Warren Buffett is considered to be the greatest investor of all time. And he is one of the most talked about investors, with financial publications always offering news and views on his interviews and stock positions.
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Every quarter, when Berkshire Hathaway publishes its quarterly report as well as its quarterly portfolio report, journalists, bloggers, investors and aspiring investors (this includes the author of this article) warm over the statements to try and learn as much as possible from The Oracle of Omaha’s actions over the previous three month
With this being the case, you would think, that with markets being genuinely efficient, trying to generate outperformance by copying Buffett’s portfolio would be impossible. It seems that this is not the case.
A study published in 2010 by John S. Hughes (University of California at Los Angeles), Jing Liu (The Cheung Kong Graduate School of Business) and Mingshan Zhang (Hong Kong University of Science & Technology) considers the above question and found that on average, it was possible to replicate the performance of Berkshire Hathaway just by copying Warren Buffett’s trades.
The evidence seems to suggest that this is possible because Wall Street is overconfident in its abilities. Specifically, the paper finds that around the times Berkshire’s holdings are made public, Wall Street tends to recommend avoiding the stocks based on other fundamental factors, overestimating their stock picking abilities and underweighting public information.
To arrive at the above conclusion, Hughes et al. studied the quarterly reports of securities holdings filed by Berkshire Hathaway to the US Securities and Exchange Commission between 1980 and December 2006. Over this period the researchers observe 2,140 quarterly stock observations on publicly traded holdings. There are also 275 observations for which Berkshire Hathaway received SEC approval for confidential treatment. Of these 2,415 observations, lack of training data available eliminates 163 from the study, leaving 2,252 observations between 1980 and 2006.
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Alongside the equity price trading data, the researchers compile insider trading data on officers, directors, and owners of 10% or more of the equity for each company under consideration.
As well as the performance data after Berkshire Hathaway reveals its position, which I will cover later, the stock holding observations show some other interesting trends about Buffett’s investment career. For example, according to the paper when it comes to Wall Street recommendations, Buffett is a contrarian with analysts recommendations somewhat lower for Berkshire Hathaway holdings than the broader S&P 500 on average measured on a five-point scale ranging from strong buy to strong sell, the median recommendations are 2.26 and 2.13, respectively.
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Further, and perhaps more revealing, is the fact that despite Buffett’s perception as a long-term investor, the median holding period of all stocks is a year, with approximately 20% of all shares held for more than two years. 30% of the positions were sold within six months.
Portfolio diversification also varies widely. The mean number of stocks owned throughout the study period was 22 for the decade ending 1990. Between 1990 and the year 2000, the average number of shares was just 12 but after 2000 the mean rose to 33. Over the 26 years of sample data, the number of holdings ranges from 95 to five. But no matter how many positions were included in the portfolio, the sectors owned were always reasonably similar. Banking, business services, insurance, and publishing are Buffett’s preferred industries, displaying his circle of competence.
But what about Buffett’s impact on the market? Does his involvement with a company ever move the price? It seems that if he has any effect on a position, it is limited. According to the study, market-adjusted returns for equities where Buffett discloses a position vary from approximately 0.7% to 0.9% over the five-day and two-week windows, respectively, for increases. They are more pronounced for disclosures of purchases receiving confidential treatment (1.3% to 2.3%).
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The reason why this is the case seems to lie with investors’ and insiders’ overconfidence in their abilities. According to the paper’s analysis, following the disclosure that Warren Buffett has entered a position, net insider sales decrease by 0.11 in the same quarter, although this impact is short lived.
Meanwhile, on average, analysts revise their recommendations slightly downward in the quarter when Berkshire Hathaway’s holdings increase, and on average over the next three quarters, suggesting that they place little if any weight on public disclosure of these changes.
The evidence suggests that this is a foolish move on Wall Street’s part.
Looking at the returns of the equity positions observed over the 1980 to 2006 study period, the paper finds that Berkshire Hathaway’s annualized abnormal return from stock holdings (adjusted for market, size, book-to-market and momentum factors) is 7.2%. What’s more, a value-weighted (equal-weighted) portfolio that mimics Berkshire Hathaway’s holdings, reformed quarterly based on company filings, generated an annualized abnormal return of 6% (6.6%) over the entire sample period.
Put simply; this paper seems to suggest that is easy to copy Warren Buffett’s performance, all you need to do is copy his positions. It is also interesting to note that Buffett is not as much of a long-term investor as he purports to be, with an average holding period of less than a year for nearly two-thirds of his portfolio between 1980 and 2006.
