Why Warren Buffett's winning formula could flop in modern markets
Warren Buffett, the world's best-known investor, has a large shareholding in Coca-Cola. When asked to explain why shareholders of his investment vehicle, Berkshire Hathaway, should be proud to own Coke, the inimitable Mr Buffett responded by saying he consumed about 700 calories of Coke a day.
Buffett, who is 86 years old, added that he wished he had a twin who had eaten only broccoli and water in the same caloric amounts as he drinks Coke - and to see how healthy that twin was. His suggestion was that he was unlikely to be any healthier by ditching Coke for broccoli.
Unfortunately, life isn't a science experiment and we can't test Buffett's hypothesis. However, an interesting thought experiment would be if Buffett did have a twin (broccoli-eating or not), would he or she have enjoyed the same investment success as Buffett if also an investor?
Buffett has trounced the S&P500 (one of the main stock market indexes in the United States) in his 52 years at the helm of Berkshire. It should be noted that the corporate structure of Berkshire and its investment in large insurance companies affords Buffett a large float from unpaid future claims that leverages the company's own equity. However, leverage adjusted, his investment track record is still stellar.
To the efficient market diehards, Buffett is the happy winner of a coin-flipping contest. If you start with enough people, you'll end up with a small number that flip a highly improbable 10 heads in a row. Repeat success for Buffett's twin, academics would argue, is akin to a lottery winner. But I'm not interested in whether Buffett is lucky or skilled - he'd argue both. I'm more interested in whether a modern-day acolyte could repeat what Buffett has done in the next 50 years. And on that question, I'm far less sanguine.
Markets in 2017 are very different to those in the 60s. I suspect if Buffett had a twin, his (or her) chances of success were far higher in the Sixties than they are today.
It could be argued that some pockets of opportunity existed in the 70s and 80s, when technology was cumbersome, access to data was both expensive and scarce, and some agents were more informed than others. But in today's world, those informational asymmetries are largely absent, and so are many of the easily exploitable opportunities.
This doesn't mean the more traditional-style hedge fund approach is going the way of the stamp and on its last hurrah. But market circumstances today are such that merely swimming against the tide of the human crowd is simply not enough. Now it's a race against the machine.
The quantification of finance has its upside. The data now reveal that much of the return advantage of consistently-successful stock pickers might actually boil down to simple bias for value, small caps, momentum or quality - factors which academics now concede offer a return premiums to the overall market.
This paint-by-numbers approach to investing is disparaged by some as hopelessly inadequate to capture the complexities of picking stocks. And they are correct. But these phenomena (value, momentum and so on) work best at the aggregate level - not the individual stock level. And so your approach is best achieved with a high degree of diversification.
So you can have your cake and eat it. The only likely obstacle in your way is human intervention in the process - that is, you. So before investing, get some advice - and then try and stay out of your own way.
Gary Connolly is managing director of iCubed. He can be contacted at firstname.lastname@example.org or on twitter @gconno1.
Any investment advice in this column is from the author directly and should not be seen as a recommendation from The Sunday Independent
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