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Why aren’t there more Warren Buffetts?

Warren Buffett is the most studied investor of all time. And with a couple of exceptions, it’s hard to find anyone who has studied him as much as Robert Hagstrom. Hagstrom recently appeared on the We Study Billionaires podcast and spoke at length about one of the investing world’s great mysteries.

That mystery is as follows:

Warren Buffett is widely regarded as the most successful investor ever. Rather than keep the secret sauce locked away, Buffett and his late business partner Charlie Munger have shared their knowledge liberally for decades. What’s more, the main principles they preach are rather simple – ignore market folly, buy shares in great companies and let compounding work its magic. The financial rewards of replicating the methods and success of these two men – even 1% of it – would be enormous. And yet despite all of the above, very few investment managers have pulled it off.

Why not? According to Hagstrom, it boils down to psychological barriers as much as anything else.

Barrier 1: The unbearable pain of losing to win

Buffett is the archetype of what Hagstrom describes as a ‘high active share’ investor. High active share managers are defined by holding portfolios that are very different to the big equity benchmarks. They are often highly concentrated, and this combination naturally leads to big differences in performance versus the benchmark.

Done well, this can bring about a truly impressive track record. The nature of investing this way, though, means that being smart enough to have good investment ideas isn’t enough. You also need to be comfortable with losing a lot of the time.

“We looked at the high active share managers in the Warren Buffett Way [his book]. Phenomenal long term track records, but their batting average was about 50%. They outperformed month to month, quarter to quarter, year to year, only 50 percent of the time. The other 50 percent of the time they underperformed.”

I recently read some lecture notes from Joel Greenblatt’s value investing classes at Columbia and this theme came up again and again. According to Greenblatt, value investing works on average because it doesn’t work all of the time – if it did, everybody would do it and it wouldn’t work. It also reminded me of the classic Peter Lynch quote about your stomach being more important than your brain.

We hear quotes like this and we nod along. Yet most of us are hard-wired against living up to them.

Hagstrom cites Daniel Kahneman and Amos Tversky’s Prospect Theory as the main reason for this. Kahneman and Tversky found that investors feel twice as much pain from losses as they feel joy from equally big gains. For most people, this makes a high active share approach like Buffett’s difficult to stomach, even if there is clear evidence of its ability to deliver outstanding relative returns.

I imagine this would be even harder as a fund manager. Not only would you have to deal with your own emotions, but you’d also have to deal with those of your clients and colleagues, too. Buffett has alluded to this advantage over fund managers many times. At Berkshire, he is not investing funds at risk of being withdrawn by skittish clients. He is investing permanent capital and enjoys the support of a shareholder base that would follow him off a cliff. Of course, it helps that one of those shareholders – with 31% voting power no less – is Buffett himself.

Barrier 2: The power of self-interest

Another reason there aren’t more Buffetts out there? Other approaches to investing are deeply entrenched and protected by webs of self-interest.

The big one Hagstrom takes aim at is Modern Portfolio Theory (MPT), which is diametrically opposed to the bumpy returns and concentration of a ‘high active share’ approach. By contrast, MPT views stock price volatility as the very definition of risk and seeks to eliminate it through diversification.

According to Hagstrom, MPT took hold in the 1970s amid a lack of strong voices championing other investment approaches and definitions of risk. This happened to coincide with a near 30-year secular bull market starting in the US, meaning that prestigious academic careers and huge amounts of assets under management became entwined with this approach.

“Go tell guys that have billions of dollars in modern portfolio theory. Oh, you know that money management practice that is making you millions of dollars a year? That gets you all the luxuries and everything that you want? Oh, you need to shut that down. It doesn’t make any sense anymore. No, they’re not going to do that. They’re going to defend that till hell freezes over.”

Even leaving MPT aside, there is little incentive for institutions with huge assets under management to take a highly active approach. At a certain point, the game becomes more about protecting assets under management than swinging for outperformance. In that situation, loss aversion kicks in again and ‘closet indexing’ becomes far more attractive than a Buffett style approach.

Barrier 3: The difficulty of focusing on what matters

According to Hagstrom, what really makes Warren Buffett different from other investors is what he does not spend time thinking about.

“[Buffett] doesn’t think in terms of common stocks, sectors, correlations, diversification. He doesn’t think about stock market theories. He doesn’t think about macroeconomic concepts. He just thinks about the business. Now, compare and contrast that with an institutional money manager…

The majority of people spend 90% [of their time] pontificating about the market, the economy, geopolitics, the presidential election. Who cares?”

Unfortunately, most investment managers need to think about those things. Why? Because that’s what their clients are thinking about. As Hagstrom put it, “9 out of 10 phone calls from clients are going to be asking these questions. You’re not going to have a long career if you don’t at least contribute something.

For some reason, I found the image of Buffett constantly being torn away from Apple’s 10-K to answer phone calls asking him about the election quite amusing. But it raises a serious question. Were it not for the unique structure he built for himself at Berkshire, would Buffett also have failed to invest the way he wanted to?

 

Joseph Taylor is an Associate Investment Specialist, Morningstar Australia and Firstlinks.

 

11 Comments
James Bell
June 23, 2024

To say Buffett is the most SUCCESSFUL investor ever is wrong - perhaps the MOST CONSISTENT LONG-TERM though.
To see this, note that the increase in capitalisation of NVidia increased in value by more than the market capitalisation of BERKSHIRE over a 7 week period during recent times (refer recent Jesse Felder Report stat). So 7 weeks outdoes 50 years!
Its an astounding statistic, but reaction must be tempered by the likely flash-in-the-pan of NVidia compared to the tried and true steady as she goes method of Buffett.
I know which one I'd rather follow over my investment lifetime and who I'd stick with, but I'd gladly take the profits of the NVidia founder at his age to be able to enjoy same.

Kevin
June 25, 2024

I don't know how this could be real.One is a company,one is a person.There is nothing at all to link them.Nvidia does not buy shares in other companies,never has,and probably never will.
Buffett buys shares in companies and has been very good at that ,it is undeniable,but people will deny it.Hiw is there anything to link them.

I use Wal Mart and BRK as a control in the USA..At a cost of US $ 15 ( or $14 ) in 1965 you can compound that @ ~ 20% and be reasonably close to the price of a BRK "A"" share.

Wal mart ~ 1971 was $16.50 at the IPO. You could have bought ~ 4 shares in Wal mart for the price of 1 share in BRK.After splits you have ~ 25,000 shares in Wal mart @ $66 each .If my mental arithmetic is right then $1.65 million .One has reinvested the dividends ,BRK.. One you have taken out the dividends,WMT.

For an outlay of ~ $150 you are extremely wealthy .People are going to deny that forever,no matter how simple and obvious it is.

For me CBA is Wal mart and NAB is BRK .I've owned them for decades,an outlay of ~ $12 or $13 K in 1991 has produced an astonishing return,just by reinvesting dividends until retirement.No matter how simple and obvious that is,no matter how undeniable it is,people are going to deny it forever.

I have no idea at all why people keep trying to turn simple common sense into complicated nonsense

Dudley
June 25, 2024

"simple common sense into complicated nonsense":

To find, on slim probability, tomorrow's winner(s) amongst thousands of likely losers.

Graeme
June 23, 2024

Reading what the best performers in any field of endeavour did to achieve that position is interesting, but that's about it. It is worth remembering that Buffett's wealth was the result of numerous responses to events occurring at the time. It is obviously impossible for us to be in his position. For a start we would have to have been born in 1930 in the USA!

Kevin
June 24, 2024

Reading one of those Hagstrom books in the mid - late 1990s the first 3 or 4 pages were taken up by the list of reasons that Buffett couldn't be a success.In no particular order ,,world war 2,Cuban missile crisis,bay of pigs incident,early 1970s oil crisis, Korean war,Vietnam war.A lot more that I have forgotten.

People will continue to do well,most of them will continue to cone up with infinite reasons and hypotheticals why they cannot do anything.

Buffett did have an advantage,people believed in him at the start,he raised $100K from people that had faith in him,but my memory could be wrong.That may be ~ $10 million now ,I don't know.

If people made a book of their own life it would be a book of reasons why the couldn't do something.There is no way it would be a book of all the mistakes they made by not trying to do something

Kerrie
June 23, 2024

What really is a successful investor?
If you continually earn more than you spend without taking a lot of risk then that to me is a successful investor.
Why earn lots of money just for the sake of doing so?
Greed is not always good.

Ed Heath
June 23, 2024

Modern society that wants everything "now" can not produce another Warren Buffett.

To become a "Warren" Buffett you need
1. to be blessed with a natural business mind
2. be a mathematical genius
3. work extremely hard throughout life
4. have strong character and clarity of thought
5. have moderate greed and remain interested in investment process
6. have patience and independent thinking
7. have good partners and teachers
8. only do things where you have some edge
9. remain humble and frugal
10. have honesty of thought and accept mistakes
11. have long term thinking and act like a business owner
12. avoid toxic people and unnecessary distractions

Today's world does not want an individual to have time to think. So producing another Warren Buffett is like expecting Jesus to come back on earth once again.



Tony
June 22, 2024

Maybe there aren't too many Buffetts in Australia, but I suspect there are quite a few investors who are doing nicely, thank you.
I have an SMSF with an external administrator. During the GFC I asked the administrator's technical guru what his typical client did. He said that most of us were all the same: the portfolios were direct Aussie blue chip shares and hardly anyone traded during the GFC unpleasantness. We just hung on and waited...

I believe the best strategy is education: understand volatility is different to risk, understand economic cycles, understand behavioural biases etc etc.
My personal competitive advantage is laziness....

Rick
June 23, 2024

“My personal competitive advantage is laziness....” - Gold! (Because it’s what most of us would be great/maybe good investors should be doing more of

Joseph Taylor
June 25, 2024

Hi Tony, my question was more about fund managers than individual investors.

I think your comment on SMSFs being able to hang on through the GFC reinforces one of my main points. SMSFs like yourself have the Buffett style advantage of "permanent capital" that clients can't ask to redeem at market bottoms. Most fund managers don't have that flexibility.

I agree that laziness is a competitive advantage. This is because it is something that most fund managers can't bring themselves to do. There is a compulsion to "do something" so that clients see that they are working hard." Doing something" often promises to help all-important short-term performance, often to the detriment of long-term results...

Jim
June 21, 2024

Great article. Hagstrom's books are all worth reading.

 

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