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Warren Buffett: do as I say, not as I do

Ed Monk

Ed Monk - Fidelity Personal Investing

Warren Buffett’s army of fans are always quick to quote their favourite Buffett wisdom, but they tend to ignore his clearest investment advice.

Warren Buffett: do as a say, not as I do

He’s set it out in various ways over the decades, but here’s how he described it to CNBC a couple of years ago: “Consistently buy an S&P 500 low-cost index fund.… I think it’s the thing that makes the most sense practically all of the time.”

And he really means it. He is on the record that he wants 90% of the money he leaves his family after his dies - no small sum, it’s fair to predict - to be invested this way. The most famous stock-picker in history wants you to invest in a passive fund - even ahead of buying shares in Berkshire Hathaway, his own giant conglomerate through which he actively invests in other companies.

If ever there were a case of ‘do as I say, not as I do’, this is it.

As if to prove this point, Berkshire Hathaway shares have underperformed the S&P 500 over the past 10 years - a fact that made it in the write up of a recent extended interview with Buffett by the Financial Times, granted ahead of the annual Berkshire Hathaway Annual Shareholder Meeting.

The paper points out that a dollar invested in Berkshire Hathaway 10 years ago would now be worth $2.40, whereas the same dollar in an S&P 500 tracker be worth $3.20. In point of fact, Berkshire Hathaway has beaten the market in the period since the start of the financial crisis - it is only in the recovery period since 2009 that it has lagged.

The FT report does a good job of dissecting this underperformance. It explains how the investing world in 2019 looks very different to 54 years ago, when Buffett took control of Berkshire Hathaway. There are far fewer under-researched corners of the corporate world for investors like Buffett and his long-time collaborator Charlie Munger to mine.

The early part of Buffett’s career involved buying ‘cigar-butt’ companies - those which the market believed were spent but Buffett saw as bargains. This cemented his reputation as the ultimate ‘value’ investor. In reality, the philosophy has morphed over the decades and late-period Buffett is more concerned with buying high-quality brands, even if that means paying prices that are less-obviously cheap.

This shift has meant buying shares of the biggest brands in America from companies that naturally feature in the biggest stock market indices - so it’s no wonder the performance of Berkshire Hathaway has moved closer to that of the market.

Additionally, there has recently been a problem of Berkshire Hathaway having too much money (if that can ever be described as a problem). Berkshire Hathaway has a value of around $700bn. Around $100bn of that is a pile of cash which has grown significantly in recent years - about $100m rolls in every working day.

To move the dial in any significant way Berkshire needs to make really, really big bets and there are only a few places big enough to do it. In fact Buffett says there are only about 100 publicly listed companies that he can meaningfully invest in. It is part of the reason that Berkshire Hathaway increasingly buys whole businesses.

Does all this mean that the age of the stock-picker is over, destined to pass when Buffett, it’s greatest exponent and now 88-years-old, calls it a day?

That seems unlikely. Firstly, the whole world can’t invest passively, even if it wanted to. Indexes rely on someone, at least, making active decisions for the rest of the market to hitch onto. Logic dictates that the greater proportion of money that invests passively, the greater the potential opportunities for active investors to exploit.

Secondly, the period since 2009 in which Berkshire Hathaway has lagged has been peculiar in a number of ways. Cheap central bank money flooded economies and stock markets after the crisis and this has tended to lift all companies, even those poor companies that an active investor would traditionally add value by avoiding. That situation can change.

The appeal of Berkshire Hathaway now is not as a high-octane source of share price growth but as an alternative way to buy a slice of blue riband corporate America. Index investing offers a very similar thing, but Berkshire may still be able to add value - particularly in periods of falling markets - by putting its huge cash reserve to use buying its own shares, or those of the companies it holds, at temporarily low prices.

Five year performance

(%)
As at 26 April
2014-2015 2015-2016 2016-2017 2017-2018 2018-2019
Berkshire Hathaway 16.1 -1.9 17.1 19.7 0.7

Past performance is not a reliable indicator of future returns
Source: Fidelity, as at 26.4.19, in $ terms with income reinvested 

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