This thread / debate has been interesting to read. Both sides are partly correct. The AQR paper referenced is a good read and did ferret out the proper conclusion that Berkshire has been rewarded for keeping quality high and price to value low, although beta and (1/22)
(2/22)low price-to-book wouldn’t be the measures I’d use. It drew some questionable conclusions and employed hypothetical, far from real world employable methods. The other side in the thread correctly I think, argued against a factor analysis of Berkshire having much utility
(3/22)but should have reasoned through counterpoints.
I’d suggest, in retort to the AQR paper and conclusion, that Berkshire enjoyed unique tailwinds from 1974 to 1998, and beyond to some extent, that none can replicate and stand to be harmed when trying, ala Greenlight Re and
I’d suggest, in retort to the AQR paper and conclusion, that Berkshire enjoyed unique tailwinds from 1974 to 1998, and beyond to some extent, that none can replicate and stand to be harmed when trying, ala Greenlight Re and
(4/22)Third Point Re as but two examples. I don’t think it was replicable or quantitative factors that led to Berkshire’s success.
Berkshire uniquely enjoyed a virtuous cycle, one which will not be seen again.
Berkshire uniquely enjoyed a virtuous cycle, one which will not be seen again.
(5/22)As I think about Berkshire’s remarkable track record, these would be my factor attributes, however academically incorrect:
Tailwinds from a rising stock market during 1975-1998.
Best in breed PC insurance and reinsurance underwriting.
Lower, by far, than the competition’s
Tailwinds from a rising stock market during 1975-1998.
Best in breed PC insurance and reinsurance underwriting.
Lower, by far, than the competition’s
(6/22)cost of float which allowed for far higher allocations to stocks. Those stocks were better than the market for 23 years. These combined to create surplus capital within the insurers which further allowed continued higher stock allocations and the ability to
(7/22)purchase entire businesses, many upstreamed to the holding company, a huge advantage since 1998 when Berkshire’s advantages in common stocks disappeared.
Yes, the modest leverage to Berkshire’s stocks did augment returns, but less so than assumed. The leverage attribution
Yes, the modest leverage to Berkshire’s stocks did augment returns, but less so than assumed. The leverage attribution
(8/22)discounts the great, no, brilliant actually, concentrated and infrequent stock picking with these sub-factors: Durable, understandable business, predictable cash flow/economic earning power, ability to retain earnings at incrementally attractive returns.
(9/22)At times a paradigm shift - as with the changing economics of railroads coupled with a depressed price. Perhaps airlines today.
Most who have tried to replicate the Berkshire model have failed miserably. What’s missing from the imposters is the degree of surplus capital
Most who have tried to replicate the Berkshire model have failed miserably. What’s missing from the imposters is the degree of surplus capital
(10/22)created that allowed for a far higher concentration in the well chosen stock portfolio.
The paper has some issues. It overstated the leverage to common stocks. Overall to total assets, yes, but not to common shares. Stocks averaged 105% of equity from 1975 to 1998,
The paper has some issues. It overstated the leverage to common stocks. Overall to total assets, yes, but not to common shares. Stocks averaged 105% of equity from 1975 to 1998,
(11/22)far less since as the concentration of capital has shifted away from insurance after the GenRe acquisition. See my 2018 letter for the tree killing analysis.
Traditional interest bearing or margin debt employed at the 170% level suggested in the paper would have been
Traditional interest bearing or margin debt employed at the 170% level suggested in the paper would have been
(12/22)catastrophically unwound in 1974, 1987, 2002 and 2008, even if employed in having constructed a factor-based portfolio of “small companies first, then large companies later”, itself incorrect.
The paper stated, “We found that both public and private companies contribute
The paper stated, “We found that both public and private companies contribute
(13/22)to Buffett’s performance but the portfolio of public stocks performs better, suggesting that Buffett’s skill is mostly in stock selection.” I totally disagree with this, particularly since 1998. Further, when you consider the quality of the insurance businesses themselves,
(14/22)National Indemnity and GEICO in particular, it was the quality underwriting that allowed the stock picking to shine. The same stock picking inside a poor or mediocre insurer, holding mostly fixed obligation securities, wouldn’t have had much impact.
(15/22)Mr. Buffett bought those businesses outright and has been their ultimate overseer as CEO. One had been private, the other public.
Cost of float over time has been lower than assumed in the paper. The paper set years when cost of float was negative (meaning insurance
Cost of float over time has been lower than assumed in the paper. The paper set years when cost of float was negative (meaning insurance
(16/22)underwriting produced a profit) at zero. It ignores substantive underwriting profitability, far higher than most at times and all over time of Berkshire’s property casualty insurance and reinsurance competitors.
(17/22)The paper created a hypothetical portfolio, simulated portfolio of factor weights which ignored transaction costs and taxes, a huge difference. The method sorted and resorted. Rebalancing, trading costs, and market impact are all very real world expenses.
(18/22)Also in the paper, “In summary, if one had applied leverage to a portfolio of safe, high-quality, value stocks consistently over this time period, one would have achieved a remarkable return, as Buffett did. Of course, he started doing it
(19/22)more than half a century before we wrote this paper!” The reality is this couldn’t have been done. It wasn’t done.
(20/22)I’d conclude that to understand why Berkshire created so much alpha, instead of attributing factors like cap size or cap equity, go back and read the 1988 Coca-Cola SEC filings. Try to see what Mr. Buffett saw. What was the opportunity cost? What were interest rates?
(21/22)How were the other names already in the portfolio valued? Then think about what the business was likely to look like 20 years hence. Do the same with Gillette, the Washington Post, etc...
(22/22, mercifully) Finally ask if you could invest 10-20% of your capital in the name at the going price and keep it there for decades. I’m pretty sure Mr. Buffett wasn’t thinking about Sharpe or information ratios, or even price-to-book...
