The importance of repeatable fund manager performance

Ian de Lange of Seed Investments writes that Warren Buffett has been described as one of the best investors of all time. He has a fantastic long term track record as an allocator of capital. But he asks 'Is the historical performance repeatable?'

Probably more than any other single person, Burret has used the magic of compounding to its fullest extent with the listed investment vehicle Berkshire Hathaway.

His 2009 annual report has recently been released, which annually compares the movement in the per share book value of the Berkshire shares compared to the annual percentage change in the S&P500 including dividends to ensure a like for like comparison from 1965, which is when Buffett took control of the company. 

The book value has been used as the most appropriate metric to measure, because this is largely controllable by the managers of the business. The market price tends to be more volatile and the managers of a business have very little to no control over this price on a year by year basis.

The book value grew from $19 in 1965 to its current $84 487 per share, which is a compounded 20,3%. By comparison, the annual compounded gain in the S&P500 from 1965 is 9,3% and so Berkshire’s book value has grown at a rate of some 11% ahead of the overall market as measured by the S&P500.

The cumulative effect of this difference over an extended period of 45 years is very big. In the case of the S&P500 index an investor would have received a cumulative 5430% and in the case of an investor in Berkshire a cumulative 434,057%.

As an early and major investor however, Warren Buffett received an even higher return. Berkshire was a listed company where the market price traded below book value – which is exactly one of the reasons which made it favourable to Buffett. From a position where the price traded at a discount, it has now moved to a position where it generally trades at a premium. Buffett, along with other early investors who stayed the course would have received this additional benefit and he calculates that on a price to price basis, the annual compounded return has been 22%, which gives a cumulative 801,516%.

The question is asked “is the historical outperformance repeatable as the company gets bigger and bigger?” This is the same question that one needs to ask of a fund manager where performance naturally attracts more assets. We have aggregated and averaged Buffett’s outperformance (alpha) into 9, five year periods. It is clear that the first 25 years produced exceptional outperformance, but that this has been tempered over the last 20 - still a very credible number.  

Buffett himself answers the question in his report : “The big minus is that our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue. To be sure, Berkshire has many outstanding businesses and a cadre of truly great managers, operating within an unusual corporate culture that lets them maximize their talents. Charlie and I believe these factors will continue to produce better-than-average results over time. "But huge sums forge their own anchor and our future advantage, if any, will be a small fraction of our historical edge.” Emphasis added.