Thursday, May 10, 2018

Why invoking Warren Buffett may be bad for the retail investor.

While Warren Buffett is over-represented in investment literature, the willingness of many gurus and trainers to channel him goes beyond belief. Invoking Warren Buffett in an investment lecture has almost become something akin to religious ritual. It creates instant credibility for the investment trainer even though in Singapore, he is not likely to be Warren Buffett.

( It's ridiculous right, it's like me quoting Xiaxue to get her readership figures.)

There are two instances in investment literature that show that such locally approximated "Warren Buffett" approaches might end up leading retail investors astray.

a) Quants have started figuring out the secret sauce of the Buffett technique

John Alberg and Michael Seckler in an article entitled Misunderstanding Buffett talks about how Berkshire Hathaway's returns can be replicated using factor models. A combination of value, quality, low beta and.... the liberal of leverage of up to 1.6x can allow a quantitative model to cover most of Buffett's returns.

Most of the time investment trainers tend to focus on the qualitative aspects of investment management like whether there is an investment moat or a sustainable competitive advantage or whether management is trustworthy. These are fluffy approaches towards investing which may cause the retail investors to lie to themselves and fall in love with a particular stock simply because too much time has already been spent analyzing it.

At this point I'd like to say that only Dr Wealth's Factor based approach seems to get the technique right with as little emotion as possible. ( While Alvin Chow is a friend, but he did not pay me to say this )

b) Berkshire actually runs three portfolios of which only two can be replicated by a retail investor.

 This second insight on Warren Buffett actually came from an autobiography by Ed Thorpe entitled A Man for all Markets whom I had a much closer affinity with because I'm primary a numbers guy, he is a mathematician and has beaten casinos in black jack and roulette before conquering the financial markets.

According to this book, the simplest way to look at Berkshire Hathaway is to see it as a collection  three portfolios. Only the first portfolio can be replicated well by a retail investor because it consists of publicly owned stocks. The second portfolio consists of GEICO/General Re - his various insurance businesses that allow him to create some kind of faux leverage through "insurance float", investing the premiums he earns that hasn't been paid out.  His third portfolio consists of stocks that simply are not publicly Wesco Financial and Clayton Homes.

Anyway, the next time you encounter a someone channeling Warren Buffett, you might want to read these two books and engage them in a spirited debate to see how their ideas hold up.


  1. Hi Christopher,

    One additional point to note is that buffet has the financial ability to buyover entire companies that he perceive to have great economics. His reputation and clout (ability to pay cash on demand) allow him to often negotiate favourable terms, while retail investors have to respond to the whims of Mr Market.

    Additionally, his investment methodology has been evolving throughout the ages. From the cigar butt approach whereby he buy companies that are worth more dead than alive, he started to pay a slight premium for growth and now he buyout huge stakes in companies that he deems to have superior economics.

    I am not sure if there is a factor based model that can incorporate all these qualitative aspects. Especially if these models utilise past information that may be poor predictor of future economics. Stocks are ultimately about projecting the future (perpetuity) to the present and most business don't present stable and linear growth.

  2. Good point. How many investors can buy such a huge chunk of shares that they can force management to release cash assets to shareholders ?

  3. Retail investors are just buying shares to sell or hold. Why some retail investors are thinking that they are part business owners?

  4. Because Millenials invented the concept of HODL.