Last week I witnessed a Twitter discussion where the instigator claimed Warren Buffet, through Berkshire (NYSE:BRK.A) (NYSE:BRK.B) did not beat the S&P for 20 years. The incendiary claim didn't hold up under scrutiny but the general conclusion Berkshire's returns have slowed a bit is well supported.
Critical articles, tweets and comments about Buffett are becoming more frequent. I believe there are a few clear reasons why it looks as if Berkshire CEO and Chairman isn't delivering. It looks that way but this is probably one of the worst of times to abandon the legend...
First, let's examine how the 20 year track record actually looks:
Buffett managed to trounce the S&P 500 decisively. If we look at the development of Berkshire's tangible book value the victory is even more convincing:
Even if we take the less reliable regular book value which allows the S&P 500 companies all their intangible fluff like goodwill, it is not close:
If you want to be really myopic and look at the last five years Buffett doesn't look so great. Neither do the records of scores of value investors who beat the market over multiple decades.
As the years pass and the length of time famous value investors are disappointing (including Buffett) the voices whispering this time its different become louder.
I don't buy it.
Buffett, David Einhorn and Bruce Berkowitz etc. all have underperformed their long year average of late. It's a function of asset prices moving independent or even contrary to their fundamental values. Earnings and asset values are increasingly ignored, over a record period because of two factors:
- The money flow from active to passive.
- The FED assisting debtors.
The chart below shows how growth outperformed value over he past decade and it is a miracle Buffett did as well as he did in this environment (also read my article the longest period growth outperformed value since WW II):
In my view the migration from active management towards passive management (ETFs) is a major factor. ETFs trade according to strict mechanical rules and don't care about anything except their mandate and to market themselves well.
To market an ETF you need a good track record or to backtest well, so you can simulate a track record. With all the new products launching in the ETF space, backtests are important. Growth is currently backtesting much better than value and should logically benefit more from the flow from passive to active. This is a vicious circle and we are witnessing it in motion.
Berkshire with its many private holdings and value bent isn't a prime beneficiary of this trend.
FED bailing out debtors
We've just had an extremely long period of low rates and rates moving ever lower. This is a headwind for Berkshire's insurance operations and it benefits other investment styles more as the conservative value or GARP style practiced by Buffett who's famous for saying:
Only when the tide goes out do you discover who's been swimming naked.
Berkshire doesn't use a lot of leverage. Instead Berkshire employs float which advantage is limited when interest rates are low. Buffett doesn't like to invest in companies with lots of debt, while lots of debt can be great when interest rates stay low.
You could also argue firms with extremely low current income projecting windfalls far into the future, like Tesla (NASDAQ:TSLA) benefit from this dynamic. Their ability to gather capital on the cheap is dependent on the long time horizon that low interest rates afford them. If interest rates rise sharply, a much shorter payback period is required.
In my view this is precisely the wrong time to abandon Buffett or his philosophy of investing based on fundamentals, real-world assets and current earnings while avoiding heavily indebted companies. It is high tide and soon we will see who has been swimming naked.
Disclosure: I/we 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.