Buffet's alpha

The Efficient Market Hypothesis (EMH) teaches that no one can beat a general market index over the long run because the market instantly adjusts to all new information. The EMH has been mainstream dogma for longer than Warren Buffet has led Berkshire. Buffett doesn’t like the EMH and responded to the theory in this story that I included in my book Financial Bull Riding:

Warren Buffett got to the heart of the problem with the EMH at a 1984 conference at the Columbia Business School held to honor the 50th anniversary of Benjamin Graham’s Security Analysis. Finance professor Michael Jensen, a defender of EMH, told the audience that investors such as Buffett who beat the market were just lucky. The EMH did not assert that no one could get lucky; only that they couldn’t get lucky consistently. “If I survey a field of untalented analysts, all of whom are doing nothing but flipping coins,” Jensen said, “I expect to see some who have tossed two heads in a row and even some who have tossed ten heads in a row.”

Buffet's Investing Advice

Fortune magazine recently published an excerpt from Warren Buffet's annual letter to investors in which Buffet offers advice for the average investor. He starts by telling two investing stories:

This tale begins in Nebraska. From 1973 to 1981, the Midwest experienced an explosion in farm prices, caused by a widespread belief that runaway inflation was coming and fueled by the lending policies of small rural banks. Then the bubble burst, bringing price declines of 50% or more that devastated both leveraged farmers and their lenders. Five times as many Iowa and Nebraska banks failed in that bubble's aftermath as in our recent Great Recession.

Buffet the Great

Authors of a new paper, "Buffett’s Alpha", Andrea Frazzini and David Kabiller at AQR Capital Management crown Warren Buffett one of the best investors ever. I welcome this after decades of having to endure the worship of Keynes as the greatest investor. Keynes achieved his reputation, after years of failure, by investing in gold mining stocks during the time in which he used his political influence and notoriety to convince the US and UK to abandon the gold standard. Keynes succeeding through insider trading. Buffett did it the old fashioned way.

Here are excerpts from the paper:

We show that Buffett’s performance can be largely explained by exposures to value, low-risk, and quality factors. This finding is consistent with the idea that investors from Graham-and-Doddsville follow similar strategies to achieve similar results and inconsistent with stocks being chosen based on coin flips. Hence, Buffett’s success appears not to be luck...

Looking at all U.S. stocks from 1926 to 2011 that have been traded for more than 30 years, we find that Berkshire Hathaway has the highest Sharpe ratio among all. Similarly, Buffett has a higher Sharpe ratio than all U.S. mutual funds that have been around for more than 30 years...

We identify several general features of his portfolio: He buys stocks that are “safe” (with low beta and low volatility), “cheap” (i.e., value stocks with low price-to-book ratios), and high-quality (meaning stocks that profitable, stable, growing, and with high payout ratios).