Superstar Investors

  • Brooks, Tsuji and Villalon
  • Journal of Investing, February 2019
  • A version of this paper can be found here
  • Want to read our summaries of academic finance papers? Check out our Academic Research Insight category

What are the Research Questions?

Many famous investors are outspoken about their investment philosophies, and carefully apply them to a select number of securities. Who among us hasn’t thought if they could at least capture some of the talents of our favorite investors in a bottle, we too could be super investors? Turns out you might just be able to capture some of the magic, but you have to be patient and take the pain to get the gain.

To find out more the authors investigate the following:

  1. Do famous investors’ philosophies (Warren Buffett, Bill Gross, George Soros, and Peter Lynch) applied broadly still generate alpha? (See here for Dan Grioli post on the same topic)

What are the Academic Insights?

By using a factor or style investing analysis, the authors find that these famous investors track record is an expression of a handful of these systematic styles.

Specifically,

  1. By studying Berkshire Hathaway (BRK) from 1977 to 2016, the authors find that it produced an excess of cash returns of 17.6% versus 6.9% of the market with a Sharpe ratio of 0.74 (compared to a 0.45 for the market). However, they also find that this alpha becomes statistically insignificant when controlling for some of the investment styles Buffett describes in his writings (market, value, low risk, and quality). The authors conclude that one of the ways that Berkshire Hathaway was able to add so much return above that of the market was from access to cheap leverage via its insurance business, allowing it to harvest greater amounts of these style exposures than most traditional investors could.(1)

  2. By studying the Pimco Total Return Fund (TRF) from 1987 to 2014, the authors find that its alpha becomes statistically insignificant when controlling for some of the investment styles Bill Gross describes in his writings (market, credit, low risk, and short volatility).

  3. By studying the Quantum Fund from 1985 to 2004, the authors find that its alpha becomes statistically insignificant when controlling for some of the investment styles George Soros describes in his writings (market, trend, value, and currencies). They find that trend/momentum factors go a long way in explaining the average returns over the period.

  4. By studying the Magellan Fund from 1977 to 1990, the authors find that its alpha becomes statistically insignificant when controlling for some of the most common styles like market, size, value, momentum, quality and low risk (it’s more difficult to figure out dedicated styles from Lynch’s writings). They find that part of Magellan outperformance ( 21% annual excess of cash) is due to harvesting small-cap and momentum premia. Magellan is the only fund that posted significant alpha on top of factor exposures.

Why does it matter?

The results in this paper suggested the following:

  1. For many great investors success is not luck or chance, but the reward for long-term exposure to styles that have historically produced excess returns.
  2. Styles analyzed in this paper have been successful in many contexts—from fixed income portfolios to global macro hedge funds. Hence, investors should understand which (if any) styles are part of a manager’s process, and decide whether there are positive expected returns associated with those styles.
  3. Styles alone aren’t sufficient for success; they also require patience, ability, and a long-horizon to stick with them.

The Most Important Chart from the Paper:


The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.

Abstract

Many famous investors are outspoken about their investment philosophies and carefully apply them to a select number of securities. In this article, we seek to apply their wisdom systematically to determine whether their philosophies might generate alpha when applied broadly. We show how four very different, extraordinary track records—from Berkshire Hathaway, PIMCO’s Total Return Fund in the Gross era, George Soros’s Quantum Fund, and Fidelity’s Magellan Fund under Peter Lynch—can be viewed as expressions of a handful of systematic styles.

References[+]

About the Author: Wesley Gray, PhD

Wesley Gray, PhD
After serving as a Captain in the United States Marine Corps, Dr. Gray earned an MBA and a PhD in finance from the University of Chicago where he studied under Nobel Prize Winner Eugene Fama. Next, Wes took an academic job in his wife’s hometown of Philadelphia and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management firm dedicated to an impact mission of empowering investors through education. He is a contributor to multiple industry publications and regularly speaks to professional investor groups across the country. Wes has published multiple academic papers and four books, including Embedded (Naval Institute Press, 2009), Quantitative Value (Wiley, 2012), DIY Financial Advisor (Wiley, 2015), and Quantitative Momentum (Wiley, 2016). Dr. Gray currently resides in Palmas Del Mar Puerto Rico with his wife and three children. He recently finished the Leadville 100 ultramarathon race and promises to make better life decisions in the future.

Important Disclosures

For informational and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice. Certain information is deemed to be reliable, but its accuracy and completeness cannot be guaranteed. Third party information may become outdated or otherwise superseded without notice.  Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency has approved, determined the accuracy, or confirmed the adequacy of this article.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).

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