“If you take away the skill that Buffett has Buffett has no skill” is a bullshit thesis.

Blogger cites an older (misinformed ) Economist article citing an academic study (rubbish) as support for Efficient Market Hypothesis (EMH) here:  http://www.themoneyillusion.com/?p=19209.

If the blogger is trying to get nearly all people to buy index funds, well say so. But don’t use that to argue that markets are *always* efficient. Or that EMH supports deeply broken economic theories like dynamic stochastic general equilibrium (DSGE).

The academic thesis in the case of the paper cited by the Economist is essentially as follows:  If you take away the skill that Buffett has Buffett has no skill.  It’s a bullshit thesis.

Like most academics their desire is to reduce investing to mathematics since without math there is no hope of getting tenure.  That the thesis is not properly tied to reality is not a concern in the academy when it comes to academic finance. What is critical is that the math is pretty, adopting things like the concept of equilibrium from physics even though a economics is vastly different than a physical system (e.g., electrons do not have feelings).

Buffett’s ability to buy stocks low and sell high is, ahem, skill. It is especially so since loss aversion and other dysfunctional heuristics makes human driven to do the opposite.

Buffett’s ability to buy businesses that generate float/free cash flow, ahem, is skill. That skill gives you cash to invest that is not leverage on which you are paying points or may suffer a collateral call in a crisis.

The idea that all one must do to outperform is to buy low beta stocks and lever up is, ahem, absolute rubbish. That beta measures risk is also rubbish.  To measure volatility is to measure volatility.

“This is why Buffett and Munger considered defining risk as volatility to be “twaddle and bullshit”, as Munger would later put it up. They defined risk as not losing money. To them, risk was “inextricably bound up in your time horizon for holding an asset.” Someone who could hold an asset for years could afford to ignore its volatility. Someone who was leveraged did not have that luxury-leverage costs; moreover the lender’s (not the borrower’s) time horizon defines the length of the loan. Thus a risk of leverage is that it takes away choices. The investor may not be able to wait out a volatile market; she is burdened by the “carry” (that is, the cost) and she depends on the lender’s goodwill.  http://www.go2cio.com/articles/index.php?id=2783

Munger on investing as taught by academia

“We’ve had very little impact. Warren once said to me, “I’m probably misjudging academia generally [in thinking so poorly of it] because the people that interact with me have bonkers theories.” Beta and modern portfolio theory and the like — none of it makes any sense to me. We’re trying to buy businesses with sustainable competitive advantages at a low, or even a fair, price.”  http://boards.fool.com/charlie-munger-in-rare-form-20741250.aspx?sort=username

That most all investors will not outperform does not mean that some small number of investor’s can’t outperform. Noah Smith puts it simply:

“Of course, even the RMI [his term for EMH] isn’t quite true. There are some people – a very few – who correctly guess price movements, and make money year after year after year (I work with a couple). But you’re very unlikely to be one of those people. And your behavioral biases – your self-attribution bias, overconfidence, and optimism – are constantly trying to trick you into thinking you’re one of the lucky few, even when you’re not.”  http://noahpinionblog.blogspot.co.uk/2013/02/in-defense-of-emh.html

Munger in 2001:

“The future returns of Berkshire and Wesco won’t be as good in the future as they have been in the past. The only difference is that we’ll tell you. Today, it seems to be regarded as the duty of CEOs to make the stock go up. This leads to all sorts of foolish behavior. We want to tell it like it is. I’m happy having 90% of my net worth in Berkshire stock. We’re going to try to compound it at a reasonable rate without taking unreasonable risk or using leverage. If we can’t do this, then that’s just too damn bad. The businesses that Berkshire has acquired will return 13% pre-tax on what we paid for them, maybe more. With a cost of capital of 3% — generated via other peoples’ money in the form of float — that’s a hell of a business. That’s the reason Berkshire shareholders needn’t totally despair. Berkshire is not as good as it was in terms of percentage compounding [going forward], but it’s still a hell of a business.”

“Berkshire’s past record has been almost ridiculous. If Berkshire had used even half the leverage of, say, Rupert Murdoch, it would be five times its current size.”  http://www.fool.com/news/foth/2001/foth010508.htm

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