia Asset Management
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Is the FT right in calling Warren Buffett the world’s richest index-hugger? Harald Berlinicke - fresh from the Berkshire AGM in Omaha - summarises the key parts of the article by the Financial Times.
Over 21 years, the return performance of the S&P and Berkshire Hathaway are all but identical. On an annual basis, their performance is 5 bps apart (the S&P has the meaninglessly tiny advantage). Yes, if you go back further, Berkshire crushes the index, but it is hard to see the relevance of that today, given how much the company has changed. 20 years is plenty of time to assess an investment strategy. It is, after all, as long as the average person’s effective investing horizon. Berkshire produces returns exactly like those of the large cap US index (this is true over 5 & 10 years, too)…because Berkshire is such a large & diversified conglomerate, it would be odd if it did anything but hug the index.
In the years when Buffett outperformed, it had a market cap of <$100bn, and represented a smaller fraction of the S&P. Now it is $900bn and about 2% of the index.
There is one obvious but problematic answer to this point. Berkshire has a lower volatility (beta) than the market (somewhere around .7 to .8 vs. 1 for the market). Buffett says — rightly — that for true long-term investors, volatility is a good thing, not a risk, because it provides opportunities to buy and sell at favourable prices. By that logic, and because Berkshire is an active buyer of its own shares, Buffett should wish that Berkshire’s beta was higher.
Real risk is the risk of permanent loss, Buffett says. And he has said that in this sense, Berkshire is probably a little less risky than the S&P. But it is not clear (to me anyway) what exactly he means by this, given that the S&P is a diversified index that growing companies automatically enter and shrinking companies automatically leave. Where is the risk of permanent loss in that?
One might argue that in times of crisis, Berkshire falls by less than the index, and that therefore it is less likely that its investors will panic and sell at the wrong time. That, of course, is the best and most common way of creating permanent investment losses. Judging by the experience of the great financial crisis, however, this is not particularly true. Berkshire’s peak-to-trough price drawdown in 2007-2008 was only slightly smaller than the S&P’s.
There is another problem with the argument that Berkshire produces superior volatility-adjusted returns. The company may have low volatility because of Buffett, who creates a magic aura of wisdom and stability around the stock. Buffett is easily the greatest public relations man in the history of finance. After Buffett, it would not be at all surprising to see Berkshire’s beta rise.
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