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Buffet up in down years?


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Buffet often claims his portfolio will vastly outperform the indexes in bad years, and he said this in early letters before he was "buying fantastic businesses at fair prices." His returns reflect his predictions. Why is this? Does a large margin of safety account for this or are there other factors?

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  • 3 weeks later...

if I remember correctly, he had the portfolio pledged at Smith Barney against a long convert-short stock hedge.

 

That makes sense.  Where, when did you hear or read about that?

 

He met Ed Thorp in Orange County just as he was starting his hedge fund in the late 60's after being introduced by one of Ben Graham's relatives.  Warren then expressed approval of Thorp's convertible arbitrage strategy.  Evidently, Warren also voted with his dollars.  :)

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Buffet often claims his portfolio will vastly outperform the indexes in bad years, and he said this in early letters before he was "buying fantastic businesses at fair prices." His returns reflect his predictions. Why is this? Does a large margin of safety account for this or are there other factors?

 

During the partnership years in particular he made this claim due to work outs (Arbs, corporate actions, stocks like Sanborn Map) generating profits regardless of how the general market performed, thus he would outperform the market in bad years, but likely lag in good years.  He clearly states that the generals will likely decline similar to the indices.  During the last few decades, I believe he has said that Berkshire will function similarly.  I don't think he says portfolio.  So I take that as being based on his focus on Berkshire's book value continuing to grow since most of the business will still be profitable in down years.

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Yes he does outperform.

 

I follow approximately 400 managers around the world (mostly value-oriented). For all of them I look at the performance of their portfolio holding as disclosed in their various fillings (for the US for example you have the 13F, D and G fillings as well as the Form 3 and 4). The various portfolio statistics are calculated based on a rebalancing the day after change have been made public (no look-ahead bias)

 

I have attached some data on BRK. The first graph is the 10 biggest holdings equal weighted, rebalanced after every new public disclosure. The last graph is the performance of the 3, 5, 10 20 largest positions equal weighted relative to the S&P 500 equal weighted total return index.

 

Hope it helps,

damien

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Buffet often claims his portfolio will vastly outperform the indexes in bad years, and he said this in early letters before he was "buying fantastic businesses at fair prices." His returns reflect his predictions. Why is this? Does a large margin of safety account for this or are there other factors?

 

During the partnership years in particular he made this claim due to work outs (Arbs, corporate actions, stocks like Sanborn Map) generating profits regardless of how the general market performed, thus he would outperform the market in bad years, but likely lag in good years.  He clearly states that the generals will likely decline similar to the indices.  During the last few decades, I believe he has said that Berkshire will function similarly.  I don't think he says portfolio.  So I take that as being based on his focus on Berkshire's book value continuing to grow since most of the business will still be profitable in down years.

 

I always wondered about this quote as well, but my understanding is the same as Tim's interpretation.

 

I think Buffett is referring to book & intrinsic value. When the market is up a lot I would bet Buffett would say that the underlying intrinsic value of the companies that compose the index also underperform the performance of the index.

 

I really think all Buffett is trying to do is set expectations. Just because we enter into a strong bull market and Bershire's intrinsic value has grown slower than the index doesn't mean that Berkshire is "out of touch" or "too big". When a strong bull market occurs and Bershire underperforms Buffett can point to his letters and say that he said it would happen this way and it doesn't mean that Berkshire will underperform the index in the long run.

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When 90% of the portfolio is in low beta stocks, its logical to outperform the market in down years. Especially because the index has stocks of companies that go bankrupt in these "down" years.

In his first years it was probably that in crashes normally high valued stocks correct more than cheap things. You see this effect live in the last week, growth stocks have plunged while most value stocks have performed well or gone sideways.

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  • 2 months later...

twacowfa...for some reason I did not see your message.....at the time warren had the deal with smith barney, you could leave securities with them and have the hedge as margin.  reg t 223-3 permitted a long hedge of 10% of the long side as cover for the spread above parity. If the position was at parity, no margin was required. So you could create deep out of the money puts for zero.

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Outperform, but not necessarily return positive right (at least in recent years)?

 

Early in his career I imagine workout-type and special situations played a significant role in never experiencing a down year (as well as a little calendar-date luck).

 

Buffet often claims his portfolio will vastly outperform the indexes in bad years, and he said this in early letters before he was "buying fantastic businesses at fair prices." His returns reflect his predictions. Why is this? Does a large margin of safety account for this or are there other factors?

 

During the partnership years in particular he made this claim due to work outs (Arbs, corporate actions, stocks like Sanborn Map) generating profits regardless of how the general market performed, thus he would outperform the market in bad years, but likely lag in good years.  He clearly states that the generals will likely decline similar to the indices.  During the last few decades, I believe he has said that Berkshire will function similarly.  I don't think he says portfolio.  So I take that as being based on his focus on Berkshire's book value continuing to grow since most of the business will still be profitable in down years.

 

Agreed.

 

I think in early years he meant that his arb/workout/special situations would not be correlated with the market.

 

In his later years (and now) I think it is more that decline in book value would be much less than market in a down market.

For example, in 2008, book value was only down 9.6% whereas the SP was down 37%. (Berkshire share price however was down something like 32% or similar to the S&P.)

 

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The simplest explanation is that he has a non-zero allocation to stuff like cash, fixed-income, etc which are expected to under-perform the S&P500 significantly during up years. I think this is the part that often gets forgotten when people buy Berkshire Hathaway. It probably should not be benchmarked to the S&P500, because Berkshire is far less risky that the average stock in there, but Buffett uses it as a high bar to compete again.

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