Revisiting Warren Buffett’s Bet on the S&P 500

Copyright DonkeyHotey

The Oracle of Omaha made a very public bet with Protégé Partners on December 19, 2007 that over the following 10 years, an unmanaged S&P 500 index fund would outperform a collection of five high-profile fund-of-funds.

Buffett won the bet… and it wasn’t even close. The S&P 500 returned a cumulative 125.8% (or 8.5% per year). The hedge funds delivered cumulative returns ranging from just 2.8% to 87.7% (0.3% to 6.5% per year). And remember, this time period includes the 2008 meltdown.

As Buffett writes in his latest annual letter,

The five funds-of-funds got off to a fast start, each beating the index fund in 2008. Then the roof fell in. In every one of the nine years that followed, the funds-of-funds as a whole trailed the index fund.

Let me emphasize that there was nothing aberrational about stock-market behavior over the ten-year stretch. If a poll of investment “experts” had been asked late in 2007 for a forecast of long-term common-stock returns, their guesses would have likely averaged close to the 8.5% actually delivered by the S&P 500. Making money in that environment should have been easy. Indeed, Wall Street “helpers” earned staggering sums. While this group prospered, however, many of their investors experienced a lost decade.

Performance comes, performance goes. Fees never falter.

On this count, I can’t argue with the Oracle. One fund delivered annualized returns of 6.5%, which might be considered competitive with the 8.5% annualized return of the S&P 500 on a risk-adjusted basis. I say “might” because I don’t have enough information to say definitively either way. But I can say with confidence that the performance of four out of the five fund of funds was pathetic.

Investors paid a lot of money in fees and got virtually nothing in return.

I’m not, however, willing to throw out the baby with the bath water and eschew all hedge funds. Depending on your time horizon and objectives, certain funds and certain strategies put into practice by funds might be worth a place in your portfolio. Over the past decade, I’ve placed many of my accredited investor clients in a variety of absolute-return funds invested in everything from medical accounts receivables to option-writing strategies. And the funds did exactly what I wanted them to do: They reduced portfolio volatility without sacrificing much in the way of returns. They avoided major drawdowns. And importantly, they gave my clients the piece of mind they needed.

I can’t, in good faith, invest 100% of the portfolio of a retirement-aged client in an S&P 500 index fund. That would be irresponsible on a level that should be considered criminal. But I also can’t, in good faith, invest a significant portion of their portfolio in bonds at today’s yields. Alternative investments, which would include hedge funds, can — if done right — act as a substitute for traditional bonds.

But the key here is “done right.” When evaluating a hedge fund, I ask myself the following questions:

  1. Does the hedge fund actually hedge, in that they manage risk? Or is “hedge fund” merely code for “aggressive equity trading.” Most of the high-profile managers you see on TV (Bill Ackman, Carl Icahn, etc.) fall into the latter category. I have no interest in those kinds of managers.
  2. How large is the fund? There is a sweet spot here. Ideally, you like to see at least $100 million under management. You know that the manager can keep the lights on with the fees generated from a portfolio that size. But when a fund gets to be several billion dollars, it can be too big to operate in their area of expertise. Just about any strategy becomes unmanageable at a large enough asset size. Buffett himself has complained that he can’t invest the way he wants to at Berkshire Hathaway because it’s simply too big at its current size.
  3. Is their strategy — and any hedges they have in place — going to survive a period of significant market turmoil? You generally can’t know with 100% certainty, but it’s useful to know how the fund performed in past periods of volatility, such as the 2008 meltdown or the 2010 or 2015 flash crashes. Or for that matter, the recent spate of volatility we saw in February.
  4. Is the fund illiquid? And if so, why? If the fund invests in traded stocks or options, it should offer monthly or at least quarterly liquidity. There’s just no reason why it wouldn’t. But if the fund invests in illiquid notes or real estate, then a lockup might be 100% warranted.
  5. Is the fund minimally correlated to the stock market… and to the other alternatives in my portfolio? This is an important one. There is literally no point in investing in an alternative strategy if it’s just going to follow the rest of your portfolio lower in a bear market.

Buffett is right that most hedge fund managers don’t earn their fees. But I’ll never begrudge a manager for charging a high fee if they’re delivering something I can’t get elsewhere for cheaper.


What’s Warren Buffett Buying?

Source: DonkeyHotey

The following is an excerpt from 5 Stocks With the Warren Buffett Seal of Approval.

It’s that time of year again. 45 days after the end of the quarter, large, institutional money managers like Warren Buffett are required to disclose their portfolio holdings to the SEC via form 13F. This gives ordinary investors like you and me a chance to look over the shoulder of some of the greatest minds in the business.

You shouldn’t view the 13F form as a pre-scrubbed buy list, as you don’t necessarily know the manager’s reasons for investment. Plus, you have no way of knowing whether a stock might be part of a larger strategy or pair trade (short positions and futures positions are not disclosed) or whether the manager still actually owns the stock by the time you read about it. (The data is a good 45 days old by the time we get it.)

This is less of an issue for an investor like Warren Buffett, as he tends to trade relatively infrequently and he doesn’t do a lot of fancy hedging or pair trading.

All the same, I recommend you use this list as a starting point for additional research rather than as “Buffett’s buy list.”

With all of that said, let’s take a look at what the Oracle of Omaha is buying these days.

Synchrony Financial (SYF)

Interestingly, Warren Buffett dumped what was left of his position in General Electric (GE), yet he added a new position in GE’s old consumer finance spin-off Synchrony Financial (SYF).

It’s not unlikely that you’ve never heard of Synchrony, though I’d bet that you or someone you know have used one of their credit cards. Synchrony is the largest issuer of store-branded credit cards in the United States. Wal-Mart Stores Inc (WMT),, Inc. (AMZN) and Lowe’s Companies, Inc. (LOW) are just a handful of the major U.S. retailers that use Synchrony for their store credit cards.

General Electric spun off Synchrony in 2014 as part of its strategy of scaling back its financial operations and refocusing as a true industrial conglomerate. Berkshire Hathaway bought 17 million shares last quarter, accounting for about 2% of shares outstanding.

Synchrony is still a very small chunk of Buffett’s portfolio, accounting for less than 1% of the total, so it’s important not to draw major conclusions here. But, as you’ll see with the next new addition, it does show a pattern of Buffett betting on American brick-and-mortar retail.

To finish reading the article, see 5 Stocks With the Warren Buffett Seal of Approval.  

Stocks the Smart Money Are Buying… and Selling


Photo credit: DonkeyHotey

The following is an excerpt from 7 Stocks the Smart Money Loves… or Hates

It’s that time again. 45 days after the end of each quarter, large institutional money managers are required to disclose the stocks that they bought or sold during the quarter. While this is an annoying to the money managers (it’s a little like playing poker with your cards face up for the rest of the table to see), it’s great for the rest of us. We can peek over the shoulders of some of the greatest investors in history.

Now, I have to give the usual caveats. The 13-F reports provided to the SEC are a snapshot in time. There is no guarantee that the manager still owns the stock by the time we read the report. We also have no information about short positions or futures positions. So in reading the raw reports, we have no way of knowing if a manager is truly bullish on a particular stock or if that stock is simply a piece of larger hedge or pair trade.

But if you’re familiar with the trading styles of the managers you follow, you can generally have a pretty good idea of what their intentions are with a stock.

So with no more ado, here are five high-profile stocks the masters of the universe are buying… or selling.

I’ll start with iPhone maker Apple (APPL), which has become something of a punching bag for hedge fund titans. As Apple has struggled to grow in recent years, several big money investors have lost patience and moved on. Greenlight Capital’s David Einhorn sold 1.3 million shares last quarter, reducing his total by nearly 17%. Apple remains his largest single holding, however, at 12% of his portfolio.

Steve Cohen, Leon Cooperman and Jim Chanos also reduced their positions in Apple.

But interestingly, one very high-profile investor – Mr. Warren Buffett himself – made a large Apple purchase. Buffett raised his stake in Apple by more than 50%. Apple still remains a small position for Berkshire Hathaway at about 1% of the portfolio. But Buffett clearly likes what he sees, and his stake is growing.

I, for one, agree with Buffett here. Apple’s slow growth is mostly a result of impossible-to-top comps due to the unprecedented success of the iPhone 6. But as Apple’s sales cycle gets back to normal, you should see very steady growth in the years ahead. And as I wrote recently, yes, Apple’s cash hoard really is a sight to behold.

To read the rest of the article, please see: 7 Stocks the Smart Money Loves… or Hates

Disclosures: As of this writing, I am long AAPL.

So, Bill Ackman Makes Some Good Points on the Index Bubble…

10159650595_aea8898457_oHe’s often controversial… and usually pretty brash. But Pershing Square’s Bill Ackman is also usually quite insightful. He’s been at this game a long time, and he’s had his share of big wins… and big losses. Ackman has an ego on him. (What hedge fund manager doesn’t?) But he’s also his own biggest critics, and like all good investors he learns from his mistakes.

Today, let’s take a look at Ackman’s latest letter to investors, which came out last week. Ackman, like a lot of hedgies, had a terrible 2015. Here were some of his takeaways:

Not All Valuation Metrics are Equal

Ackman bet big on Valeant Pharmaceuticals (VRX)… and lost big when the stock rolled over. Per Ackman,

Principally, we missed the opportunity to trim or sell outright certain positions that approached our estimate of intrinsic value. Our biggest valuation error was assigning too much value to the so-called “platform value” in certain of our holdings. We believe that “platform value” is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions. [Emphasis Sizemore]

Charles here. I learned a similar lesson in 2015. Just as Ackman lost money in an acquisition-hungry pharma stock, I lost money in MLPs, small-cap REITs and business development companies — three sectors that would normally have very little in common. But the tie that bound them was their dependence on the capital markets for fresh funding. When the credit markets got skittish, Mr. Market relentlessly punished these sectors, and two of my holdings — Kinder Morgan (KMI) and Teekay (TK) were forced to slash their dividends.

Know Who You’re In Bed With

Due to Ackman’s high profile, he tends to attract copycats. I myself have been guilty of perusing his SEC disclosures. This creates risks of its own:

Perhaps the largest correlation in our portfolio is one that we have not previously considered; that is, the fact that we own large stakes in each of these companies. We have had the benefit of a “following” of investors who track and own many of our holdings. This has given us significantly greater clout than is reflected by our percentage ownership of these companies, and we believe that it is partially what has caused the “pop” in market price when we announce a new active investment. As a result, these active managers’ performance is often closely tied with ours. When Valeant’s stock price collapsed, our performance, and that of Pershing Square followers, were dramatically affected. Nearly all of these investment managers are subject to daily, monthly, and quarterly redemptions, and therefore, many were likely forced to liquidate substantial portions of their holdings which overlap with our own…

While it is impossible to know for sure, we believe that our continued negative outperformance in the first few weeks of the year relates primarily to forced selling of our holdings by investors whose stakes overlap with our own.

This raises a bigger issue of simply considering who the major holders of your stocks are and what their constraints or motivations might be. Returning to my own losses last year, The selloff in MLP shares was massively exacerbated by mutual funds, ETFs and — most importantly — leveraged closed-end funds and hedge funds that were forced to liquidate to meet redemptions or margin calls. This were holders that were forced to sell at whatever price the market gave them.

The Index Fund Bubble… And What It Means

Finally, Bill Ackman has some insightful comments about the “bubble” in indexing. Given the lousy performance of active managers over the past decade, it’s easy to see why investors continue to flock to index funds. They are cheaper in terms of fees, more tax efficient and have had better returns of late.

But here’s the problem. Indexing only works when their are a sufficient number of active managers to make the market at least semi-efficient. If everyone becomes a passive indexer, then the returns of the major indexes will start to lag in a major way as the stocks in the index become overowned and overpriced.

But there are other considerations too. Passive ownership essentially gives management a free pass and allows lousy management teams to stay entrenched.

As Ackman writes,

As index fund ownership grows as a percentage of shares outstanding, the voting power of index fund managers increases. While on the one hand, one might believe this is good for America as these “permanent” owners should think very long term compared with the many investors whose average holding period is less than one year.

On the other hand, there are significant drawbacks… While index fund managers are, of course, fiduciaries for their investors, the job of overseeing the governance of the tens of thousands of companies for which they are major shareholders is an incredibly burdensome and almost impossible job. Imagine having to read 20,000 proxy statements which arrive in February and March and having to vote them by May when you have not likely read the annual report, spent little time, if any, with the management or board members, and haven’t been schooled in the industries which comprise the index…

Of course, this is impossible. Index managers are passive and will generally toe the line for management. Ackman points out some very significant long-term effects of this, asking the proverbial question of what happens when index funds effectively control corporate America:

If the index fund trend continues, and it looks likely to do so, what happens when index funds control Corporate America? Courts have often deemed shareholders to be in control of a corporation with as little as 20% of the ownership of a company. At current rates of asset inflows, it will not be long before index funds effectively control Corporate America and the corporations of many foreign countries.

The Japanese system of cross corporate ownership, the keiretsu, has been blamed for decades of Japanese corporate underperformance and economic malaise. Large passive ownership of Corporate America by index funds risks a similar outcome without the counterbalancing force of large active investors…

The thought of corporate America turning Japanese should be enough to make even the biggest proponent of indexing pause for a moment.

Ackman says that the “greatest threat to index fund asset accumulation is deteriorating absolute returns and underperformance versus actively managed funds” because money flows into these funds with no consideration of value. I agree, and would add that this was the major rationale for the “smart beta” movement.

But perhaps the greatest takeaway here is simply to not give up on active management. When you invest outside of the mainstream, you will have returns that are outside of the mainstream. That means that there will be plenty of years when you underperform.

But if you’re a good investor, it also means that there will be years where you massive outperform. So keep your chin up. Even hedge fund masters of the universe lose money some years.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long KMI and TK.

Photo credit: InsiderMonkey


What’s David Einhorn Up To?

Photo credit: InsiderMonkey
Photo credit: InsiderMonkey

Greenlight Capital’s David Einhorn made a splash this week by seeking a seat on the board of troubled solar company SunEdison (SUNE). SunEdison’s stock is down nearly 90% since July, though Greenlight has been adding to its position since the beginning of this year and now owns about 6% of the company.

While SunEdison is getting the headlines right now, I’m more interested in some of Einhorn’s other investments. Einhorn, like a lot of aggressive hedge fund managers, runs a concentrated long portfolio. So the movement of a single stock or two can have an outsized impact on his portfolio. And Einhorn — like a lot of value managers, myself included — has taken his lumps  over the past year.

At any rate, let’s take a look at what Mr. Einhorn has in his portfolio:

SymbolCompanyValue ($1,000)% of Portfolio% of Company
AAPLApple Inc1,238,36820.530.20
GMGeneral Motors Co489,2908.111.05
KORSMichael Kors Holdings Ltd297,5264.933.83
CBIChicago Bridge & Iron Co296,7144.927.13
CNXConsol Energy Inc290,1734.8112.93
AERAerCap Holdings NV280,8544.663.72
TWXTime Warner Inc262,2614.350.48
GRBKGreen Brick Partners Inc261,2044.3349.41
MUMicron Technology Inc185,3323.071.19
ONON Semiconductor Corp162,6732.704.19
BKBank of New York Mellon Corp156,6002.600.37
VOYAVoya Financial Inc141,4872.351.69
SUNESunEdison Inc133,5862.215.87

With the exception of SUNE, which reflects recent buying, the rest of these holdings are as of September 30. We should get updated numbers for the fourth quarter in a little over two weeks. (I should also mention that these are his long positions only; Einhorn also runs a short book, though those positions are not disclosed.)

But as of the most recent numbers we have, two stocks really jump off the page: Apple (AAPL) and General Motors (GM), which make up 21% and 8% of his long portfolio, respectively. [Disclosure: I am long both as well.]

Apple is taking a beating today after it gave disappointing guidance for the next quarter. Well, let me just say that I would be very surprised to see Einhorn dump Apple on that news. Einhorn is patient enough to see beyond the next quarter, and Apple has been priced as a no-growth company for a long time. Apple is one of the cheapest large stocks in America with a price/earnings ratio in the mid single digits once you strip out its gargantuan cash hoard. Fellow activist investor Carl Icahn, who also holds about 21% of his portfolio in Apple, has said publicly that he estimates Apple’s value at well over $200 per share. We’ll see. But I can say this: Given the low expectations built into Apple’s stock price right now, it wouldn’t much in the way of good news to send the shares up sharply.

If Apple drifts lower, I’d recommend backing up the truck to buy more.

I’m also bullish on General Motors. China is looking wobbly and there are valid concerns that last year’s banner year for car sales isn’t sustainable. But again, like Apple, GM has been priced as a no-growth stock for a long time. And at today’s prices, you’re picking up a nice 5% dividend.

I don’t know when valuation will matter again. The past year has been a nightmare for value investors, and 2016 isn’t getting off to a good start either. But by owning cheap stocks throwing off a high and rising dividend, you’re at least getting paid to be patient.

Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long AAPL and GM.