2008-03-10

So A Slow-Moving Ape Can Beat The Market?

The Moomin Valley blog’s post, “Does Warren Buffett have Investment Skill?,” pointed me toward a paper by two finance professors titled, “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway.” mOOm’s post does a great job giving a Cliff-Notes-style summary of the professors’ study—which concluded that Buffett’s performance over the years is explained by skill, not luck.

For the optimistic, that translates into: you can beat the market. For the more cynical, that translates into: one guy can beat the market, and you don’t happen to be him.

Okay, so really, that main conclusion is not that earth-shattering to me. The tenure and magnitude of Buffett’s track record was already enough for my little pea brain to believe it wasn’t luck. But two other things slapped me in the face about the study.

First, I have always thought of Buffett as big value investor. The Wikipedia entry on “value investing” describes Buffett as a “[n]otable proponent” and describes the origins of value investing in reference to Benjamin Graham (including as described in The Intelligent Investor). And Buffett is widely known to have described The Intelligent Investor as “by far the best book on investing ever written.” But the two professors here concluded that the investment style of Warren Buffett and Berkshire Hathaway is really large-cap growth. (Here are a couple of links to descriptions of large cap and of growth investing.)

Second, as mOOm describes in his post (and unlike me, he is an economist and can understand the paper!): the study concludes that you can ape Buffett’s moves—even quite a bit of time after he has made them (or after they have become public knowledge)—and still beat the market.

Whoa. Let’s go through that again. Watch what Buffett does. Understand that you are finding out about what he does way after he’s done it—and probably way after lots of other folks have noticed he’s done it. Still consider doing the same thing!

Here’s the abstract of the paper:

We analyze the performance of Berkshire Hathaway’s equity portfolio and explore potential explanations for its superior performance. Contrary to popular belief we show Berkshire’s investment style is best characterized as a large-cap growth. We examine whether Berkshire’s investment performance is due to luck and find that beating the market in 28 out of 31 years places it in the 99.99 percentile; however, incorporating the magnitude by which Berkshire beats the market makes the “luck” explanation unlikely even after taking into account ex-post selection bias. After adjusting for risk we find that Berkshire’s performance cannot be explained by assuming high risk. From 1976 to 2006 Berkshire’s stock portfolio beats the S&P 500 Index by 14.65%, the value-weighted index of all stocks by 10.91%, and the Fama and French characteristic portfolio by 8.56% per year. The market also appears to under-react to the news of a Berkshire stock investment since a hypothetical portfolio that mimics Berkshire’s investments created the month after they are publicly disclosed earns positive abnormal returns of 14.26% per year. Overall, the Berkshire Hathaway triumvirates of Warren Buffett, Charles Munger, and Lou Simpson possess investment skill consistent with a number of recent papers that argue investment skill is more prevalent than earlier papers suggest.

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