- 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:
- 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.
- 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
- 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).
- 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.
- 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:
- 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.
- 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.
- 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:
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.