Berkshire Hathaway is one of the most extraordinary business success stories of the last 60 years. When Warren Buffett took control in 1965, it was a little-known textiles business. Buffett shifted its focus from textiles to investments and acquisitions, and, over the decades, the company bought or took large stakes in companies across multiple industries, including Coca-Cola and American Express. Today, Berkshire Hathaway owns more than 60 subsidiaries and has a market capitalisation of more than $1 trillion.
It’s not surprising, then, that countless investors around the world — both ordinary investors and professionals — have tried to copy Warren Buffett’s investment style. Unfortunately, though, very few have enjoyed anything like the success Buffett himself has had.
Why is that? Well, there are a number of reasons.
Why Buffett’s success is so hard to replicate
First of all, Buffett has never been a conventional stock picker. Buffett hasn’t just invested in companies; he’s taken an active role in running them and making them more profitable. His track record means he has been offered opportunities to take large positions in established companies at favourable prices. These opportunities and the company information he was given were generally not available to ordinary investors.
A second reason why Buffett’s long-term record has been so hard to beat is that he was particularly successful early on in his career at Berkshire Hathaway. For example, Buffett placed a large bet on the insurance company GEICO which paid off massively. Profits from GEICO and other insurance firms provided a steady cash flow, allowing him to invest heavily in other companies.
In fact, Warren Buffett’s performance during his first two decades at Berkshire Hathaway was significantly stronger than his performance later on. From 1965 to 1985, Berkshire’s compounded annual gain in book value was about 23% compared to the S&P 500’s 10%. In contrast, post-2000, average annual returns fell to around 10%, aligning more closely with the broader market.
Indeed, Buffett’s performance has tailed off further since the global financial crisis. That’s right: even Buffett has failed to outperform the S&P 500 index in recent years.
A third reason why Buffett’s success has never been repeated over long periods is simply this: consistently beating the stock market is very difficult. As anyone who’s watched our online documentary Investing: The Evidence will know, only a tiny proportion of actively managed funds succeed in beating the market in the long run on a properly cost- and risk-adjusted basis.
There’s no escaping it: Warren Buffett’s track record is exceptional.
What was Buffett’s secret?
All of this, then, begs a question. OK, his performance has faltered over the last 24, and particularly the last 16, years, but he’s one of very few people to have outperformed the market in the long term. So how did he manage to do it? Buffett has often acknowledged the role of random chance in investment outcomes, and it may well be that some of his biggest calls have been lucky. But there are, surely, other possible reasons.
Some interesting explanations for Warren Buffett’s success are provided in a 2018 paper called Buffett’s Alpha by Andrea Frazzini, David Kabiller and Lasse Pedersen. The authors’ analysis shows how Buffett typically used leverage — in other words, borrowed money — to amplify returns. Crucially, this leverage was sourced at low cost.
The paper also explains how, unlike most mutual funds, Buffett’s portfolio has generally been concentrated in a relatively small number of positions. Another key factor, it suggests, is that Buffett has always focused on the long term, holding stocks for many years (and even several decades), and resisting the temptation to keep buying and selling.
Perhaps the most important finding of Buffett’s Alpha, however, is that his record is due less to his superior stockpicking abilities than his implementation of what we now call a factor investing strategy. In other words, Buffett was one of the first investors (if not the first) to discover that, by focusing in particular characteristics of stocks — value, profitability and low volatility, for example — it’s possible to achieve superior returns over time.
Buffett’s genius, in other words, was to identify these factors even before academics like Eugene Fama and Kenneth French provided empirical evidence to support them.
The good news for investors today, as Ben Felix from the Rational Reminder podcast explains, is that we now know these factors exist, and, with the help of an evidence-based financial advice firm like rockwealth, we can position our portfolios to profit from the higher returns they are expected to generate.
“It is not by stock picking,” says Felix, “but by maintaining consistent exposure to the factors that brought Buffett so much success that will bring you anywhere near (his) track record.
“This is a huge argument against stock picking, and in favour of factor investing, which can be largely accomplished using index funds… If you wish to replicate Buffett’s results, you are more likely to do so by maintaining exposure to the factors that Buffett intuitively took advantage of than by trying to mimic his stock picking process.”
Warren Buffett is a big fan of index funds
If you’re still feeling tempted to try to beat the market by picking stocks, you should heed the advice of Warren Buffett himself. Buffett has made it very plain, on many occasions, that “both large and small investors should stick with index funds.”
That is a direct quote from Buffett’s 2016 letter to Berkshire Hathaway shareholders. In the same letter he wrote: “The bottom line is that investing is not as difficult as it looks. The basic rules of investing are to keep costs low and invest in diversified, low-cost funds.”
Indeed, Buffett announced in his 2013 letter that, after his death, he wants the vast majority of his own wealth to be invested passively. “My advice to the trustee couldn’t be more simple,” he wrote, “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.”
In short, you may be tempted to try to replicate the success that Warren Buffett enjoyed in the first half of his career, but you will almost certainly fail. Not even Buffett has been able to manage it. Yes, you could try to identify the next Warren Buffett, but again, your chances of identifying such a fund manager, ahead of time, are minuscule.
Thankfully, though, copying the most famous living investor just isn’t necessary. By simply doing what he says you should do and patiently investing in index funds, you will outperform the majority of investors.
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rockwealth Wharfedale is a fixed-fee Independent Financial Adviser situated in Wharfedale, North Yorkshire.About Us: Nestled in Wharfedale, rockwealth is your dedicated local financial planning firm. From tailored financial advice to pension and retirement advice, evidence-based investing, and inheritance tax planning, we are here to facilitate your financial journey in Wharfedale and the broader North Yorkshire area.
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