World Beta Blog

One of the best takeaways from this paper, Buffett’s Alpha,  is the realization that the best performing mutual fund OR stock over long periods only clocked in at a Sharpe ratio of around 0.76.  If you’ve read a lot of our old posts you would know that is something we have been chatting about but still most investors get dazzled with claims of Sharpe ratios of 1, 2, or even higher (ahem options selling funds).  Here is a post we did in 2009 called Where Have All the Sharpe Ratios (Over 1) Gone?  

As a follow up to our earlier post “Let’s Talk About Professional Funds“, here is a great graphic from the guys at BlackStar showing the unsustainability of a Sharpe Ratio over 1 for longer than short periods of time (and this is for CTAs that still exist!!)  :

Likewise, Wes Gray did a fun post on the difficulty of sustaining big returns (reposted here from 10/2011):

I like reading Joel Greenblatt’s books, and there is a nice summary from the recent VIC where Greenblatt presented here (referring to Tilson’s Value Investing Congress, different than Greenblatt’s Value Investing Club (recent post here) which is confusing since Greenblatt is speaking at Tilson’s).  I often see references to Greenblatt’s Gotham Capital returns over 20 years – 40% a year.  If true, those are some of the best returns in the history of markets.  Indeed, an investor in his fund would have seen returns of almost two orders of magnitude above his initial investment.  ie assuming the fund was started at a reasonable $10mln, after 20 years it would be worth $8.4 BILLION.  That is without any withdrawls or additions of course.  Although my best guess is that the fund was small, existed largely during the go-go ’80s and ’90s, maybe used a little leverage, and paid out regular distributions.  Regardless, those are awesome numbers.

To see just how difficult that is check out the great blog post by my buddy Wes at Turnkey Analyst: Mission Impossible:  Beating the Market Over Long Periods of Time.  (Also lots in the blog archives on the difficulty of sustaining alpha returns…)

From the Turnkey Analyst Blog:

Summary Findings

Before I even begin, here are some findings (I use the CRSP return database which starts January 1, 1926 and runs through December 31, 2010):

• Earning 20%+ returns over very long horizons is for all intent and purposes virtually IMPOSSIBLE(assuming the market experience of the past ~90 years is representative of the future).
• 31.5%+ returns over the 1926 to 2010 period imply that an investor will end up owning over halfof the ENTIRE stock market.
• 33%+ returns imply that an investor will end up owning the ENTIRE STOCK MARKET!
• A 40% return will have you owning the entire stock market in ~60 years–not a bad retirement plan!
• A “doable” 21.5% a year implies an investor will own .62241% of the market at the end of 2010. With a $16.4 trillion total market value as of December 31, 2010, this would imply a personal stock portfolio worth $102 billion!!!
• Warren Buffett–and perhaps a very select handful of others–have been able to achieve 20%+ returns over very long time periods. These individuals represent some of the richest people on the planet because of this very phenomenon.
• An investor might have an epic run of 20% returns for 5, 10, maybe even 15, or 20 years, but as an investor’s capital base grows exponentially, the capital base slowly becomes ALL capital, and all capital cannot outperform itself!

What is really interesting to me is that often the great investment approaches seem so obvious in retrospect.  Buffett has one of the best track records ever by buying cheap, safe, high quality stocks in a structure that allows for sub Tbill leverage.  But the key is that he came to this realization before most.  Ditto for the top endowments like Harvard and Yale and their extreme diversification – it is quite obvious now, but they were pioneering these concepts decades ago.  The pioneering trendfollowers and managed futures shops caught onto an idea long before computers made it simple, as did Bogle (indexing), and DFA (quant multifactor).

The question is, what will seem obvious 10, or 20 years from now?

I think this is a really interesting paper.  I am really surprised at the stat that “Berkshire Hathaway has a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years” at only 0.76.

We identify several 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  are pofitable, stable, growing, and with high payout ratios)….we create a portfolio that tracks Buffett’s market exposure and active stock-selection themes, leveraged to the same active risk as Berkshire. We find that this systematic Buffett-style portfolio performs comparably to Berkshire Hathaway. Buffett’s genius thus appears to be at least partly in recognizing early on, implicitly or explicitly, that these factors work, applying leverage without ever having to fire sale, and sticking to his principles.

Buffet’s Alpha

ABSTRACT

Berkshire Hathaway has a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha become statistically insignificant when controlling for exposures to Betting-Against-Beta and quality factors. We estimate that Berkshire’s average leverage is about 1.6-to-1 and that it relies on unusually low-cost and stable sources of financing. Berkshire’s returns can thus largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks. We find that Berkshire’s portfolio of publicly-traded stocks outperform private companies, suggesting that Buffett’s returns are more due to stock selection than to a direct effect on management.

I linked to the risk parity paper recently, but here is another paper out from the good folks at Cass…

Charlie Munger, “I believe in the discipline of mastering the best that other people have ever figured out.  I don’t believe in just sitting there and trying to dream it up all yourself.  Nobody’s that smart”.

One of the challenges of successful investing is getting access to high quality ideas - the old “finding the signal in the noise” problem.  Often, investors do not have access to (or the funds) to subscribe to many of these private publications that can cost anywhere from $100 to well over $100,000 per year.

To help our readers, as well as try to find some investments gems ourselves, we have a new email list / website that we are starting this month called The Idea Farm.  The concept is simple, and free:

-  Each week the reader will receive an email with a new research piece from one of the top boutiques across the country. (Likely on Sunday so you can read it with your Barron’s).

-  The focus will be research that tends to be independent, actionable, and practical.

-  Often we will disagree with some or all of the material, but believe in being exposed to ideas that contradict our own.

-  You will gain access to publications that would cost well over $100,000 to subscribe to individually, for free.

-  We will never share, sell, or otherwise pass along your email address.  You can unsubscribe at any time with one click.

That’s it.  I subscribe to many of these publications, and find that reading independent, and often variant, perceptions helps to hone my own investment process.  Since we are reviewing these research pieces already we feel like many of our readers would also be interested in being exposed to some of these ideas and concepts.

As always, let me know what you think.  Feel free to pass along the website to friends, and if you have any ideas for improving the concept please let me know!

The first email will go out soon so make sure to signup here: The Idea Farm. (Note:  This is a separate list from my Cambria updates…)

PS:  If you write an investment newsletter and want to share you work with our readers feel free to shoot me an email to review you most recent publication.

The S&P 500, including dividends, is at an all time high? (HT: Petruno)

Travel gonna start picking up after a few more weeks of summertime…Lots of interesting announcements and some fun summer readings coming up in the next few weeks.

As always, drop me a line if you’re in the following cities.

Denver:  September 7- 10

San Francisco:  September 11th +- a few days, FX

Chicago:  October 3-5, Morningstar

Scottsdale:  October 10-12, Powershares

Boston:  October 17-18, State Street

Seattle:  October 19-21, MTA

Back in the day my firm was going to launch two exchange-traded funds in the Fall of 2008.  One was going to be a tactical endowment style ETF, and the other was going to be a foreign listed hedge fund ETN with funds sorted based on discount to NAV.

Fast forward and our partners got cold feet as the financial markets were imploding.  We wrote a little bit about the foreign listed hedge fund space in our book The Ivy Portfolio, and below are a few of the funds we profiled with performance since 2009 publication.  Some have done better than the S&P, some worse, and one much better.  That fund is Third Point, and one of the reasons the performance has been so strong is that it was trading at a 30-50% discount to NAV at the end of 2008 as we mentioned back in early 2009.  (Foreign listed hedge funds trade like closed end funds do in the US with discounts/premiums to NAV.)

Lots more info in the archives and the blog on these funds.  I eventually gave up writing about these funds as very few have/had any interest or even knowledge of their existence, and they are a pain for US investors.

Third Point, TPOG

BH Macro, BHMG

Dexion Absolute, DAB

Alternative Investment Strategies, AIS

Goldman Sachs Dynamic Ops, GSDO

Thames River Multi Hedge, TRMU

Dexion Equity Alternatives, DEA

Samuel Lee has a great article “The Hedgehog’s Error” on Morningstar that does a simple quant sorting of global countries based on value (P/B).  Not surprisingly he finds that sorting on value, aka buy low sell high, works.  More importantly he unveils a database of French Fama international data on a country level basis that I previously had not seen and that costs $10,000 plus elsewhere.  Huge find!:

I’ve reproduced the results of a classic price/book sorting strategy applied to country indexes. The country-level stock market and price/book data come from the French Data Library. The strategy is simple: At the end of each December, sort country equity markets by their price/book ratios. Buy in equal weights the six with the lowest ratios (the cheapest markets); short in equal weights the six with the highest ratios (the most expensive markets). Rebalance monthly. The strategy produced an excess return of 4.42% annualized for the period 1976–2011. With Europe trading at depressed valuation ratios, mean reversion suggests that the region is poised for long-run outperformance.

Long time Blue Ridge Capital analyst Rick Gerson is starting his own firm with a solid $1.2B launch…not a bad seed!

We have talked about the Tiger Cubs in our book and blog quite a bit before, but it has been awhile so below is a summary of the top 10 most popular stocks owned by 21 Tiger Cubs since 2000, some solid outperformance.  Top holdings currently include GOOG, AAPL, PCLN, QCOM, and MA.

(Not related but here is GMOs latest quarterly letter as well.)

Source: AlphaClone

Newsweek to move online:

“The transition to online from hard print will take place,” Diller said. “We’re examining all of our options.”

A plan to move Newsweek to an online-only publication will be announced as early as September, Diller said. Newsweek became part of his media holdings in 2011 when it merged with IAC’s Daily Beast Co., an online news startup that Diller started with former Vanity Fair editor Tina Brown. The merger was part of an agreement with the late Sidney Harman, who acquired Newsweek from Washington Post Co. for $1 and the assumption of liabilities.

And an older announcement From TalkingBizNews:

“Dow Jones & Co. plans to stop publishing the print version of SmartMoney, a personal finance magazine, although it will expand its digital platform, according to two people familiar with the matter, reports John Jannarone and William Launder of The Wall Street Journal.

Jannarone and Launder write, “Layoffs are expected, but the number of positions to be eliminated is unclear, one of these people said. An official announcement could come as soon as Thursday.”

The business models of these magazines (and many websites) is opposite of what it should be in today’s world.  Instead of having a bloated staff with tons of overhead like most magazines, a publication can outsource the content to the best all-star writers already writing.

Our old post on the theStreet.com below from December 2011 (since the post has vanished from my archives for some unknown reason):

There was news yesterday that an activist fund is getting more activist on TheStreet.com.  I had a good friend that thought about buying the company at one point (but I seem to remember some sort of poison pill or some weird structure that prevents it?).

It has always astounded me how TheStreet.com doesn’t make money.  And by that I mean make money hand over fist.  After all, they’ve had some pretty amazing writers over the years.  The usually have revenue in the ballpark of $30 mln or so per year, but as long as I can remember, have not ever really turned a profit.  The get most of their revenue from the premium offerings so I am not sure whey they litter their sites with Google ads promoting penny stocks.  It isn’t a major revenue driver and it kills your credibility.  You hold yourself out to be a great education resource but you’re touting retail currency trading and penny stocks?

Now, this isn’t just limited to TheStreet.com.  The lack of quality investment websites also floors me.  This has been a major opportunity for the past 10 years, but most sites simply follow the ‘vomit up as much content as possible and put as many Google ads on a page’ business model.  Most are simply low quality content farms, with some – and I’m not joking – having over 4000 writers.

I used to write for/get aggregated by a number of these sites before cutting ties with all of them many years ago.  Out of frustration, for a number of years I had considered launching a new site that would be focused on quality investment ideas and commentary.

The concept is so simple:  just choose the top 10-20 blogs and republish their best stories (with permission).  Create a place where the bloggers can interact with each other.  Do a monthly or bi-weekly magazine online that republishes the 10 best articles.  To the extent the authors offer premium services, let those be offered.  The top 20 blogs already control vast traffic, so they can form their own site, control their own destiny, and don’t need to partner with a non-rev generating partner.

Heavy emphasis on branding the story with the author’s blog with prominent links to their logo and site.  All of the bloggers will receive a share of the ad revenue from their content pages, as well as founding bloggers receiving equity in the parent company.

The fixes the high noise problem (too many bad writers), as well as the blogger problem (are not compensated at most sites, don’t want to be associated with low quality sites).

There would be very little editorial costs, perhaps a couple editors/tech hires in-house (but certainly not $30 mln worth of expense!).  I went as far as contacting a number of the best bloggers, and most were on board.  The problem for me is that it is not what I want to spend my time doing (that is research, writing, and money management).  So, if you want to run with this idea let me know.

Seems like a much better business model than what is currently out there.