There’s been a lot written, digested, spat out and sensationalised recently over the apparent demise of Warren Buffett. Also known as the Sage of Omaha, Buffett has long been hailed as the greatest genius the investing world has ever witnessed.
There’s no denying his incredible successes over many decades of investing with his business Berkshire Hathaway. If you’d bought £1,000 of Berkshire shares in 1964 you’d find they are worth £18.3m by the end of last year. But now at 84 and with a few significant losses tarnishing his recent portfolio strategy – he admitted the $678m hit he took on Tesco shares was a “huge mistake” – many media pundits are looking to the next generation of prodigious stock-pickers.
They can give up looking right now. The start truth is that there is no future generation. Active investing – that is, frequently buying and selling shares in companies you think will deliver you the best profits – no longer works. It’s a dead art. And Buffett’s exit march will be the final nail in its common.
Don’t look back in anger
Times have changed since Buffett started making a name for himself. Back then, glorious insight into low-value and low-risk companies to invest in was a rare and precious commodity. Buffett had the ability to pick out the value and used that ability in abundance to his own ends.
He has made mistakes along the way, of course, and several times people have questioned whether the great man had lost his golden touch, only for him to bounce back with a fresh ‘win’, or calmly hang on to any investments that had dramatically tanked and watch them rise again from the ashes.
But things are different now. His decision to sell Tesco shares after they bombed is telling. That could have been his second biggest error in recent years. Buffett appears to be going against his own philosophy and looks unsure. His ardent followers – and there are millions the world over – will be feeling nervous. And so they should. Stock-picking is officially a mug’s game.
Beating the best
Everyone wants the edge; everyone wants to make more than the next man. And herein lies half of the problem. We’re all on the look out for the next Buffett, the next superstar fund manager. So we go in search of the guy who made stellar investment returns last year. “He’s got it! He’s a genius!” we tell ourselves. “And he’s new. I’ll get in there first, put my money – and trust – in his fund and he’ll make me a ruddy millionaire!” Wrong.
The media coverage soon builds up a near-mythical status around any fund manager performing well over a short space of time. They are catapulted to stardom appearing in top 10 best fund lists from here to Timbuktu, winning awards for best broker, best regional fund manager, best commodities trader, and so on. Collectively, the apparently elite in investment management.
It’s all hogwash. They just had a lucky run. They don’t have secrets or special insight or data modelling systems that are more sophisticated than any other. But people back them, they put their money with them and this means that the shares they pick go up in value.
It’s catch 22, a self-fulfilling prophecy perpetuated by nothing but media hype. And when it goes wrong and a Tesco or an RBS in their portfolio bombs, you’ll see everyone question that very same fund manager. Under the scorching spotlight of scrutiny his or her investors pull out and go in search of the next big thing. It’s a complete fallacy and an entire industry, the biggest and most powerful industry in the world, is built on this hot-air, illusion and fabrication.
Pulling the plug
The truth is slow to emerge because it puts many people out of business. The fund managers, their accountants and traders, the banks that look after the money, the journalists and broadcasters that write and pontificate about it day and night. There’s nothing in it for them to declare the whole thing a myth. But that’s what it is.
So, to the alternative. Passive investing. If you’re looking for your next big thing, that’s it.
Passive investing is boring. It’s sensible. It gives you reliable, long-term returns on your money. It works but it doesn’t make for catchy headlines so there’s not much written about it. And it doesn’t require millions of people to do it. When it becomes the norm, and it will, it effectively puts more than half the current investment industry workforce on the dole. It relies on technology and data, not instinct or chance.
Passive investing is where you spread your money across hundreds or even thousands of different companies to track the large financial markets, like the FTSE in the UK or the S&P in the US. You can do the same with stock markets all around the world, not to mention bond markets, commodity markets, commercial property, and more.
The theory is simple: All big companies that can go tits up. You invest heavily in one such bad apple and you lose a lot of dosh. Passive investing protects you from that. It tracks the best of breed investment opportunities in a way that doesn’t leave you in danger of losing the lot on a bad pick.
Passive is trending
It’s starting to catch on. Assets in actively managed US funds rose by 38.7pc from 2007 to 2014, while their passively managed peers grew by 169.9pc.
More and more research is emerging every year to demonstrate the benefits of passive investing and highlights the pitfalls of active investing. Using data from 1982 to 2010, economists Eugene Fama and Kenneth French found that after the fees charged by actively managed funds, only about 3pc of these funds outperform their passive peers – the funds that attempt to mimic the market as a whole, rather than to game it.
A Dalbar study in the US has shown that over the the 30 years to the end of 2013 fund investors earned an average annual return of 3.69%. If they’d simply tracked the S&P 500 in that time they’d have got 11.1% return. But most investors jump in and out of the market all the time, looking for opportunities, trying to beat the market in their crass active way.
Man or machine
The bottom line is that human instinct (greed) takes over. Our behaviour cannot be trusted in a financial environment.
Life after Buffett? It’s going to be very different. And we’ll miss the big man, because he’s an incredibly engaging, fascinating showman. In some ways, to me at least, he’s the embodiment of the old-school trading room hustler.
But the future is bright. The future is going to be beautifully elegant in its simplicity and technical sophistication. It’s time to embrace it, ditch active investing and drag the industry into more modern times.