Warren Buffett is an even better investor than you think.
The Oracle of Omaha released his latest annual letter to shareholders of Berkshire Hathaway Inc. on Saturday. It's a good excuse to marvel anew at Buffett's track record, particularly at a time when stock pickers are losing their aura.
Buffett famously likes to invest in companies that are highly profitable and selling at a reasonable price. That formula has routinely beaten the market, according to University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French.
The Fama/French US Big Robust Profitability Research Index — which selects the most profitable 30 percent of large-cap companies — beat the S&P 500 Index by 1.2 percentage points annually from July 1963 to 2017, including dividends, the longest period for which returns are available. The profitability index also beat the S&P 500 in 81 percent of rolling 10-year periods.
Similarly, the Fama/French US Large Value Research Index — which selects the cheapest 30 percent of large-cap companies — beat the S&P 500 by 2.3 percentage points annually from July 1963 to 2017, and in 82 per cent of rolling 10-year periods.
What makes Buffett special, however, is that he has outpaced the market by a huge margin, even after accounting for those profitability and value premiums. The per-share market value of Berkshire has returned 20.9 per cent annually from October 1964 through 2017, according to the company. That's an astounding 9 percentage points a year better than a 50/50 portfolio of the Fama/French profitability and value indexes for more than five decades.
It's a feat that can't be dismissed as mere luck. For one thing, Buffett has been shockingly consistent, beating the 50/50 profitability/value portfolio during 40 of 44 rolling 10-year periods since 1974, or 91 percent of the time. Also, Buffett's margin of victory is “statistically significant,” as finance aficionados would say, with a t-statistic of 3.1. That's a fancy way of saying that there's an exceedingly low likelihood that his outperformance is a result of chance.
Good luck finding another stock picker like Buffett. There are 514 actively managed U.S. large-cap value mutual funds, including their various share classes, for which Morningstar calculates a 20-year load-adjusted return — that is, a return net of fees and sales charges. Of those, 182 beat the Fama/French value index over the last two decades from 1998 to 2017, or 35 percent of funds.
The median margin of victory, however, was just 0.5 per cent annually, a fraction of Buffett's outperformance. And not one of those value funds generated outperformance that is statistically significant, which means that they may have just gotten lucky.
Growth funds haven't fared any better. Of the 681 actively managed U.S. large-cap growth mutual funds with a 20-year load-adjusted return, 176 beat the Fama/French growth index, or 26 per cent. The median margin of victory was 0.7 per cent annually, and here again, not a single fund's outperformance is statistically significant.
It's also worth noting that those 1,195 funds are the best of the bunch. The last two decades are littered with failed funds.
Buffett is unique in another respect. There's evidence that investors can expect a so-called investment premium from companies that pay out their earnings rather than reinvest them. The Fama/French US Big Conservative Investment Research Index — which selects the 30 per cent of large-cap companies that are most reticent about reinvesting earnings — returned 12.2 per cent annually from July 1963 to 2017. By comparison, the Fama/French US Big Aggressive Investment Research Index — which selects the most aggressive 30 per cent — returned 9.2 per cent.
Don't bother telling that to Buffett. As my Bloomberg Gadfly colleague Tara Lachapelle has previously pointed out, Buffett paid a dividend to Berkshire shareholders only once, in 1967. Buffett thinks that he can invest Berkshire's profits better than its shareholders, and he's obviously not wrong.
None of this is lost on investors, who are increasingly giving up trying to find the next Buffett and handing the stock picking to computers. Investors plowed US$184 billion into quantitative active management — or smart beta ETFs — from 2015 to 2017, while pulling US$308 billion from equity mutual funds, according to data compiled by Bloomberg Intelligence. It's only a matter of time before there are smart beta funds mining the investment premium, too.
But before we say goodbye to stock pickers, let's take a moment to acknowledge a master. The bots will never catch Buffett.