If you were to ask investors who is the greatest investors of our time, Warren Buffett’s name would be at or near the top of everyone’s list. Buffett’s two great contributions have been that he has taught investors to have a value approach and that he has preached the importance of patience and discipline, avoiding the noise of the market. The latter contribution is evident among Berkshire Hathaway (BRK) shareholders, who have a “religious” belief and confidence in him.
An interesting question is: How would Buffett be viewed if, instead of being the chairman of Berkshire Hathaway, he ran an open-end mutual fund by the same name? Would the same Berkshire shareholders who religiously hold their shares have the same patience and discipline? Before answering, consider the following:
- From 2009 through June 2020, BRK returned 9.3%, underperforming Vanguard’s 500 Index Fund (VFIAX) return of 13.7% by 4.4% per annum for 11.5 years. And it did so with greater volatility: annual standard deviation of 16.0 versus 14.6. A $10,000 investment in BRK would have ended the period with $27,671. VFIAX’s total return was 58% greater.
- In the more recent period from 2017 through June 2020, BRK returned 2.6% versus 11.9% for VFIAX. Over this period the volatilities were virtually identical. The total return difference was 9.5% (BRK) versus 48.3% (VFIAX).
In my 25 years of experience as an investment advisor, I have learned that one of the greatest mistakes investors make is that when it comes to judging performance, they treat three years as a long time, five years as a very long time, and 10 years as an eternity. Given that BRK has underperformed for more than a decade, if Buffett were a fund manager, many investors would have bailed, just as they bailed on Bill Miller (former chairman of Legg Mason Capital Management, now part of ClearBridge Investments), the only fund manager to ever beat the S&P 500 Index 15 years in a row (1991-2005). When that streak ended, as the following table demonstrates, his performance deteriorated.
Investors fled with abandon. Miller’s performance eventually led to his departure from Legg Mason in 2012. And this was the man who had done what no fund manager had done before or since. His departure came after just six years. Buffett has been underperforming for about twice as long, suggesting that if he were a fund manager and not the chairman of Berkshire Hathaway, investors would not have remained as loyal.
Before concluding, let’s take a look at another period over which BRK underperformed – the dot-com era. From January 1995 through March 2000, BRK underperformed Vanguard’s 500 Index Fund (VFINX) by 5.8% per annum and did so while experiencing twice the volatility (30% versus 15%). If you lost faith in Buffett, and value investing in general, due to that period of underperformance, you would have missed out on BRK’s spectacular outperformance over the next period. From April 2000 through December 2008, BRK returned 6.2% per annum, outperforming VFINX, which lost 4.0% per year, by 10.2% per year. Volatilities were similar.
Reviewing the period 2000-2008 is important because it followed the very same type of outperformance of growth stocks that has occurred since 2017. In both cases, all of the outperformance of growth stocks was due to increasing relative valuations, not positive earnings surprises for growth stocks or negative ones for value stocks. Consider that we have now lived through the greatest drawdown in value’s performance in history by a wide margin. That has left valuations at the cheapest levels in history relative to growth stocks. This is basically true all around the globe.
Each time we have had a period like this, the returns to value eventually recovered. And once the recovery began, it was massive and swift. For example, at the end of March 2000, value had done so poorly over the prior five years that it had underperformed growth over one-, three-, five-, 10-, 15- and 20- year periods. Just one year later it had outperformed over all those periods!
The question for BRK investors, and value investors in general, is: Having endured the pain of underperformance, is it wise to bail out when there is little evidence supporting the idea that growth stocks should be expected to outperform value stocks going forward? Remember, there has been no “regime change” whatsoever. Growth has not outperformed because earnings have done better relative to value than has historically been the case. It has all been about changes in valuations – in other words, speculation.
Summary
Buffett knows what all financial economists know: 10 years is likely nothing more than noise when it comes to returns of risk assets – which is why we diversify, not run from risk. We diversify because we don’t know which risk asset will be the next one to go through a long period of bad performance, and we don't want to run the risk of concentrating our assets in that asset class or factor.
So, had you invested in a fund run by Buffett, would you sell the fund?
Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.
Important Disclosure: Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of actual portfolios nor do indices represent results of actual trading. Information from sources deemed reliable, but its accuracy cannot be guaranteed. Performance is historical and does not guarantee future results. Total return includes reinvestment of dividends and capital gains.
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