Even Warren Buffett is no match for the S&P 500

By Mark Hulbert

The stock market's incredible efficiency eventually catches up with the best of the best

Berkshire Hathaway's sheer size makes it much more difficult to find companies that make a difference to its bottom line.

Berkshire Hathaway (BRK.A) (BRK.B) stock over the past 20 years has almost precisely equaled the return of the S&P 500 SPX. Let that sink in for a minute. Berkshire Hathaway's CEO, Warren Buffett, widely considered to be the most successful investor alive today, has merely matched the market's return over the past two decades.

The fundamental question this raises for investors is how long we should give a manager the benefit of the doubt when failing to beat the market. All of us can readily agree that even the best advisers will suffer short-term periods of market-lagging returns. But as this period of underperformance lengthens, it becomes increasingly difficult to write it off as a fluke.

We can all hope that Buffett chooses to address this question in his much-anticipated shareholder letter, which is expected to be released in conjunction with Berkshire Hathaway's earnings report later this month. A telephone call to Berkshire Hathaway seeking comment was not immediately returned.

To appreciate how difficult it becomes to dismiss market-lagging performance, I conducted the following Monte Carlo simulation: What if, in each year going forward, Berkshire Hathaway's alpha (return relative to the S&P 500) would be picked at random from his actual annual alphas of the past 59 years? If I reran this experiment 10,000 times, for various holding period lengths, how many times would Berkshire Hathaway's stock have lagged the market?

The results are summarized in the table below:

   Length of holding period  % of 10,000 simulations in which Berkshire stock doesn't beat the S&P 500 
   5                         21.2% 
   10                        12.8% 
   15                        7.9% 
   20                        4.8% 

If you use the 5% threshold, as many statisticians are inclined to do, then you'd have to conclude that failing to beat the market over a 20-year period is not something that can be dismissed as a random fluke.

There are a number of possible causes of Berkshire Hathaway's declining alpha. My preferred explanation is the stock market's incredible efficiency, which eventually catches up with even someone of Buffett's abilities. As Buffett has acknowledged in prior annual shareholder letters, Berkshire Hathaway's sheer size now makes it much more difficult to find companies that are both significantly undervalued and large enough to make a difference to Berkshire's bottom line.

We also shouldn't forget that Buffett in recent years has shared stock picking with co-portfolio managers Todd Combs and Ted Weschler. This isn't a criticism of them, but simply an acknowledgement that we have no way of knowing what Berkshire Hathaway's performance would have been had Buffett selected all of the stocks.

And of course Buffett no longer has his right-hand man Charlie Munger, who died last November. Who knows what impact Munger's passing will have on Berkshire's future performance.

This discussion underlines how difficult it is to find a market-beating manager. It would be great if we could discover the next Warren Buffett before the rest of Wall Street. But we won't recognize this Buffett clone until after this manager has beaten the market over many years - by which point the rest of the world will know as well.

Once again, it's hard to argue with the standard advice to invest the bulk of a stock portfolio in a broad-market, low-cost index fund.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

More: Berkshire Hathaway loads up on shares of Sirius XM and Chevron, exits home builder D.R. Horton

Also read: The truth about investing: 'Common sense' can be the worst advice

-Mark Hulbert

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02-17-24 0742ET

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