Monday, September 12, 2016

Buffett on Active Investing

Warren Buffett said the following on CNBC back in May:

"Active investing as a whole is certain to lead to worse than average results."

He goes on to explain that those who are active, in aggregate, must by definition get an average result. Subtract all the fees and what happens is a below average result. John Bogle has previously made the point that it's tough to get around what he calls the "relentless rules of humble arithmetic".

Naturally some think they themselves will be able to outperform over the long haul or, alternatively, that they'll be able to reliably pick, beforehand, an active manager who will outperform.

This might prove possible for some but history shows it's much easier in theory than reality.

Buffett's bet with Protege Partners -- one that now goes back more than eight years -- was, from his point of view, meant to demonstrate that while many "smart people are involved in running hedge funds...to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors."

Naturally, Protege held the opposite view.

The results so far?*

Index Fund: 65.7%
Hedge Funds: 21.9%

Of course, one example doesn't necessarily prove anything but Buffett elaborated on his thinking during the 2016 Berkshire Hathaway (BRKa) shareholder meeting:

"Supposedly sophisticated people, generally richer people, hire consultants, and no consultant in the world is going to tell you 'just buy an S&P index fund and sit for the next 50 years.' You don't get to be a consultant that way. And you certainly don't get an annual fee that way. So the consultant has every motivation in the world to tell you, 'this year I think we should concentrate more on international stocks,' or 'this manager is particularly good on the short side,' and so they come in and they talk for hours, and you pay them a large fee, and they always suggest something other than just sitting on your rear end and participating in the American business without cost. And then those consultants, after they get their fees, they in turn recommend to you other people who charge fees, which... cumulatively eat up capital like crazy."

And, according to Buffett, it's not easy to change behavior:

"I've talked to huge pension funds, and I've taken them through the math, and when I leave, they go out and hire a bunch of consultants and pay them a lot of money..."

And guess who these consultants tend to recommend?

Hedge funds that typically get paid via something like a 2-and-20 or a similar compensation structure.

According to Buffett these consultants usually "have lots of charts and PowerPoint presentations and they recommend people who are in turn going to charge a lot of money and they say, 'well you can only get the best talent by paying 2-and-20,' or something of the sort, and the flow of money from the 'hyperactive' to what I call the 'helpers' is dramatic."

During the CNBC interview Buffett added the following:

"In...almost every field, the professional brings something to the party."

Yet, in contrast, Buffett points out that the world of professional investing as a whole produces "negative results to their clientele. And that's a very interesting phenomenon to live with, if you spend your life doing something where your expectancy is to hurt your customer. And yet that is the case for professional investors."

Naturally, some capable individual managers will outperform but, as Charlie Munger said at the Berkshire meeting:

"There have been a few of these [fund] managers who've actually succeeded... But it's a tiny group of people; it's like looking for a needle in a haystack."

Think about it this way: if 80% to 90% of actively managed funds tend to underperform, then that by definition means the purchaser of a low-cost index fund, with no skills whatsoever, should over the long-term outperform roughly 80% to 90% of the professional managers.**

Can you imagine such a product existing for other professions?

In other words, there's just no way to buy a product that will enable someone to perform better than, for example, 80% to 90% of doctors without the requisite expertise. The same would be mostly true for other professions (and, for that matter, this also applies to skilled trades).

Of course, one of the problems with this is investors tend to trade index funds too much -- the net reward for the incremental effort being reduced returns -- as well as the actively managed funds they own. Such behavior usually turns what should be inherently, at least on a relative basis, an advantageous approach into one that is less so.

It's tough to outperform picking individual stocks. Similarly, it's tough to pick the professional investors who, going forward and over the long-term, will not only outperform, but will outperform by enough to justify all the frictional costs and, possibly, the incremental risks they'll need to take.

Stocks, generally speaking, appear to be not all cheap these days. So it would seem to be rather unwise to expect market averages will produce more than modest results as long as such valuations persist. Of course, what look like high-ish valuations can for a time become even higher and, as far as near-term price action goes, almost anything can happen.***

Some will see such a situation for what it is and no doubt be tempted to find some creative ways to outperform.

An understandable response?

Possibly.

That doesn't necessarily make it the correct response.

The vast majority (I'd 80% to 90% qualifies) of  active investors -- many who are smart, capable, and hardworking -- do worse than what a passive approach could achieve. So that means many market participants, if nothing else, must have a built in bias; they inherently overestimate their own likelihood of success. To them, it's always the other less prepared and able participants who'll do worse than the average.

Certainly not themselves.

It's worth amplifying that all the extra effort involved isn't just producing no incremental benefit, it's producing a worse than passive outcome; a negative return on all the additional invested time and effort.

A subpar result for the investors though likely not for the managers.

Where else is so much time and talent put forth to achieve so little or, in fact, what is a net reduced outcome?

Adam

Long position in BRKb established at much lower than recent market prices

Related posts:
Index Funds vs Actively Managed Funds
John Bogle on Investor Returns
Buffett's Hedge Fund Bet
John Bogle's "Relentless Rules of Humble Arithmetic" Revisited
Index Funds vs Individual Stocks
Why Do So Many Investors Underperform?
When Mutual Funds Outperform Their Investors
John Bogle's "Relentless Rules of Humble Arithmetic"
Investor Overconfidence Revisited
Newton's Fourth Law
Investor Overconfidence
Chasing "Rearview-Mirror Performance"
Index Fund Investing
Investors Are Often Their Own Worst Enemies, Part II
Investors Are Often Their Own Worst Enemies
The Illusion of Skill
The Illusion of Control
Charlie Munger on LTCM & Overconfidence
When Genius Failed...Again

* Through December 31, 2015.
** Think of it this way: it's essentially a choice between a small chance of picking the manager who produces long-term outperformance versus near certainty of being at or near the top ~10% or 20% in terms of long-term market performance. Also, there's still some (usually rather modest) fees to consider in an index fund that might produce a lesser outcome.
*** As always, I have no view on what near-term market prices might be. I'll leave that sort of thing to those who attempt to profit betting on price action. The focus here is definitely not on speculation; it is always on investment -- judging what something is intrinsically worth, looking for reasonable (if not considerable) mispricings, then benefiting, in general, mostly from what's produced over the long run. Valuations right now do seem to be more on the high side than not for many stocks. Or, well, let's just say it seems wise to, considering where valuations are at the present time, use conservative assumptions and lower future return expectations. Of course, higher multiples in the near-term can naturally occur. Those higher multiples may even theoretically make those with a shorter horizon (who sell) better off -- or, at a minimum, will make some participants feel better off -- but, in fact, a meaningful drop in market prices would logically make life easier for the long-term investor. Those with a substantial investing time horizon who are hoping for market prices to continue higher near-term (or even intermediate-term) should keep this in mind. It is lower market prices that increase the possibility of making incremental purchases -- whether done directly by the shareholder or via buybacks using the company's excess cash -- at a nice discount to intrinsic value. The potential long-term compounded effects for continuing owners (i.e. not traders) need not be small. Buying shares at increasingly large discounts to conservatively estimated value over time should, all else equal, reduce risks/improve returns.
(Notice the sometimes overlooked inverse relationship here. Risk and reward is at times positively correlated, but some incorrectly assume they're always positively correlated. Well, the correlation is not always positive and is, as far as I'm concerned, too often a rather underutilized consideration.)

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, August 16, 2016

Berkshire Hathaway 2nd Quarter 2016 13F-HR

The Berkshire Hathaway (BRKa2nd Quarter 13F-HR was released yesterday. Below is a summary of the changes that were made to the Berkshire equity portfolio during that quarter.
(For a convenient comparison, here's a post from last quarter that summarizes Berkshire's 1st Quarter 13F-HR.)

There was some buying and selling during the quarter. Here's a quick summary of the changes:*

Added to Existing Positions
Phillips 66 (PSX): 3.2 mil. shares (4% incr.); tot. stake $ 6.3 bil.
Apple (AAPL): 5.4 mil. shares (55% incr.); tot. stake $ 1.5 bil.

I've included above only those positions worth at least $ 1 billion at the end of the 2nd quarter. In a portfolio this size -- more than $ 236 billion (equities, fixed income, cash, and other investments) as of the latest available filing with roughly half made up of common stocks** -- a position that's less than $ 1 billion doesn't really move the needle much.

Shares that were added to among positions worth less than $ 1 billion include Liberty Global (LBTYA), and Liberty LiLAC (LILA & LILAK).

The additional shares in the latter two stocks are directly related to this recent corporate action by Liberty Global.

There was also some brand new, not very large, new positions related to another recent corporate action by Liberty Media (LMCA and LMCK).

New Positions
Liberty SiriusXM (LSXMK): 20 mil. shares; tot. stake $ 617 mil.
Liberty SiriusXM (LSXMA): 10 mil. shares; tot. stake $ 314 mil.

Berkshire's latest 13F-HR filing did not indicate any activity was kept confidential.

Occasionally, the SEC allows Berkshire to keep certain moves in the portfolio confidential. The permission is granted by the SEC when a case can be made that the disclosure may cause buyers to drive up the price before Berkshire makes its additional purchases.

Shares that were sold among positions worth more than $ 1 billion include the following:

Reduced Positions
Wal-Mart (WMT): 15 mil. shares (27% decr.); tot. stake $ 2.9 bil.
Charter (CHTR): 989 thous. shares (9% decr.); tot. stake $ 2.1 bil.
Deere & Co. (DE): 1.3 mil. shares (5% decr.); tot. stake $ 1.8 bil.
VeriSign (VRSN): 32 thous. shares (<1% decr.); tot. stake $ 1.1 bil.

The other reduced positions worth less than $ 1 billion include Liberty Media (LMCK), Liberty Media (LMCA) -- also related to the Liberty Media corporate action noted above -- as well as Suncor (SU).

Sold Positions
There were no positions sold outright during the quarter.

Todd Combs and Ted Weschler are responsible for an increasingly large number of the moves in the Berkshire equity portfolio. These days, any changes involving smaller positions will generally be the work of the two portfolio managers.

Top Five Holdings
After the changes, Berkshire Hathaway's portfolio of equity securities remains mostly made up of financial, consumer and, to a lesser extent, technology stocks (mostly IBM).

1. Kraft Heinz (KHC) = $ 28.8 bil.
2. Wells Fargo (WFC) = $ 22.7 bil.
3. Coca-Cola (KO) = $ 18.1 bil.
4. IBM (IBM) = $ 12.3 bil.
5. American Express (AXP) = $ 9.2 bil.

As is almost always the case it's a very concentrated portfolio. The top five often represent 60-70 percent and, at times, even more of the equity portfolio. The relatively new and very large stake in Kraft Heinz has, in fact, simply made the portfolio even more concentrated. In addition, Berkshire owns equity securities listed on exchanges outside the U.S., plus fixed maturity securities, cash and cash equivalents, and other investments.

The portfolio excludes all the operating businesses that Berkshire owns outright with ~ 361,000 employees (with 25 being at headquarters) according to last year's letter. Numbers like these -- along with many other things of interest especially for Berkshire shareholders -- will soon be updated when the new annual report and letter is released.

Here are some examples of Berkshire's non-insurance businesses:

MidAmerican Energy, Burlington Northern Santa Fe, McLane Company, The Marmon Group, Shaw Industries, Benjamin Moore, Johns Manville, Acme Building, MiTek, Fruit of the Loom, Russell Athletic Apparel, NetJets, Nebraska Furniture Mart, See's Candies, Dairy Queen, The Pampered Chef, Business Wire, Iscar, Lubrizol, Berkshire Hathaway Automotive, Oriental Trading Company. Precision Castparts, and Duracell.
(Among others.)

In addition to the above businesses and investment portfolio, Berkshire's large insurance operation (BH Reinsurance, General Re, GEICO etc.) has historically been rather profitable while providing plenty of "float" for their investments.

See page 115 of the 2015 annual report for a more complete listing of Berkshire's businesses.

Adam

Long positions in BRKb, PSX, AAPL, KO, WFC, and AXP established at much lower than recent market prices. Also, long positions in WMT and IBM established at somewhat less than recent market prices. (In each case compared to average cost basis.)

* All values shown are based upon the last trading day of the 2nd quarter.
** Berkshire Hathaway's holdings of ADRs are included in the 13F. What is not included are shares listed on exchanges outside the United States. The status of those shares, if a large enough position, are updated in the annual letter. So the only way any of the stocks listed on exchanges outside the U.S. will show up in the 13F is if Berkshire buys the ADR. Investments in things like preferred shares (and valuable warrants, where applicable, as explained in the recent letters) are also not included in the 13F.
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Monday, July 25, 2016

Berkshire 2016 Meeting: Charlie Munger Highlights - Part II

A quick follow up to this recent post.

Below are some additional comments made by Charlie Munger at the 2016 Berkshire Hathaway (BRKashareholder meeting:

Berkshire 2016 Meeting: Charlie Munger Highlights - Part I

On Anchoring
"...we're not anchored to what we're ignoring. We try to avoid the worst anchoring effect, which is always your previous conclusion. We really try and destroy our previous ideas."

On "Standard Stupidities"
"What you've got to do is be aversive to the standard stupidities. If you just keep those out, you don't have to be smart."

On Volumes
"...sometimes when you reduce volume it is very intelligent because you're losing money on the volume you're discarding. It's quite common for a business not only to have more employees than it needs, but it sometimes has two or three customers that could be better off without. So it's hard to judge from outside whether things are good or bad just because volume is going up or down a little."

On Negative Interest Rates
"I don't think anybody really knows much about negative interest rates....None of the great economists who studied this stuff and taught it to our children understand it either...our advantage is that we know we don't understand it."

Munger then added:

"If you're not confused then you haven't thought about it correctly."

And Warren Buffett chimed in with:

"I thought about it correctly then."

On Packaged Goods
"A lot of great businesses aren't quite so great as they used to be. The package goods business[es] ...are all weaker than they used to be at their peak."

On Humor
"I think if you see the world accurately, it's bound to be humorous because it's ridiculous."

Here's a comprehensive transcipt of what was said at the meeting by both Buffett and Munger.

Also, here's a transcript focused on what Charlie had to say.

Adam

Long position in BRKb established at much lower than recent prices

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Wednesday, June 29, 2016

John Bogle: Arithmetic Quants vs Algorithmic Quants

From a recent speech by John Bogle:

"As I see it, the plain and simple, well-armed, lightly-dressed, unencumbered shepherd is the index fund, a portfolio holding all 500 stocks in the Standard & Poor’s 500 Index. The David approach to investing, then, is 'buy a diversified portfolio of stocks operated at rock-bottom costs, and hold it forever.' The index fund relies on simple arithmetic, a mathematical tautology that could be calculated by a second grader: gross return in the stock market, minus the frictional costs of investing, equals the net return that is shared by all investors as a group. Taking the lion's share of those costs out of the equation is the key to successful long-term investing.

In contrast, many (most?) Goliaths of academia and quantitative investing believe the contrary: the application of multiple complex equations—the language of science and technology, of engineering and mathematics (yes, STEM), developed with computers processing Big Data, and trading stocks at the speed of light—make our Goliaths far stronger and more powerful than are we indexing Davids. The question posed in my title is essentially, 'who wins?'—the arithmetic quants or the algorithmic quants."

In the early days, when the hedge fund Goliaths* were individually smaller in size and part of a much smaller industry (assets of $ 120 billion in 1997), annualized returns were impressive: 11.8 percent vs 7.2 percent for the S&P 500 from 1990 to 2008.

By 2008, the Goliaths had $ 1.4 trillion in assets that have now grown to roughly $ 2.8 trillion and their relative performance has suffered a bunch: 5.3 percent vs 13.5 percent for the S&P 500 from 2009 to 2016.

Will there prove to be, in the long run, any advantage to all this additional complexity? Is the additional size the main cause of the more recent underperformance?  Is it the additional competition from capable individuals entering what is, if nothing else, a potentially rather lucrative profession? Or is it the addition of less capable managers entering the industry? For Bogle this all just reflects what is an inevitable reversion to the mean. The extra muscle and heavy armor -- in terms of industry assets -- has certainly led to huge compensation for the Goliaths.
(Bogle estimates ~$ 84 billion in annual fees while The New York Times reported that the top 25 managers alone were paid an average of $ 465 million in 2014.)

In any case, not unlike the classic battle, all that additional muscle and armor didn't make the Hedge Fund Goliaths a more formidable opponent to the indexing Davids; instead, it appears -- at least based upon the more recent results -- to have made them vulnerable to a much simpler and low cost approach.

Huge frictional costs -- roughly 3 percent per year or more according to Bogle -- are, of course, a meaningful factor but, with a greater than 8 percent annualized gap since 2009, it comes down to more than just those costs. Keep in mind that in the early days the drag of these heavy frictional costs also existed.

The range of outcomes is also a concern. Over the past 5 years, according to Bogle, individual hedge fund returns have been between -91 percent to 157 percent.

Yikes.

These Goliaths may perform much better in the future, of course. There's, as always, just no way to know. Yet I think it's fair to ask whether such long-term outcomes deserves so much time, talent, and capital especially when much less costly, simple, and effective alternatives exist.

If nothing else, over the long haul, the headwind coming from all the frictional costs is no small thing for most to overcome. Some exceptional managers no doubt will overcome those costs -- whether through pure chance or skill or a bit of both -- but that doesn't change the reality that a hedge fund with typical fees must outperform by ~3 percent each year just to keep up with the indexing Davids.

Adam

* It's worth noting the wide variety of investment and trading strategies employed by hedge funds. Still, what most have in common is vastly greater complexity and cost.

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.

Tuesday, June 7, 2016

Berkshire 2016 Meeting: Charlie Munger Highlights - Part I

The following are excerpts of comments made by Charlie Munger at the 2016 Berkshire Hathaway (BRKa) shareholder meeting:

Munger on Ignorance
"...looking back, I don't regret that I didn't make more money or become better known, or any of those things. I do regret that I didn't wise up as fast as I could have — but there's a blessing in that, too. Now that I'm 92, I still have a lot of ignorance left to work on."

So, for those who are a bit younger than Mr. Munger (and also similarly did not "wise up" as fast as they'd have liked), I guess this way of thinking potentially offers an even bigger opportunity for them. Well, at least it possibly could for the person who hasn't become convinced they already have most things figured out and, as a result, focus their efforts on confirming it.

"If others examined themselves attentively, as I do, they would find themselves, as I do, full of inanity and nonsense. Get rid of it I cannot without getting rid of myself. We are all steeped in it, one as much as another; but those who are aware of it are a little better off -- though I don't know." - Michel de Montaigne

To me, it's through the "though I don't know" that Montaigne adds a crucial element of healthy doubt (though I, as well, certainly don't know!); much like Munger, it seems a humble recognition that no matter how long and hard one attempts to better understand the world, the work is ultimately incomplete, and to a great extent this comes down to inherent limitations of the human mind.

And those who might be very smart and capable aren't exempt from it; the question is whether they think they are, in fact, entirely or mostly exempt. In other words, individuals convinced they already don't have much "ignorance left to work on" seem rather guaranteed to possess a whole lot more of it than they realize.

Munger on Retailing & the Internet
"...I would say that we failed so thoroughly in retailing when we were young, that we pretty well avoided the worst troubles when we were old. I think net Berkshire has been helped by the Internet. The help at GEICO has been enormous and it's contributed greatly to the huge increase in market share. Our biggest retailers are so strong that they'll be among the last people to have troubles from Amazon."

What comes across loud and clear during the meeting is how much Jeff Bezos and Amazon comes into play in their thinking when it comes to retail businesses (and, who knows, maybe one day even some of their other businesses).

Munger on the Health Effects of Coca-Cola (KO) Products
"...every person has to have about eight or ten glasses of water every day to stay alive...and it improves life to add a little extra flavor to your water -- a little stimulation, and a few calories if you want to eat that way. There are huge benefits to humanity in that and it's worth having some disadvantages. We ought to almost have a law....where these people shouldn't be allowed to cite the defect without also citing the advantage. It's immature and stupid."

Munger says those who choose to look at only the downside without also weighing the benefits are making an "inexcusable" error.

Munger on Microeconomics vs Macroeconomics
"Well, there could hardly be anything more important [than microeconomics]....Business and microeconomics are sort of the same term. Microeconomics is what we do and macroeconomics is what we put up with."

Considering how little Berkshire relies on macro factors in their investment decision-making it's notable, as a contrast, just how much time and energy is expended by a whole bunch of market participants -- as well as the many economists, consultants, and analysts who advise and opine -- on macro-oriented forms of analysis.

"It's kind of a snare and a delusion to outguess macroeconomic cycles...very few people do it successfully and some of them do it by accident." - Charlie Munger at the University of Michigan

Here's a comprehensive transcript of what was said at the Berkshire meeting by both Warren Buffett and Charlie Munger.

Also, here's a transcript focused specifically on what Charlie had to say.

Adam

Long position in BRKb and KO established at much lower than recent prices
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This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.
 
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