The seductive Warren Buffett
Andrew Ross Sorkin and Jim Surowiecki both had lunch with Warren Buffett recently: with this book, unlike the last one, Buffett is taking an active role in the book tour. And he’s staying on-message. Here’s Surowiecki:
The investing world is dominated by a manic-depressive style, in which the average mutual fund turns over nearly its entire portfolio every year. Yet Buffett has prospered by ignoring all this. As an investor, he’s known for his patience—he says that he likes holding stocks “forever”—and he prefers a few big bets to an endless number of small ones. “If you go from flower to flower, you have to find a lot of flowers to make a lot of money,” he told me. “There aren’t that many great ideas out there.”
And here’s Sorkin:
Warren E. Buffett was sitting across from me over lunch at a private club in Midtown Manhattan last week, lamenting the current state of Wall Street, which promotes a trading culture over an investing culture and offers incentives for brokers and traders to generate fees and fast profits.
“The emphasis on trading has increased. Just look at the turnover in all of the stocks,” he said…
Mr. Buffett, 82, is famous for investing in companies that he sees as solid operations and essential to the economy, like railroads, utilities and financial companies, and holds his stakes for the long run.
The heart of this is unexceptional: as every personal-finance columnist will tell you, trading costs just eat into your returns, you will almost certainly buy and sell at the wrong time (since you can’t time the market), and a buy-and-hold strategy doesn’t just save you time but also saves you money.
But there’s also another implication here: that a disciplined, fundamentals-based buy-and-hold strategy can outperform all the whiz-kids. (Sorkin: “When I asked, for example, if there were any private equity investors that he admired, he flatly replied: “No.””)
I’d love this to be true, but at heart I’m deeply skeptical that any strategy can consistently outperform, over decades. Buffett famously avers a distaste for being judged on Berkshire Hathaway’s stock-market returns, preferring to use its book value as a measure, but the fact is that Berkshire has underperformed the S&P 500 for the past 1 year, 2 years, 3 years, and 5 years. At some point, Berkshire still outperforms, but I’m not sure where that point is: I’m having difficulty finding a suitable total-return index so that I can be sure that I’m including the effect of reinvesting the dividends which the S&P 500 pays out but Berkshire does not.
To put it another way, the Buffett legend rests in large part on the hypothetical returns that you would have received if you bought Berkshire Shares decades ago, which very few people actually did. Buffett is a hugely successful investor, and there are a handful of early investors whom he also made extremely wealthy. But even Buffett himself has been saying for years that his future returns won’t be as good as his past ones.
All strategies eventually run out of steam. Some have longer legs than others: the fundamentals-based investing philosophy of Buffett, which he inherited from Ben Graham, worked for decades, while the clever excess returns that academics find hidden in the market tend to disappear as soon as they’re published. And in the world of quantitative investing, even unpublished strategies have ever-shortening shelf-lives.
The same is true outside the investing world, too, as the Obama campaign discovered with its fundraising emails. A good one would work — and then it would stop working, and a new one would have to be used. Alexis Madrigal draws the obvious conclusion:
Any detailed social media primer I give you would be out of date by the time I could finish writing it. Any operational headline writing strategy would stop working if everyone used it. Everyone clamoring for your attention on the web is trying to strike that perfect mix of familiarity and novelty. And that means the content techniques that work are necessarily recursive. You change what people like by doing whatever you do. Which then requires that you do something else, which then changes their tastes again.
To generalize: anything which works will eventually stop working, and the less intuitive it is, the more quickly it will stop working. Buffett had a good run, but at this point there’s really zero reason to believe that his kind of fundamentals-based value investing still gives anybody an edge. (On the other hand, simply being Warren Buffett does confer an edge: he gets to see a lot of opportunities which are unavailable to anybody else.)
In turn, that means that even looking for an edge is nearly always an exercise in disappointment. Most people who aspire to outperforming the market won’t. Is there any good reason to believe that you’re in the minority of people who will? Not really. Buffett is in that minority, but to state the obvious, you are not Warren Buffett. He might be approachable and folksy, but beware anybody who makes it look easy. It’s not easy: it’s really hard. And even Warren Buffett can’t consistently outperform the market any more, despite the fact that he has access to hundreds of billions of dollars from Berkshire Hathaway’s policyholders, which he can invest in a tax-sheltered manner.
As I said last week, stock-market investing is at heart a modestly expensive upper-middle class men’s hobby. Buffett is idolized within those hobbyist circles, and by America more generally: he’s just as assiduous about massaging his public profile as he is about picking companies. And admiring Buffett is fine. The problems arise when people try to emulate him.