Can Warren Buffett’s Protégé Outperform Her Mentor?

• Last week, Tracy Britt Cool, a Warren Buffett protégé, said that she’d leave Berkshire Hathaway to start a new company.
• Berkshire Hathaway has underperformed the S&P 500 by a wide margin this year.

Last week, Tracy Britt Cool noted that she planned to leave Berkshire Hathaway (BRK-B) (BRK.B). She joined Berkshire Hathaway as CEO Warren Buffett’s assistant in 2009. Year-to-date, Berkshire Hathaway is underperforming the S&P 500 (SPY). In this article, we’ll analyze what could work in Cool’s favor as she starts her own firm.

In an interview with the Wall Street Journal, Cool said that she intends to look at smaller companies. She said, “There are companies that I think there’s a lot of value in helping them get to the next level, but they’re too small for Berkshire.”

For a company the size of Berkshire Hathaway, it’s tough to outperform the markets. Buffett also echoed similar views earlier this year. Speaking with the Financial Times, he said, “I think that if I was working with $1m or if Charlie [Munger, Berkshire’s vice-chair] was working with $1m, we would have no trouble earning 50 per cent a year.”

Given Berkshire Hathaway’s mammoth size, it doesn’t make sense for the company to look at small companies. Speaking with the Wall Street Journal last week, Buffett said, “The toughest part is finding things to buy.”

He added that Cool has “an easier job” than he does, as she would be targeting smaller companies. Meanwhile, size is not the only issue that’s plagued Berkshire Hathaway in recent years.

Buffett likes to invest in his circle of competence, which generally excludes the tech sector from Berkshire Hathaway’s portfolio. However, Buffett has previously invested in tech firms like IBM and Oracle.

Buffett also invested in Apple (AAPL) in 2016 and has gradually increased its stake in his portfolio. However, Buffett sees Apple as a consumer company rather than a tech company.

Buffett also admitted to missing out on Alphabet (GOOG) and Amazon (AMZN). Earlier this year, another investment manager at Berkshire Hathaway took a stake in Amazon.

Cool’s venture could score a point here, although we don’t know much about her investing style yet. However, her 2014 interview with CNBC tells us that she might be amenable to the technology sector.

She said, “Over the next 25 years, technology is going to be a critical component of business.” She added, “I’m very excited about the future. There will be lots of changes, new businesses and businesses disrupting existing business.”

On the face of it, Cool would have the advantage of a smaller size and a much wider choice of companies in which she can invest. However, these advantages don’t mean automatic outperformance.

Earlier this year, Buffett said that Ted Weschler and Todd Combs have slightly underperformed the S&P 500. Popularly known as Ted and Todd, both are investment managers at Berkshire Hathaway. Elsewhere, numerous actively managed funds are underperforming the S&P 500.

Generally, it is tough to outperform markets consistently. Although Buffett has a strong track record in outperforming the S&P 500, most of this outperformance occurred in the last century.

Given the improvement in information flow, it’s becoming increasingly tougher to outperform the markets. Add the abundant supply of cheap money, and you have too much money chasing too little quality.