Buffett on Institutions: Wit, but no Wisdom?

Buffett on Institutions: Wit, but no Wisdom?

May 6, 2014 Behavioral Finance
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(Last Updated On: May 8, 2014)

A student in my class passed along a great quote from one of Buffett’s annual letters.

Warren Buffett outlines a great story told to him by his mentor Ben Graham:

Ben Graham told a story 40 years ago that illustrates why investment professionals behave as they do: An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.


source: http://www.berkshirehathaway.com/letters/1985.html

The story above is initiated after Buffett claims:

You might think that institutions, with their large staffs of highly-paid and experienced investment professionals, would be a force for stability and reason in financial markets. They are not: stocks heavily owned and constantly monitored by institutions have often been among the most inappropriately valued.

Buffett tells a compelling story that institutional money managers cause mispricing, but is it true that stocks owned and monitored by institutions are largely mispriced?

Unfortunately, the answer isn’t clear cut:

Although a large body of literature has studied the behavior of institutional trading and its impact on asset prices and returns, the informational role of institutional investors remains an open question.


Source: http://business.missouri.edu/yanx/research/horizon_RFS.pdf


Story tellers are entertaining, but one should always consult the evidence before making a decision.

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Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. 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.

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  • John Butters

    Hmm. I would read Buffett as:

    “[it is not unusual to see certain] stocks [that are] heavily owned and constantly monitored by institutions… among the most inappropriately valued.”

    In other words, I would have taken this as an argument that institutional coverage does not necessarily promote rational pricing, rather than as an argument that it increasing pricing irrationality.