I think this is a really interesting paper. I am really surprised at the stat that “Berkshire Hathaway has a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years” at only 0.76.
We identify several features of his portfolio: He buys stocks that are “safe” (with low beta and low volatility), “cheap” (i.e., value stocks with low price-to-book ratios), and high-quality (meaning stocks that are pofitable, stable, growing, and with high payout ratios)….we create a portfolio that tracks Buffett’s market exposure and active stock-selection themes, leveraged to the same active risk as Berkshire. We find that this systematic Buffett-style portfolio performs comparably to Berkshire Hathaway. Buffett’s genius thus appears to be at least partly in recognizing early on, implicitly or explicitly, that these factors work, applying leverage without ever having to fire sale, and sticking to his principles.
ABSTRACT
Berkshire Hathaway has a higher Sharpe ratio than any stock or mutual fund with a history of more than 30 years and Berkshire has a significant alpha to traditional risk factors. However, we find that the alpha become statistically insignificant when controlling for exposures to Betting-Against-Beta and quality factors. We estimate that Berkshire’s average leverage is about 1.6-to-1 and that it relies on unusually low-cost and stable sources of financing. Berkshire’s returns can thus largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks. We find that Berkshire’s portfolio of publicly-traded stocks outperform private companies, suggesting that Buffett’s returns are more due to stock selection than to a direct effect on management.
