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Why Buffett’s Outperformance May Be a Thing of the Past

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  • Berkshire Hathaway Chair Warren Buffett has outperformed the markets by a wide margin over the last five decades. However, Berkshire’s returns have lagged the S&P 500’s this year.
  • In general, Buffett’s outperformance versus the S&P 500 has narrowed over the last 20 years. The legendary investor might not be able to replicate his last century’s magic due to multiple factors.
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Warren Buffett’s outperformance

Between 1965 and 2018, Berkshire Hathaway (BRK-B) (BRK.B) stock rose at a CAGR (compound annual growth rate) of 20.5%. The S&P 500 (SPY) rose at a CAGR of 9.7% in the same period. The S&P 500’s returns also included dividends. The data in Berkshire Hathaway’s 2018 annual report showed how Chair Warren Buffett’s magic had worked over the last five decades.

Such outperformance of the markets is no small feat. The fact that Buffett has managed to deliver such stellar returns over such an extended period makes the achievement even more special.

However, as the chart above depicts, Berkshire Hathaway’s outperformance of the S&P 500 has narrowed a great deal. Let’s take a look at the various factors that could be affecting Warren Buffett’s performance.

Size matters

Berkshire Hathaway is now a $500 billion conglomerate. Buffett himself admitted earlier this year that given Berkshire Hathaway’s size, outperforming the markets might not be easy. He also admitted that Berkshire might only slightly outperform the S&P 500 now. Berkshire Hathaway’s size reduces its pool of investable companies. A $500 billion conglomerate might not look at smaller companies, as they won’t really move the needle.

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In addition, Buffett’s aversion to technology stocks could be affecting Berkshire Hathaway’s returns. Over the last decade, the tech-heavy Nasdaq (QQQ) has outperformed the S&P 500 by a wide margin. While Berkshire Hathaway has invested in companies such as Apple (AAPL) and Amazon (AMZN), overall he’s largely stayed away from tech stocks.

Old isn’t always gold for Buffett

Berkshire Hathaway has invested in companies such as the Coca-Cola Company and Kraft Heinz (KHC), which were very strong brands once upon a time. While these companies are still good performers, consumer preferences are changing, and new age brands are giving established brands a run for their money. Incidentally, Kraft Heinz has fallen sharply this year. To sum it up, the age-old recipe of investing in strong consumer brands with moats doesn’t seem to be working for Buffett anymore.

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Markets are getting efficient

Equity markets are getting efficient, as the flow of information has improved with technological advancements. Several active fund managers are underperforming markets after fees. Investors have, therefore, been increasingly turning to ETFs, which have much lower fees. In efficient markets, outperformance becomes even more challenging.

There’s too much cheap money on the table

We’ve been in a low-interest environment for more than a decade now. In 2015, the US Federal Reserve started hiking rates to move toward a normalized monetary policy. However, the move stalled as US economic growth cooled. Earlier this year, the Fed abandoned its rate hike cycle, and it’s since lowered rates twice. Now, low interest rates have led to a supply of cheap money that inflates asset prices. That’s kind of a nightmare for value investors such as Buffett.

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Also, because capital has been cheap, there’s too much money chasing quality companies. Incidentally, Buffett hasn’t been able to find a major acquisition since at least the fourth quarter of 2018. One of the reasons is that assets aren’t cheap. Secondly, given low interest rates, some hedge funds have been liberally using leverage for buyouts. This strategy increases the competition to acquire companies—and hence their asking prices.

Could a recession change the scene for Buffett?

To sum it up, Warren Buffett has an impeccable record compared to the S&P 500. Buffett is arguably the best investor of all time, and publicly available information on his investment style will continue to be a source of knowledge for investors. However, going forward, we shouldn’t expect the kind of stellar returns we’ve seen in the last century.

With that said, given Berkshire Hathaway’s massive cash pile, a major market sell-off could provide Buffett with an opportunity to deploy that cash. Incidentally, some of Buffett’s best investments happened at times when others were fearful. But while such a scenario could spell opportunity for Buffett, President Trump might not want a sell-off amid the upcoming presidential election.

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