In an age of mature, highly liquid markets where arbitrageurs exploit ever smaller market inefficiencies, it’s easy to become jaded about the prospects of any manager to produce alpha over the long term. In his (excellent) new book “More Money Than God“, Sebastian Mallaby wonders if Julian Robertson’s 26% annual return between 1980 and 2000 was skill or statistical fluke…
“…Over the 21 calendar years in which Tiger’s investment decisions were controlled by Robertson, the fund was up seventeen of them…Could it be that Robertson was merely lucky? The laws of probability lay down that if one thousand people flip 21 coins, four of them will come up with heads 17 or more times, mimicking Robertson’s performance.”
By illustrating that Robertson’ “Tiger Cubs” also tended to beat the market, Mallaby concludes that Tiger’s fantastic returns were, in all likelihood, alpha.
The same argument can be made about Warren Buffett. Despite his long term returns, the academic buried within many of today’s “sophisticated investors” and commentators (including us back in 2007) apparently just can’t come around to believing that The Oracle of Omaha has a fundamental market advantage or that he manages to exploit some kind of market inefficiency that no one else can see.
This is also one of the conclusions of a study by John Hughes, Jing Liu (both of UCLA) and Mingshan Zhang (of Hong Kong University of Science and Technology). The trio finds that even when Buffett reveals his holdings via 13F filings, investors still refuse to replicate his positions…
“…Assuming Buffett’s success is attributable to superior information, the rationale for Berkshire Hathaway holding positions beyond public disclosure of trades based on that information is puzzling. An efficient market, in the semistrong form, would quickly drive equilibrium prices to reflect the information content of such disclosures, implying no further benefit should be in the offing. Moreover, if the market under reacts, then given required quarterly disclosure of portfolio changes, it would seem a simple matter to mimic that strategy and achieve quite similar success. Accordingly, one would expect that sophisticated market participants would quickly dissipate any inefficiency of that nature. However, as we will show, this does not occur.”
Why? The authors suggest hubris – or at least the quest to make a name for one’s self – may be the cause…
“…financial analysts and fund managers may believe their independent judgment is superior and seek to distinguish their expertise by purposefully not mimicking others such as Buffett.”
This overconfidence, the say, takes the form of ratings downgrades following Berkshire Hathaway disclosures, and institutional investors eager to take the other side of the Oracle’s trades. They also cite research showing the chances of Buffett’s track record occurring by chance as less than 1% (even less likely than Robertson’s). But such market under-reaction to apparently useful information is nothing new. Previous research has shown that investors also tend to yawn in the face of earnings announcements, dividends and a whole host of other corporate information.
After establishing that Berkshire Hathaway did indeed produce alpha (after accounting for the usual factors plus a host of accounting factors), the authors chart the progress of hypothetical “mimicking” portfolios that invest in Berkshire Hathaway’s positions during successive months following the 13F filings. You’d expect more than a few investors to load up of any new Buffett favorites immediately when the 13F hit the street. But what surprised the authors the most was that the upside in Buffet’s positions was not immediately arbitraged away.
The chart below contains the abnormal returns from copying The Oracle’s positions the month after they go public, two months after, and so on. Missed the 13F filing? No worries. Were at the cottage for the summer? No problem. Were living under a rock for the past six months? You’re good! In fact, you could have quit your job as a portfolio manager, started a village bookstore in rural Connecticut, got bored, joined a hedge fund a year later and still, you could have exploited the information contained in that outdated 13F.
Berkshire Hathaway isn’t the only institutional investors at which analysts thumb their noses. Hughes, Liu and Zhang also look at the performance of stocks owned by other top performing institutions. Again, they found that you can generate alpha by simply copying the portfolios of these top performers.
Efficient markets? Apparently not that efficient. At the end of the day, the market’s apparent unwillingness to exploit all the information contained in 13F filings may boil down to an existential question of whether investors should believe in something they cannot see – or rather ignore what they clearly can see.
Either way, it spells good news for the creators of fund mimicking techniques such as the one described in this AllAboutAlpha.com post by CAIA designee Mebane Faber.
[Ed: Does that German octopus of World Cup prognostication fame have to file 13F’s?]