CHAPEL HILL, N.C. – Will Warren Buffett address his disappointing recent performance at this weekend’s Berkshire Hathaway annual meeting?
He isn’t saying, and I received no response from the company’s press office when I asked if he plans to address the topic.
What we do know is that he has lagged the stock market, over not just a year or two but over longer periods as well. Consider the extent to which Berkshire Hathaway’s stock BRK.A, -1.29% BRK.B, -0.95% has outperformed the S&P 500 SPX, -0.72% over the trailing 15 years. This outperformance — or alpha — has been steadily declining over the last four decades.
In 1979, for example, the first year for which a trailing 15-year track record existed, Berkshire Hathaway’s trailing 15-year alpha stood at over 15 annualized percentage points. By the turn of the century, it was only half as large. And by the end of last year it had slipped into negative territory.
Notwithstanding this decline, however, Buffett’s lifetime record is still outstanding. Since 1965, Berkshire Hathaway stock has beaten the S&P 500 on a total-return basis by an annualized margin of 18.3% to 10.2%. What this means: His performance prior to the last 15 year was so impressive that even after incorporating the more recent period, he still comes out way ahead.
Buffett’s sale of airline stocks
Many are advancing an explanation for his recent disappointing performance that I think is unfair: That Buffett has lost his touch, as evidenced by his decision to sell his airline holdings a year ago during some of the darkest early days of the pandemic. Since last year’s Berkshire Hathaway annual meeting, when he announced the sale, the airline stocks he sold have gained more than 100%, on average, more than doubling the return of the S&P 500.
But this narrative relies on a considerable amount of Monday-morning quarterbacking. Buffett’s rationale for selling, as he said in last year’s meeting, was that “there are certain industries, and unfortunately, I think that the airline industry, among others, that are really hurt by a forced shutdown by events that are far beyond our control.”
I submit that he was right.
Who knew at the time whether the vaccines then in development would be successful? One of Buffett’s investment principles, which previously has served him well, is to never invest in a business you cannot understand. And, notwithstanding what some may be saying now, no one at the time knew whether an effective vaccine would be developed in time to save the airlines from bankruptcy.
Michael Brush in May 2000: Here’s why Warren Buffett made a huge mistake selling his airline stocks
Blaming Buffett for his sell decision is akin to blaming someone in a casino for failing to know which of myriad slot machines would soon hit the jackpot.
It’s helpful to think of this in terms of probabilities. Imagine for purposes of discussion that 60% of the time, Buffett is able to pick companies that will outperform the S&P 500 and that his average holding period is 10 years. (I have no idea whether these assumptions are accurate, but they strike me as plausible.)
If so, Buffett would need to invest for many decades—well more than 100 years, in fact—before the statistical odds of beating the overall market become nearly certain.
This is just another way of saying that over shorter time horizons, luck plays an outsized role in explaining returns. This is important to keep in mind, since our minds are hard-wired to discount the role luck may play—leading us to instead concoct narratives to explain what’s going on. That’s a mistake, Dartmouth professor Ken French once told me: “Statistical noise—luck in other words—is always the first possibility to consider.”
Warren Buffett versus Jim Simons
Another revealing comparison is to Renaissance Technologies’ James Simons, whose Medallion Fund has outperformed even Berkshire Hathaway during the period in which both have existed. Brad Cornell, a professor emeritus at UCLA, reports that Simons’ fund produced a 39.2% annualized return (after fees) between 1988 and 2018, in comparison to a return of “just” 15.5% for Berkshire Hathaway and 10.0% for the S&P 500’s total return.
Even better, the Medallion Fund’s returns have been incredibly consistent. Cornell reports that the fund has had only one losing year in three decades: 1989, when its net-of-fees return was minus 3.2%.
Cornell reports that the odds of success of any of Medallion Fund’s individual trades have been just 50.75%–considerably less than the 60% I assumed in my hypothetical Berkshire Hathaway example and only slightly higher than 50%.
But when coupled with high-frequency trading, those apparently modest odds are enough to produce a highly profitable strategy. Medallion’s “strategy involved constantly opening and covering thousands of short-term positions, both long and short… Taken over millions of trades that [50.75%] percentage allowed the firm to make billions,” Cornell wrote.
Buffett, in contrast, is at the opposite end of the spectrum from high-frequency trading. That’s why it takes so many more years for Buffett’s odds of success to translate into consistently outperforming the market.
It’s also worth pointing out that Simons early on recognized that there is a limit to how much money could be managed, according to the Medallion Fund’s strategy. The fund is not open to outside investors, for example. Buffett, in contrast, has made his strategy available to all. In fact, there are some who believe that, had Berkshire Hathaway remained as small as the Medallion Fund, Buffett’s recent performance would be far better.
To be sure, Buffett’s personality is such that he is unlikely to blame just bad luck for his recent disappointing performance. Even when it’s true, many think that the explanation is in poor taste, akin to not taking responsibility. So it will be interesting to see if he is asked this weekend about his negative 15-year alpha and, if so, what he says about it.
But, regardless, don’t underestimate the role that luck—randomness, in other words—has really played.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org