The arrival of Berkshire Hathaway’s annual letter, the latest of which landed over the weekend, is eagerly anticipated by mutual fund managers for Warren Buffett’s pearls of investment wisdom and insights into his stockpicking prowess.
Yet the Oracle of Omaha has never been too enamoured of the actively managed mutual fund industry. A year ago, he told everyone he wanted his wife to put her money into a Vanguard stock market tracker fund after he is gone.
Hopping in the Tardis, we find that Buffett's harsh words for many fund managers stretch all the way back to his days running the Buffett Partnership, the forerunner to Berkshire. This golden anniversary year for Buffett's association with Berkshire is a good excuse to delve into the archives, and it is surprising just how relevant his insights are to today's debate between active and passive management.
The Buffett Partnership began comparing itself to four of the era's largest US mutual funds back in 1962. Needless to say, none of the Massachusetts Investors Trust, Investors Stock Fund, Tri-Continental Corp or Lehman Corp funds were a match for Buffett. The best of the four, Tri-Continental, returned 45 per cent over the four years Buffett had been investing, compared with 107 per cent by the partnership; by 1969, Tri-Continental had returned 200 per cent, while Buffett's partnership was up 1,403 per cent since inception.
Performance benchmarks
Tellingly, the mutual funds were not even able to keep up with the Dow Jones Industrial Average for most of the 1960s, although they had moved very modestly ahead by the end of the decade. To all intents and purposes, active managers hugged the Dow.
Buffett’s early letters argued that fund managers should be judged against performance benchmarks, as Buffett judged himself against the Dow.
For what was still a relatively young and opaque mutual fund industry, this was a novel idea back then. It was an argument that was eventually won, of course, but still the Buffettian critique of benchmark-huggers masquerading as active managers remains relevant today.
The antidote to benchmark-hugging performance was, and still is, portfolio concentration, where a mutual fund manager can make a small number of outsize bets, so that winners can really move the needle.
This is harder at the very large mutual funds than it is at smaller rivals, and it requires investors who are willing to take the heightened risks and a fund manager with supreme self-confidence.
It sounds more like a hedge fund, in fact, which in many ways the Buffett Partnership was.– Copyright The Financial Times Limited 2015
