22 November 2016

Warren Buffett's alternative to stock-picking

by David Blumenthal

KEY POINTS   
            In 2014, Warren Buffett revealed that his will contains instructions that a majority of Berkshire Hathaway's excess cash be invested in a low cost index fund.
Buffett was convinced that for most investors “passive” low cost index funds are a superior strategy to “actively” picking individual stocks or trying to time the market
Two and a half years later, we revisit the data that underpinned Buffett’s decision and find that the vast majority of “active” fund managers continue to underperform their benchmarks
Automated investment management services ("robo-advisors") use technology and index funds to provide everyday investors with trustworthy, professional investment management at a low cost.

        

In early 2014, Warren Buffett revealed that his will contained the following investment instructions for Berkshire Hathaway's excess cash:

"My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers."

At the time, data from the S&P Indices Versus Active “Scorecard” (read more here) showed that the vast majority of actively managed funds had underperformed their indexes over a five-year period ending December 2013.

Two and a half years later, we revisit these numbers:

Buffett’s case for passive investing is even more pronounced today. Over the last five years, just 8.1% of large cap U.S. funds outperformed the S&P500 sharemarket index. Less than 23% of Australian equity funds managed to outperform the S&P/ASX200 over an equivalent period.

What’s more, S&P data also shows while a very small number of fund managers manage to "beat the market" from time to time", such outperformance is generally not be sustained for extended periods.

For example, recent SPIVA data for domestic US funds (available here) showed that of the top 25% of active fund managers 5 years ago, just 0.3% of those still operating remained top quartile performers today. So if you pick a managed fund based on it's "Top 25%" ranking today, don't expect that performance to be the case in five years.