Buffett and Hedge Funds Share a Trait: No Alpha

Buffett and Hedge Funds Share a Trait: No Alpha

March 3, 2015 Guest Posts, Tactical Asset Allocation Research, $SPY, $brk-a
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(Last Updated On: March 3, 2015)

Aaron Seager, a portfolio manager at Arbor Hill Advisors, offered up the following charts showing alpha over the past 15 years for Warren Buffett and an index of Hedge Funds.

Humbling to say the least…

Warren Buffett’s Alpha

Warren Buffett arguably runs the most famous “value investing fund” in the world. His performance record over the past 50 years is extraordinary. But how has he performed over the last 15 years?

Below we highlight the 5-year annualized rolling alpha estimates of Berkshire relative to the S&P 500 (daily data of BRK/B-RF on SPY).

The pattern over the past 15 years is not on a positive trend…

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

 Hedge Fund Alpha

Hedge fund managers are considered the “masters of the universe” with their sophisticated organizations, slick marketing mechanisms, and extraordinary fees. How have the masters of the universe fared in recent memory?

Below we present the 5-year annualized rolling alpha estimates for hedge funds (monthly data on CS DJ Equity L/S HF Index on S&P 500 TR Index).

Again, the pattern over the past 15 years is not on a positive trend…

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

Simple alpha estimates aren’t the end-all-be-all for performance assessment, and perhaps they are influenced by an underlying pattern in risk-free rates, but the trend to zero for some of the smartest people in the marketplace is not inspiring!


If Warren Buffett and the hordes of high IQ hedge fund managers can’t generate alpha, who can?

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • sdfasdf

    Does that mean we should dump valueshares and go with index?

  • Doug

    Nice post. Short, straight and to the point. Quick clarification – when you say “Alpha” is it just the straight ALPHA = BRK-RFR-S&P500, or is it the CAPM Alpha, which adjusts for beta (BRK = ALPHA + BETA(S&P 500 – RFR)? I say this because BRK has a lower beta than the S&P (about 0.85 right now), and I’m sure that hedge funds have a beta even lower than that (which is why many people invest in hedge funds).

  • uber simple. Nothing fancy here with fama french factors ,etc.

    S&P 500 beta exposure is accounted for in the regression below:

    ret-rf = alpha + B * S&P TR + e
    using S&P TR – rf gives ~same result.

    I’m sure you could extend the analysis and get fancier, but the big muscle movement is clear…simple alpha is fleeting

  • Corpraider

    “Has Buffett Lost It?” I’ve read that before somewhere…It will be interesting to see if this “mean” reverts. If I had to wager, I would say yes. Recent market (last ~5 years) reminds me of “1999 lite”, where a mindless growth – momentum tilt of a cap weighted index was crushing everything.

  • Love the guy, and I think he has structural edge via his unique deal-flow, but he’s got too much money to do much better than average at this point…but he’s worked miracles before!

    That said, you can probably achieve a better long-term performance stream by buying a cheap hiqh quality stock strategy focused outside of the mega-cap arena Buffett HAS to play in… ala Frazzini et al. http://www.econ.yale.edu/~af227/pdf/Buffett%27s%20Alpha%20-%20Frazzini,%20Kabiller%20and%20Pedersen.pdf

  • Michael Milburn

    Buffett has mentioned in the past (and I think in his most recent letter) that the sheer size of BRK makes generating excess return increasingly more difficult. Buffett has said that he could do much better with less money to manage. So presumably he still thinks excess returns are still possible on smaller equity base.

  • Eric

    Buffett has said he could achieve 40% returns if he had a small amount of cash to manage. As you know, if you outperform the market long enough you eventually own the entire market and Buffett just has too much to manage.

  • Had a question about this article.

    One quick question I have is what metric the researcher in the referenced paper is using as the yardstick for returns – Is he using book value of BRK? Market value of BRK? Portfolio of BRK? I see that he references BRK/B, but there’s a problem with that if he’s using market valuations of BRK/B shares.

    For hedge funds, it’s pretty straightforward as you can calculate the returns on funds invested from LPs. For Berkshire, it’s not a fund, but you can measure returns in different ways. To make it apples-to-apples one would need to compare one or more of the following:

    1 – BRK’s entire book value (not just BRK/A or BRK/B which doesn’t make sense) compared to NAV or net asset value of hedge funds (adjusted for redemptions and contributions) over time.

    2 – BRK/A and BRK/B market values (BRK’s entire market value) compared to publicly traded market values of hedge fund (if such exists) over time. By using BRK/B or BRK/A market values, you’re adding a variable which most hedge funds don’t have which is market valuations at which they can trade, at a premium or discount to NAV. That’s essentially what BRK market cap is – a market cap that trades at various premiums or discounts to reported book value of equity or NAV.

    3 – BRK’s (entire company) ROE’s year to year compared to annual hedge fund returns over time. This would be the best way to compare apples-to-apples, in my opinion.

    Not disagreeing with the author’s conclusion as it may be right, but I am not sure if I understand his methodology.

    The table I put together (attached) is the way I would look at it. If you invested $100 dollars in BRK in the beginning of 2000 (15 years ago), you would have $402 dollars, compared to the S&P 500’s total return including dividends of $187. I look at book value per share as a more stable measure of portfolio/investment performance, and even then you would have $385 at the end of 2014 compared to $187 in the S&P including dividends.

    Feel free to contact me at scmessina.com or https://www.quora.com/If-Warre….

    Would like to hear your thoughts.

  • Benjamin Graham was a scholar and financial analyst who mentored legendary investors such as Warren Buffett, William J. Ruane, Irving Kahn and Walter J. Schloss.

    Buffett once wrote a lengthy article explaining how Graham’s principles are everlasting, and how Graham’s record of creating exceptional investors (such as Buffett himself) is unquestionable. The article is called “The Superinvestors of Graham-and-Doddsville”.

    Buffett describes Graham’s book – The Intelligent Investor – as “by far the best book about investing ever written” (in its preface, which Buffett wrote). In The Intelligent Investor, Graham recommended various categories of stocks and specified precise qualitative and quantitative rules for each category.

    Serenity Stocks shows how one can assess 5000+ NYSE and NASDAQ stocks by a complete 17-point Benjamin Graham assessment, with no adjustments other than those for inflation.

  • Jan Švenda

    I would like to ask a question with regards to the fact that as there is an increasing number of funds (you can see it here for example; http://ftalphaville.ft.com/files/2014/03/ScreenShot005.jpg). Don’t you think this is why alpha creation is faltering? In history hedge fund have been reserved to the very best managers, but now with the accommodative policy from central banks and possibly darkened prospects for prop trading, managers can have, or could have a nice performance (20% yoy) without the real ‘skill’ in alpha creation. I do believe this is just a phenomenon of the last decade (faltering alpha) and now the enviorment of the markets is certainly more limited in terms of possibility of having this ‘easy’ performance again.