Who Do You Think You Are? Warren Buffett?

 Six years ago, Warren Buffett – without a doubt, the smartest investor alive on the planet bet $1M (a negligible amount of money when you consider his fortune) and most importantly his reputation on the idea that Vanguard’s S&P index fund will outperform a selection of hedge funds by Protege Partners over the course of a decade.

 So far, Buffett’s el cheapo index fund is winning handily at 43.8% against average of 12.5% on Protégé’s fund of funds, as at the end of 2013.

No victory dance for indexers as yet though, there are four more years to go and who knows, the clever hedgies could pull some of their magic. But it doesn’t really matter what the outcome is, what I find intriguing that the world’s smartest investor was willing to stake his hard-earned reputation on such a dumb idea  in the first place.

When you think of it though…. perhaps it’s not such a dumb idea after all? If you take the trouble, like I did, to review the work of some of the smartest economists, including notably Nobel Laureates Harry Markowitz, William Sharpe, Robert Merton, Daniel Kahneman, Gene Fama and even Robert Shiller, you will quite easily see why placing a bet on index funds is in fact, a very clever thing and probably the best for the vast majority of clients.  (And in case you are wondering what Shiller is doing on that list, I found absolutely nothing in Shiller’s work to help me or anyone else for that matter outsmart the market consistently.  But if you do, please let me know!)

I picked these people because their work has been widely critiqued by their fellow academics and practitioners alike, and rightly or wrong their ideas seem to have risen to the top. I came to a simple conclusion years ago that I couldn’t possibly be smarter than any one of these people, let alone four or five of them. And I don’t know any adviser who is either, even though I have met some exceptionally brilliant advisers!

The overwhelming body of work on evidence-based investing should at least lead anyone to approach active fund management with a high degree of skepticism. I would go even further as saying that the default recommendation should be index funds and selecting active fund should be only and only where there is demonstrable evidence that it adds value. And by evidence, I don’t mean past performance! Active share and expense ratio are by far the best predictor of performance, but even then its a little more than guess work.

Yet, what I see is exactly the opposite. Somehow, everyone acknowledges picking a great fund in advance, is a very difficult thing to do, yet on individual level, they think they can.  As in ‘it’s so difficult most people get it wrong but I’m different!’ I get into these conversations on Twitter all the time with people who acknowledge that picking funds is very hard but somehow they think can they can do it better than everyone else.

I think this goes into the heart of the profession and the questions everyone of us has to answer is: what do you know that  about investing that Warren Buffett and these Nobel Laureates somehow missed? Really, who do you think you are?






9 thoughts on “Who Do You Think You Are? Warren Buffett?

  • “Jean” Fama?

  • The problem is one of choice, not ability.

    Question; why is it that although the use of passive products is on the rise, this is almost exclusively through the use of open ended collective vehicles? The answer I would suggest is one of ease.

    It is very easy to use a index tracking OEIC. Readily available, easy to explain, transparent charging structure; why wouldn’t you use one? However, exchange traded products are an unknown quantity within the UK. Unknown, not in the sense that advisers are unaware of what they are, but unaware in what are the implications of dealing within them. What are the charges associated within them? What are the platform transactional costs?

    I asked these questions to a good friend of mine who works for a larges ETP provider – he did not have a clue. He asked his colleagues, specifically those who’s role is to liaise with the platforms themselves; they didn’t have a clue either. The providers are unsure what the situation is with their own sprouts, the disparity on charging between platforms is vast, the mechanics of using these within model portfolios is complex (I am aware that Schwab have sorted something out in the states with regards to rebalancing and reconciliation, yet they hold the patent pending on this system so its unlikely this will come to this side of the Atlantic soon).

    What has this got to do with the initial post? One of choice. In the UK the open ended range of index trackers is dire. As someone who’s job for the last 10 years is to construct investment portfolios with clients, I could not effectively do this using the open ended trackers available within the UK. Fixed Income as one example. ETP’s would solve this if the ability to transact was easier, but as it is not, they are discounted in the main.

    In the states, from which all data in the above post is quoted, fair enough. The menu of available passive options is huge and therefore greater consideration may be given to the use of passives as the opportunity to fully reflect your asset allocations views can be materialised. But in the UK, not a hope.

    Bottom line, I use actives in the main because I simply refuse to “make do”. The day I begin to “make do” is the day I do a Reggie Perrin.

    • 1) You state that ETP charges are difficult to nail down. Not my experience at all.

      ETP charges are easily obtained from provider websites. The iShares site has an almost overload of data on it’s range of ETPs.

      Platform provider charges re ETP trading are in the public domain and easily available. They are also coming down, especially if you deal with companies like Transact, which aggregate customer “buys” to spread the dealing costs.

      2) Lack of index tracking OEICs to construct a diversified portfolio over the last 10 years.

      Really? Since 2004 L&G has offered two broad UK gilt (conventional and index linked) trackers; iShares a Corporate Bond ETP (notwithstanding your previous comments); Dimensional a global bond fund. All these have been available fully during the last 10 years you have been constructing investment portfolios.

      Vanguard and L&G now have corporate bond index tracking OEICs (as opposed to ETPs).

      Throw Vanguard and Dimensional’s equity OEICs into the mix (both offering global small cap and emerging markets) and the argument could be made that the index tracking / passive OEIC Universe is broad enough already.

      Who needs ETPs?!

      • Nick,

        ETP annual charges are clear, that is not my point. My point is all the extraneous charges that may or may not be levied onto the client via transaction through a platform…

        Your second point; is that what you called diversification? Global bond, gilt and credit? As for equities, aside from large cap developed markets and value biased small from DFA, what else can you offer? How can you control volatility effectively using these meager options? The answer is you cant.

        Again, I wont simply make do in order to cut costs to push an easier sale through.

        • And that universe is getting smaller http://is.gd/J29Zgg

          “The decision had been taken ‘due to the asset size being too small to allow efficient management of fund. It was in the shareholders’ interests that SSgA decided to close it.’ The fund was around £25 million in size before it liquidated this month.”

      • Andrew, you may have a point about availability of ETP/ETFs on platforms. I have said before, the choice of platform should be driven by the investment prop, and not the other way round.

        I agree with Nick that unless you are trying to do some exotic portfolio engineering, the range of ETFs/OEICs/Unit trust available on the market is more than adequate.

        I was involved in a research for an asset manager recently, looking at inflows in this the main asset classes in this space. Blackrock/iShares, Vanguard, L&G and SSGA/SPDR. Add DFA to the mix, and you probably have all you need to run decent portfolio for most clients.

        If you want to add exotic stuff into the mix (not that I believe you should), there are plenty of others waiting to take you money.

        Specifically what are you looking for that you can’t find?

  • Hi Abraham

    I think I’m like most advisers. I dont have a strong opinion about this and, frankly, it doesnt matter that much.

    Asset class is the most important determinant of investment returns. We dont need some blokes at Harvard to tell us that, do we?

    But I am not convinced that there is a direct link to the use of index tracking funds. If asset class is the important factor, then all else being equal, it doesnt matter if you opt for a passive or active fund.

    The difference in cost now is marginal, just a few basis points.
    So I use index tracking funds when appropriate.

    What I dont like is “funny money”. Taking on credit risk unnecessarily, by betting on an index rather than buying the underlying stock. As a result, there are certain things I cant buy in a tracker – high yield bonds, UK property etc.

    ETFs come with extra regulatory risk – most arent UK regulated, so is it worth adding to risk just to shave a few basis points off the price. If the money in Ireland disappears, there’s no compensation scheme to bail you out. I dont have a good enough understanding of French language or Luxembourg culture to make sense of the rules and regulations of an ETF or any other investment based there.

    And ETF providers can be shady about price too; it doesnt seem possible to get data showing movements in the spread of ETFs (I cant run a chart showing the spread over a period of, say, three years – I’d be delighted to be proved wrong, by the way). Same goes for unit trusts, it’s true.

    I cant track cash now that Investec have closed their High accounts – so, if you dont believe in active management, what do you do?

    Finally, my experience of financial planning for clients is that most of the work is on legacy products. The advisory costs of moving from a legacy product are high (how much time does it take to complete those pension switching and replacement investment business forms and who pays?) and will usually outweigh the benefit of shaving a few basis points off the annual management charge.

    Index tracking funds are good but their providers need to get over themselves.They aint all that!

  • Exotic? What Mid Caps, Infrastructure, ABS, Private Equity, EMD, never mind an ability to develop certain style blends or biases? You know, pretty standard fare… Unless you want vanilla developed equities and bond exposure, passive is restrictive akin to life co’s in the 90’s.

    Adequate and decent is something that I am not accustomed to unfortunately. Clients I work for tend to require more than adequate. Passive selection within the UK is significantly less than adequate; inferior possibly and therefore not an option.

    Here is a question. I have just reduced my GEM exposure across the board. Where should I reinvest that capital if the risk budget is not to be affected? Passively. Using collectives.

  • Interestingly though Warren Buffett himself doesn’t invest his own money in an index. He prefers investments he understands.
    That alone is evidence that there is a place for skill. Warren Buffett isn’t the only example.

    Warren Buffett’s advise is important in the sense that not everyone say they are an active manager really understands wha they are doing. Most of them are speculating on market price movements rather than identify great companies they intend to own for the long term.


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