I’m scheduled to do an event for investors this week, and as part of the lead-up to it, attendees were asked to submit questions I would then address for them. One of the inquiries that came in happens to be among the most asked questions I regularly receive: Instead of building a globally diversified portfolio, why not just buy stock in Warren Buffett’s company, Berkshire Hathaway (BRK.A)?
In answering that question, the first thing I note is that owning BRK.A means accepting a lot of idiosyncratic risk, which is risk that can be diversified away by owning passively managed value funds that invest in hundreds or maybe even thousands of value companies (Buffett may be the market’s most iconic value investor). In addition, investors should at least consider Buffett’s age, as we cannot know if his designated successors will be able to repeat his performance. With that being said, using data from Morningstar, we can compare BRK.A’s performance to that of domestic value funds offered by two of the leading passively managed mutual fund families.
Dimensional Fund Advisors (DFA), with more than $300 billion in mutual fund assets under management, is the leading provider of passively managed structured asset class funds. (Full disclosure: My firm, Buckingham, recommends DFA funds in the construction of client portfolios.) Vanguard is the leading index fund provider. So, let’s go to the videotape.
Berkshire Hathaway vs. Passive Value Mutual Funds
For the 15-year period ending September 23, 2016, BRK.A returned 8.67%. DFA’s U.S. Large Cap Value Fund (DFLVX) returned 9.17% and its U.S. Small Cap Value Fund (DFSVX) returned 11.37%. These are live mutual funds, meaning that we are seeing real-world, not hypothetical or index, results. BRK.A underperformed both, and underperformed an average of the two funds by 1.6 percentage points a year.
We can also compare BRK.A’s performance to the performance of Vanguard’s index funds. BRK.A outperformed Vanguard’s Large Cap Value Index Fund (VIVAX), which returned 7.18%, but it underperformed Vanguard’s Small Cap Value Index Fund (VISVX), which returned 10.5%. It also underperformed the average return of the two funds by 0.39 percentage points a year.
The bottom line is that investors who took the risk of concentrating their investments with the legendary Oracle of Omaha were not well rewarded. Those investors who did take the concentration risk might want to ask themselves these two questions:
If I have been waiting 15 years for superior performance as compensation for taking concentration risk, how much longer is it prudent to keep waiting?
Why would I expect to be rewarded now, when for 15 years taking that risk has actually resulted in lower, not higher, returns?
My guess is that most investors in BRK.A are unaware of the evidence. You no longer have that excuse.
We can take another look at this question (whether investing with “superstar” fund managers is a well-rewarded strategy) by reviewing an article, “The Superinvestors of Graham-and-Doddsville,” that Buffett wrote to help promote value investing. The article was based on a speech given in May 1984 at the Columbia University School of Business in honor of the 50th anniversary of Benjamin Graham and David Dodd’s book, “Security Analysis.” The article appeared in the Fall 1984 issue of Hermes, Columbia’s business school magazine.
With the benefit of hindsight, the article challenged the idea that equity markets are efficient through a study of nine successful investment funds that had outperformed the market over the long term. Each of the nine funds was managed by Benjamin Graham’s alumni, who pursued different investment tactics but followed the same “Graham-and-Doddsville” value investing strategy.
Buffett argued that if these long-term winners belonged to a group of value investing adherents, and they operated independently of each other, their success was more than a lucky outcome. It would be the triumph of the investment right strategy. Buffett presented evidence showing how each of the investors had trumped the market by wide margins.
Only two of the nine funds that Buffett examined have been available to retail investors for the past 15 years. We will again use returns data from Morningstar to review the performance of both: the legendary (at least once legendary) Sequoia Fund (SEQUX) and the Tweedy Browne Value Fund (TWEBX). For the 15-year period ending September 23, 2016, SEQUX managed to return 7.18% and TWEBX returned just 5.84%. Both underperformed all four of the DFA and Vanguard domestic value funds, and TWEBX did so by wide margins.
Now, to be fair to TWEBX, it is no longer a U.S.-only fund. Its mandate was changed to make it a worldwide fund. That should, in theory, give it more opportunity to add value. So, we will also analyze the returns of the three DFA international value funds over that same 15-year period. Their International Large Value Fund (DFIVX) returned 7.66%, their International Small Value Fund (DISVX) returned 11.97% and their Emerging Markets Value Fund (DFEVX) returned 13.89%. Each of them far outperformed TWEBX.
We can also take a look at the returns of Tweedy Browne’s flagship fund, TBGVX. Over that same 15-year period, it returned 7.72%. Of the five DFA funds we looked at, TBGVX outperformed only DFIVX, and did so by just 0.06 percentage points. TBGVX underperformed the other four by margins ranging from 1.51 percentage points to as much as 6.17 percentage points.
Before concluding, let’s take a look at the Morningstar rankings for the passively managed funds we have reviewed. As you review the figures, keep in mind that Morningstar’s rankings fail to account for survivorship bias in the data, as its rankings only include funds that have survived the full period. As a result, the ratings understate the relative performance of the surviving funds. For the same 15-year period we have been examining, the following are Morningstar’s rankings:
The average ranking of the DFA funds was the 5th percentile, meaning that on average they outperformed 95% of the surviving actively managed funds. The average ranking of the Vanguard index funds was the 36th percentile, meaning that on average they outperformed 64% of the surviving actively managed funds. Such evidence is why Charles Ellis called active management the loser’s game.
The Bottom Line
In conclusion, perhaps, like Buffett, these superinvestors have been burdened by a huge amount of assets under management. Or, as my co-author, Andrew Berkin, and I demonstrate in our book, The Incredible Shrinking Alpha, perhaps markets have become more efficient over time, making it harder for Buffett to identify undervalued companies. Maybe it’s a combination of the two. However you want to look at it, the superinvestors of Graham-and-Doddsville have been anything but super for at least the past 15 years. And neither has BRK.A.
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