Is the track record of Berkshire Hathaway still the performance baseline that investors big and small should strive to match or exceed? Or is there a better benchmark? This piece addresses these questions in order to define an updated gauge for evaluating asset allocation strategies and tactics.
I. From Paperboy to Tycoon
Warren Buffett's success at amassing a monumental fortune has made him an international celebrity and the idol of numerous investors. When he graduated high school as a 16-year-old, he had already saved $6K (about $55K in today's dollars) from various business ventures, including 3 paper routes, 7 pinball machines installed in barbershops, and a used Rolls Royce he and a friend rented out. A portion of these profits were then put to work when he bought 40 acres of farmland.
Over the next seven decades, he grew his wealth at an exponential rate, passing one milestone after another: $10K at age 21, $100K at 25, $1M at 30, $10M at 37, $1B at 56, $10B at 64. This summer he'll turn 86, and current estimates of his net worth are in the $60-to-70 billion dollar neighborhood.
Last year Buffett issued a letter to Berkshire Hathaway (BRK) shareholders, detailing the firm's history on his golden anniversary of being chief executive. He took the helm in 1965 (age 35), and through 2014 the stock price of BRK realized a 21.6% compounded annual growth rate (CAGR), an astonishing figure. For comparison, the annualized total return of the S&P 500 over the same period was 9.9%.
Figure 1 displays the shareholders' incredible reward (geometric mean of yearly returns) during Buffett's tenure, plotted against volatility (standard deviation of yearly returns). Shown for reference is the efficient frontier of the US stock and bond markets over the same time period. Also depicted is the capital market line (CML), drawn from the risk-free return of 3-month Treasury Bills to a point tangent to the optimum portfolio of stocks and bonds.
Figure 1. Buffett's Unparalleled Performance over a 50-Year Span
Investing in Berkshire for those many decades would have involved significant volatility however. During the 50-year period, BRK experienced a 34.5% annualized standard deviation, roughly double the S&P 500 level of 17.1%. Nevertheless, BRK had a greater return per unit risk than an optimal mix of the broad stock and bond markets. An illustration of this advantage is if an investor chose to move up the CML with a highly levered portfolio of the market indices. BRK would have realized a CAGR about 2% more (sizable when compounded over half a century) than the most efficient index portfolio leveraged to the same 34.5% volatility level.
The above analysis is consistent with the pivotal research published in 2013 by Frazzini, Kabiller, and Pedersen of AQR Capital Management (link). One of their headline findings was that BRK shares had a higher Sharpe ratio (return in excess of T-Bills, divided by risk) than any other US stock or mutual fund with a history of more than 30 years. The authors' conclusion, put in layman's terms, was if you could travel back in time and pick one stock, Berkshire would be your pick.
II. How'd He Do That?
Buffett transformed BRK early on, from a textile manufacturer to, in large part, an insurance company. This strategic conversion helps explain the size of Buffett's personal wealth. If one were to invest $4M for 50 years at a 14% CAGR (an exceptional return, owing to great investing savvy), the end result would be almost $3B. But if you were to use the $4M to purchase an insurance company to exploit what's known as insurance float, the account after 50 years would skyrocket to about $69B, assuming 1.54x leveraging of the investment. While oversimplified, this is the basic secret to Buffett's success -- the sustained use of significant leverage combined with extraordinary stock picking skills.
The rigorous work by Frazzini et al homed in on Buffett's novel approach, and provides us a credible explanation of what he has been doing all these years. They point out that collecting insurance premiums up front, and later paying a diversified set of claims, is like taking a "loan". And a cheap loan at that! The estimated annual cost of BRK's insurance float, averaged over the decades, is only 2.2%, substantially below the historical (1976-2011) average rate of 5.3% for T-Bills.
With controlling interests in a broad array of firms (notably consumer goods, transportation, and of course, insurance), and such a long record of making astute decisions, it's quite understandable why the Oracle of Omaha is the virtual Pied Piper of Seeking Alpha. A search of this website, as summarized in Table 1, indicates that the name-dropping frequencies of other investment gurus pale in comparison.
Table 1. Recent Search Results on Seeking Alpha
|Warren Buffett||82,000||John Bogle||3,000||Kyle Bass||900|
|Carl Icahn||23,000||Seth Klarman||2,000||David Dodd||900|
|Peter Lynch||22,000||John Paulson||2,000||Ray Dalio||600|
|Benjamin Graham||9,000||Leon Cooperman||1,000||John Templeton||600|
|Bill Ackman||7,000||Mario Gabelli||1,000||Julian Robertson||500|
|David Einhorn||5,000||Jim Rogers||1,000||William O'Neil||400|
|George Soros||4,000||Joel Greenblatt||1,000||Stan Druckenmiller||300|
|Charlie Munger||3,000||T. Boone Pickens||1,000||Bill Ruane||100|
But is the cult-like following still deserved? Are Buffett's recent achievements still the gold standard? Let's take a look.
III. What's He Done Lately?
In my way of thinking, I categorize BRK not so much as a conglomerate, but essentially as a hybrid fund, one with the aspects of a private equity firm, a hedge fund, and an ETF. Contrary to popular opinion, there are many other well established funds available to the average investor with better 21st-century performance than BRK. Financial analysts and market observers increasingly have taken note, arguing that Warren Buffett has lost his Midas touch. Another explanation for the diminished performance is that Berkshire has become too big, something that Buffett himself recognized in his 1995 shareholder letter:
The giant disadvantage we face is size: in the early years, we needed only good ideas, but now we need good 'big' ideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
It's important to keep in mind that we have witnessed a stagnant US economy for the last 15 years or so, coupled with a wildly oscillating stock market that has provided little progress in real terms. I like to refer to this difficult investment period, from 2001 through 2015, as the "Lean 15". It may in fact represent the new normal, and prudent investors would be wise therefore to give weight to investment alternatives with superior track records during this timeframe.
Figure 2 compares the Lean 15 risk/reward profiles of top ranked mutual funds along with BRK and the S&P 500 index. Annualized return is plotted against two different risk measures -- on the left, standard deviation of returns; on the right, my proprietary "composite risk", a more comprehensive indicator of investment risk than individual metrics such as standard deviation, downside semi-variance, and maximum drawdown. Three mutual fund groupings are shown: (1) yellow symbols are the actively managed stock funds that demonstrated the greatest total return from 1982 to 2001, according to the September 2001 issue of Kiplinger magazine (link); (2) brown symbols are other actively managed stock funds that performed well throughout the 1990s, selected from various newsletters and magazine articles; (3) orange symbols are the best of the actively managed balanced funds, i.e., those with allocations in both stocks and bonds.
Figure 2. Buffett's Unremarkable Performance in the New Millennium
Green lines have been drawn from the y-axis point corresponding to risk-free T-Bills, through the BRK data point. Berkshire share performance during the Lean 15 is generally in the middle of the stock-fund pack. Most of those with the best 20-year record prior to 2001 (yellow symbols), and all those selected based on solid returns in the 1990s (brown symbols), outperformed the S&P 500. An appreciable number of stock funds are above the green lines, indicating their superior risk-adjusted returns compared to shares in Berkshire. Notable performances were turned in by the First Eagle Global Fund (MUTF:FESGX) and the Fidelity Low-Priced Stock Fund (MUTF:FLPSX).
Balanced funds (orange symbols) achieved very impressive risk-adjusted returns, with just about every one outperforming BRK. Eye-catching performances during the Lean 15 were delivered by the Bruce Fund (MUTF:BRUFX), the Berwyn Income Fund (MUTF:BERIX), the Vanguard Wellesley Income Fund (MUTF:VWINX), the FPA Crescent Fund (MUTF:FPACX), and the T. Rowe Price Capital Appreciation Fund (MUTF:PRWCX).
IV. A Better Benchmark
The purpose here is to establish a baseline against which I can evaluate the return of various portfolios strategies. Any strategy that has historically produced a CAGR equal to or greater than this benchmark is worth further investigation.
Investment benchmark candidates ought to have a track record of no less than 20 years. In addition to the equity and balanced funds highlighted above, my selection includes five excellent Lazy Portfolios. These five are among the top performers I'm aware of in terms of risk vs. reward, and only require annual rebalancing:
- Ray Dalio's All-Weather portfolio
- David Swensen's Yale Endowment simulation
- Harry Browne's Permanent Portfolio
- The Bogleheads' Three Fund portfolio
- Tyler's Golden Butterfly portfolio
Table 2 shows the candidates and their past performance, in descending order of annualized returns for the period of 1994 through 2015. Starting years for the other periods correspond to various market tops. The last column gives the most recent calendar year performance. Along with Berkshire shares, the list includes two stock market indices: the S&P 500 Index (market cap weighted) and the Wilshire 5000 Equal Weight Index.
Table 2. Historical Returns of Candidate Benchmarks
The top two performers in each period are indicated by bold font. Berkshire displays the best return prior to the 1990s, with the W5000EW index as the runner up (very interesting, since it happens to be the broadest and most democratic of all stock market indices). The 1990s and subsequent decades are led by the W5000EW index or the Bruce Fund. The Bruce Fund also produced a positive gain in 2015, exceeded only by the TRP Capital Appreciation Fund.
These results suggest a composite type of benchmark may be a good idea. By picking from among a passive all-stock index and two actively managed stock/bond funds (W5000EW, BRUFX and PRWCX), the performance baseline would thus reflect world-class returns across the lookback periods.
Figure 3 shows the CAGR of investments bought on the first trading day of any year since 2001, and held continuously until the end of 2015. This way of comparing past performance helps remove doubt about the dependence of the returns on the starting date, an idea originally introduced by frequent SA contributor Varan. The graph below provides a more comprehensive picture than the common practice of tabulating performance from the prior 1, 3, 5, and 10 years.
Berkshire's return is no longer stellar, as shown in the comparison with the composite benchmark and its three constituents. Even in the case of a 2012 or 2013 purchase, where BRK remains ahead of the composite benchmark, it falls short of the S&P 500 total return, the traditional gauge for active fund managers.
Alas, nobody can beat the market (i.e., the S&P 500) forever - not even Warren Buffett. It's been pointed out that as an investor's capital base grows exponentially, the capital base slowly becomes the market, and the market cannot outperform itself. Over the past dozen years or so, Berkshire performance has been average at best, suggesting that BRK's price appreciation is not entirely immune to the phenomenon known as reversion to the mean. Like all good things, Buffett's reign and alpha have come to an end. It's time for investors to refer to a baseline better than Berkshire.