A recent paper by Frazzini (et al) at AQR uncovers the driver behind Warren Buffett’s returns:
we find that the alpha become statistically insignificant when controlling for exposures to Betting-Against-Beta and quality factors. We estimate that Berkshire’s average leverage is about 1.6-to-1 and that it relies on unusually low-cost and stable sources of financing. Berkshire’s returns can thus largely be explained by the use of leverage combined with a focus on cheap, safe, quality stocks.
In other words, low beta investing with leverage. The previous post showed a low beta quintile portfolio turning $1 in 1974 to $100 in 2007 [CAR 14%].
Berkshire Hathaway returns $1500 over the same period [CAR 24%], which matches Frazzini’s estimated leverage [24/14.5 = 1.6]. There is a significant reduction in rate of return from 1998. However, a strategy based on Buffett’s style appears to retain effectiveness over the entire period (outside recessions), consistent with a low beta strategy.
This strategy is outside the reach of the individual investor due to the size of the portfolio and frequent rebalancing. But could the strategy be approximated using a low beta fund? Access to low cost financing for leverage is the key. Buffett’s borrowing costs are legendary: the free float from his insurance business. Unfortunately for the privateer, interest is likely to consume much of the 10% per annum generated by gearing.
An alternative is to find a fund or manager aligned with this strategy. For example, AQR has a low volatility fund AUEIX:
SPLV is the largest fund in this category at $4B assets and 2.7% yield.
Robeco offers enhanced low volatility funds and has several billion under management also:
None of these funds employs leverage though.