Has the Sage of Omaha, now 82, lost his touch? In his annual letter to the stockholders of Berkshire Hathaway published last week, Warren Buffett admitted a “subpar” performance in 2012. He acknowledged that his next annual letter may show that, for the first time, his fund had underperformed the S&P index over a five-year period.
This year’s “subpar” performance represented an increase in the net asset value of his fund of only 14.4 per cent, 1.6 per cent less than the rise in the more excitable S&P. The anticipated deficiency in the 2009-13 result will arise because the figures for 2008 (when the index plunged but Berkshire’s NAV fell only modestly) will drop out of the five-year average. Meanwhile, the data for 2009 (when the index partially recovered but the Berkshire portfolio did not regain the value it had never shed) will remain in the calculation.
It seems that even Mr Buffett is being dragged into the wealth-destroying trap of judging investment skill by relative performance. In these terms, 1999 was his worst ever year. But his underperformance was a measure, not a criticism, of his skill. His rivals, seduced by fantasies of the “new economy”, would within a short time mostly relinquish more than all the gains they had made. I would not entrust a penny to a fund manager who did not underperform the market in 1999.
But the most remarkable thing about Mr Buffett’s achievement is not that no one has rivalled his record. It is that almost no one has seriously tried to emulate his investment style. The herd instinct is powerful, even dominant, among asset managers. But the herd is not to be found at Mr Buffett’s annual jamborees in Omaha: that occasion is attended only by happy shareholders and admiring journalists.
Still, the result of their attention is that more has been written about Mr Buffett than any other figure in the world of investment. Carol Loomis, who first wrote about him in Fortune almost 50 years ago, has recently collated a selection of his letters, which she co-writes. The lesson of this material is not only that there is nothing secret about the origins of Mr Buffett’s success, but also that there is nothing that is even difficult to understand.
Berkshire owns a number of insurance companies, which are strongly cash-generative, since the nature of insurance is that the payment of premiums precedes the payment of claims. These funds, and Berkshire’s retained earnings, are invested in a portfolio of wholly owned businesses and large holdings in some listed companies. The distinguishing characteristic of all these businesses is that they have sustainable competitive advantages: market positions competitors would find it difficult or impossible to reproduce. There is little portfolio turnover. The preferred holding period for stocks is, Mr Buffett has often said, for ever.
If he is a genius, it is the genius of simplicity. No special or original insight is needed to reach his appreciation of the nature of business success. Nor is it difficult to recognise that companies such as American Express, Coca-Cola, IBM, Wells Fargo, and most recently Heinz – Berkshire’s largest holdings – meet his criteria.
Which leads back to the question of why Berkshire has so few imitators. After all, another crucial insight of business economics is that profitable strategies that can be replicated are imitated until returns from them are driven down to normal levels. Why do the majority of investment managers hold many more stocks, roll them over far more often, engage in far more complex transactions – and derive less consistent and profitable results?
Partly the problem is the trap of short-term relative performance measurements – the distortion of perspective that allows a 14.4 per cent gain to be described as subpar performance. But the deeper issue is that complexity is intrinsic to the product many money managers sell. How can you justify high fees except by reference to frequent activity, unique insights and arcana? But Mr Buffett understands the limitations of his knowledge. That appreciation distinguishes people who are very clever from those who only think they are.