This new paper reveals the secrets of investment guru Warren Buffett It's an old question - and until now an unanswered one - just how does Warren Buffett manage to make all that money?
The investment guru is an anomaly, and the chart below is a reminder (if you needed one). It's a representation of the success of Buffett's company, Berkshire Hathaway. Its returns are a complete outlier.
More fully that chart shows how Berkshire stacks up against common stocks, and the numbers have been crunched by Andrea Frazzini, David Kabiller, and Lasse H. Pedersen in their new paper "Buffett's Alpha".The City AM folks didn't provide a link so here's the version at Yale (45 page PDF)
Berkshire Hathaway has realised a Sharpe ratio (a measure of risk-adjusted performance) ahead of any other stock or mutual fund with a history of more than 30 years.
Buffett says it's not luck either - he thinks it's no coincidence that many stock market winners come from the same intellectual village. And that Sharpe ratio - 0.76 - is less than many would imagine (despite being nearly double the ratio of the overall stock market).
The paper's authors try to explain Buffett's staggering success with statistical techniques. Most common theories - based on the "alpha" and "beta" of stocks don't stand up.
You can also throw out the idea that Buffett's success comes from his influence on the companies whose stocks he owns - his publicly traded stocks perform better than the companies he owns in whole.
The researchers find that exotic returns have a less than alien explanation, "neither luck nor magic". Leverage The authors show that Buffett is rewarded for the use of leverage (the authors estimate a leverage of about 1.6-to-1). That leverage ratio boosts his risk and excess return in that proportion....MUCH MORE
Back in September 2012 we looked at an early draft of the paper at The Economist:
Warren Buffet: The King of Leveraged Low Beta (BRK.B)
See also Institutional Investor's "Is Alpha Dead? Beating the Market Has Become Nearly Impossible".
