Warren Buffett's Portfolios Don't Reward Investors For The Added Risks

| About: Berkshire Hathaway (BRK.A)


Warren Buffett has underperformed the S&P 500 total return over 5 and 10 years.

Warren Buffett's portfolio assumes much higher risk than a broadly diversified index.

Warren Buffett's public persona doesn't match his portfolio construction.

I recently wrote an article highlighting how Warren Buffett's portfolio was highly concentrated, completely void of any vision and underperformed the S&P 500 Index for 5 and 10 years. The portfolio is basically a highly concentrated financial sector fund with some other unrelated, mostly Dow Jones Industrial stocks thrown in. Warren basically has bet big (23% of the portfolio's top 15 holdings) on Wells Fargo Bank (NYSE:WFC), and he bet right. Most/all professional portfolio managers would never dream of making such concentrate bets, but then again most portfolio managers don't have Treasury Secretary Hank Paulson calling them during the peak of the 2008 financial crisis either. I don't have access to the transcripts of the phone calls or closed door meetings, but if the movie "Too Big To Fail" is even close to accurate, betting big on WFC would have been a no brainer. It helps to have friends in high, very high places.

My previous article generated the expected criticisms and presented certain claims that inspired this second article. Warren Buffett has a loyal following, and people seem to be impressed by his long-term record. I've worked in the financial industry many years and am very aware of how long-term performance masks very poor portfolio management. Many financial institutions base their entire success upon a short period years ago that allowed them to generate decent returns, but never repeated that success again. One only needs to follow the track record of 5 Star Funds to see how fast success turns over in the financial world. Having a short period of success years ago isn't justification for earning the title of a financial guru. The closest person I can think of that has earned the title of a financial guru is Bill Miller of Legg Mason (NYSE:LM) that beat the S&P 500 for 15 consecutive years, and then even he faltered. Warren Buffett is no Bill Miller, not even close.

Most of the comments I am getting on the previous article are about how successful Warren Buffett has been, but to me as a past portfolio manager, success is measured by beating the index, not by what you did 20 years ago, or more. Over the past 5 years, Warren Buffett has underperformed S&P 500 Price Index, and just squeaked ahead of the Dow Jones Industrials. Once again, those are the price indexes. If success is measured by the number of friends and supporters, yes, Warren is a success. His performance is another matter.

(Source Google Finance)

On a total return basis, Warren gets smoked by the Dow Jones Industrial, especially when risk is taken into account. Once again, Warren has a large concentration in financial stocks, and the Dow Jones Industrials total return index appears to be less volatile. The Dow Jones Industrials offers greater returns and lower risk than Warren has over the past 5 years. Those kinds of numbers get portfolio managers fired, not crowned king financial guru.

The numbers get even worse going back 10 years. From this chart the increased volatility of Berkshire Hathaway (NYSE:BRK.A) is apparent, and BRK.A underperforms the total return of the Dow by 12%. Most important, Warren totally participated in the 2008 crisis. In fact from their peaks to troughs, Warren lost more than the Dow did. If Warren truly deserved the title of a financial guru, he would have at least lost less than the major index, not more. From the rate of change of the BRK.A stock price going into 2008, it looks like Warren was becoming more aggressive, not less. Also, look at the large spike in late 2008. Warren appears willing to take huge risks hedging. Not only does it appear the portfolio was hedged to protect against further losses, Warren actually made money for a brief time showing that he was likely over-hedged. Unfortunately, it appears he wasn't able to capitalize on his short-term gain, and lost all the gains back and then some. Being right on a hedge trade earns one the title of financial guru only if it is exited properly. Being over-hedged and then losing it all back gets portfolio managers fired, not promoted to financial guru status.

(Source Google Finance)

This following graphic shows BRK.A and the S&P 500 total return going back to March 1990. Unfortunately, I don't have access to the Dow total return going back that far. It clearly shows the increased volatility of BRK.A over the index, and more importantly, holders of BRK.A would have nearly given back all their outperformance gains by March 2000. BRK.A at one time was beating the S&P 500 total return by over 600%, but the vast majority of that success was lost by March 2000. Post 2000 however is where Warren did shine, and his lack of vision most likely helped him. Holding oil school stocks in the early 2000s was a good thing during the "Tech Wreck."

(Source Y-Charts)

What really made Warren's reputation is the period between March 2000 and March 2003, that was Warren's brief shining Camelot moment. When the S&P 500 went down, BRK.A went up. Companies invested in America's future crumbled, and companies invested in America's past succeeded. Warren's investments made through the rear view mirror really paid off during that period. While Microsoft (NASDAQ:MSFT), Amazon (NASDAQ:AMZN), Cisco (NASDAQ:CSCO), Oracle (NASDAQ:ORCL), Adobe (NASDAQ:ADBE), Apple (NASDAQ:AAPL) and Intel (NASDAQ:INTC) were all taken to the woodshed, BRK.A did just fine. In a nut shell, Warren's success is due to him clinging to the past instead of building the future. Hardly the vision held by a "progressive" or "socially conscious" investor.

The Impact of Technology and the Internet
"For society, the Internet is wonderful, but for capitalists, it will be a net negative. It will increase efficiency, but lots of things increase efficiency without increasing profits. It is way more likely to make American businesses less profitable than more profitable." Munger added, "This is perfectly obvious, but very little understood."

After his "Tech Wreck" success, Warren went back to being mediocre at best, running a rather high risk portfolio with index matching returns. If he was truly a visionary financial guru he would have been loading up on names like AAPL, AMZN, Netflix (NASDAQ:NFLX) and Google (NASDAQ:GOOG), but he didn't. The brief shining moment had passed. Over the past 20 years, Warren can attribute most of his success as an investment manager to a brief 3 year period, where he eschewed America's future and clung to its past. Hardly the legacy of a visionary financial guru. Because he failed to repeat his success in the 2008 crisis, it is more evidence of the blind squirrel or broke clock theory than insight of a true financial genius.

My real problem isn't with Warren's mediocre performance, it is the fact that his actions don't seem to match his public persona. To those who much is given, much is expected in return. Unlike the Morgans, Rockefellers, Vanderbilts, Carnegies, Fords and Edisons of the past that built something from nothing and left America a great industrial legacy and future, Warren has invented or created nothing revolutionary. There are no life improving inventions Warren will leave society. He is the 4th richest man in the world and he got there by riding the coat tails of great entrepreneurs and capitalists. Warren Buffett isn't a great financial guru, what he truly is, is a capitalist talent scout. He simply scans the newspapers and financial statements and finds the best capitalists, management teams and entrepreneurs in America and then buys them out. Warren's talent is in identifying people that have vision, insight, inventions, patents, managerial skills and entrepreneurial talent that he lacks and then he buys them out. It is like he is building a sports team, only he recruits capitalists.

Unfortunately, what Warren does and what he says are two different things. The public persona of Warren is the "1%" that is pandering to the "99%" crowd, stirring up class warfare, publically supporting higher taxes on the rich while paying a lower tax rate than his secretary and fighting for tax breaks for his companies. His company even owed back taxes.

A little over two weeks ago, Berkshire Hathaway CEO Warren Buffett, the third-richest person in the world, penned an op-ed critical of the low tax rates for the super-rich. It would seem his own company hasn't prioritized paying its rightful share in a timely fashion either.

He promotes destructive populist ideas like a higher minimum wage when he is speaking to the general public, and then promotes a far more intelligent idea of expanding the earned income tax credit when speaking to a crowd more familiar with real world economics.

Buffett said increasing the minimum wage is likely to reduce the number of jobs somewhat. He said expanding the earned income tax credit would be a more effective way to reduce income inequality.

He portrays himself as a champion of liberal causes, hero of the little man, and yet his major holdings are the evil "multi-national corporations," corporations that make high fructose soda that can cause obesity, corporations that represent "Big Oil," corporations that are extremely non-union and worst of all, that "evil" industry that caters to the "1%ers," the home of the "banksters," Warren invests heavily in Wall Street banks.

Worst yet, this son of privilege, now works to promote policies and agendas that would have robbed him of the opportunities that he had as a youth that allowed him to build the work ethic and job skills that proved so valuable later in his life.

The Early Years
Buffett was born to Howard and Leila Buffett on August 30, 1930, in Omaha, Nebraska. He was the second of three children, and the only boy. His father was a stockbroker and four-term United States congressman. Howard served non-consecutive terms on the Republican ticket, but espoused libertarian views.

As a child Warren was expected to work for a living, and a high minimum wage and an expansive welfare state would have been a huge obstacle to his early success. His father taught him to work hard, earn your own money and save for the future. Today Warren promotes economic policies that destroy all the incentives that shaped him into what he is today. Today Warren tells people to tax the rich and vote for a higher minimum wage to improve their lives. His father taught him just the opposite. Society should follow the principles that made Warren successful, not his words that are used to fool the public into believing that he is something that he is not. Great leaders are honest and work to improve society for all generations, Warren panders to this generation's liberals, more concerned with being well liked and accepted than doing what is right for the country as a whole. Stirring up class resentment is something that is best left in the 1930s.

Making money was an early interest for Buffett, who sold soft drinks and had a paper route. When he was 14 years old, he invested the earnings from these endeavors in 40 acres of land, which he then rented for a profit.

Instead of promoting the higher minimum wage, taxing the rich, stirring up class resentment and investing in yesterday's companies, Warren should be out aggressively promoting ideas like approval of the Keystone XL pipeline. Warren supports that project, but he doesn't put nearly as much effort into promoting this sure winner for the country and his legacy. He may also be on the right side of climate change. Clarifying his position might help create many more jobs than raising the minimum wage and pitting American's against each other ever will.

The take-home message for people considering investing in BRK.A is that they are likely to do just as well or better by simply buying a Dow Jones Industrial Index Fund (NYSEARCA:DIA).

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.