"If you don't find a way to make money while you sleep, you'll have to work until you die."
This is what the world's most famous investor Warren Buffett has said.
In the world of investing, there are many such great investors came and went
But there is hardly anyone who has been able to achieve as much wealth and fame as Buffett.
In this investment world, everyone must be knowing about Warren Buffett.
Buffett is an American business tycoon, philanthropist, and investor.
He is the chairman and CEO of Berkshire Hathaway, which owns more than 60 companies.
The list includes well-known names- Apple, American insurance company Geico, battery maker Duracell, and restaurant chain Dairy Queen.
Buffett is one of the richest people in the world with a net worth of $101 billion.
Perhaps all these things are known to the whole world.
But very few people know what Warren Buffett, popularly known as the Sage of Omaha, was his investing methodology.
How much risk he took, and what was the secret of his returns?
We will decode Warren Buffett's investment strategy with very interesting numbers with the help of an article in the
Journal of Financial Analysts published by the CFA Institute called "Buffett's Alpha".
And at the same time try to compare him with the rest of the players.
So let's start today's video.
Let me tell you the meaning of some technical terms.
First of all, information ratio.
In simple terms, the information ratio is how much return any portfolio is able to give from the market, given the volatility of the portfolio.
After considering the portfolio's volatility, how much more return it generates for its investors than the market, we call it the information ratio.
Comparing the portfolio with the market means comparing it with the benchmark index as we have with Nifty 50 or Sensex.
The more it is, the better it is.
Another important term is Sharpe Ratio.
The Sharpe Ratio gives investors an idea of ​​how high a return they have received against the risk taken on their investment.
If the Sharpe Ratio of a fund is high, it means that the fund is generating very good returns in comparison to the risk that the fund is making in its investments.
The more it is, the better it is.
The other 2 parameters that an investor should be aware of are alpha and beta.
Alpha refers to the number of additional returns a stock or fund is able to generate compared to the benchmark index.
That is if Nifty gave a 10% return and Stock A gave 12%, then the alpha of Stock A would be 2%.
Beta refers to how volatile a stock or fund is compared to its benchmark index.
That is, if there is a change of 2% in Nifty, and 4% in Stock A, then the beta of Stock A will be 2 times.
Also, whenever we talk of a leveraged investment or a leveraged firm, it means that we have borrowed money from the market for investment.
In simple language, investing by borrowing is called Leveraging.
And lastly, we would like to tell you something about quant or factor investing.
The stocks are filtered according to the quant or factor investment mee pre-decided criteria.
As in the value factor, we select to book stock or low price to earnings.
In the Quality factor, we choose high ROE/ROCE/Margin stocks and in the Momentum factor, we choose high-price momentum stocks.
All the returns of the Buffet as per paper are web-based on quality and price factors.
We will cover this in detail.
Let's go ahead and find out why people like Buffett is the best investor of our time.
Now if you look at Buffett's track record of returns, you'll probably start getting FOMO too.
If you invested $1 in Berkshire Hathaway in October 1976, you would have received $3,685 in March 2017.
That is, a CAGR of about 22.18% over a period of about 41 years.
During this period, Berkshire Hathaway gave its investors an additional average annual return of 18.6% over US Treasury bills
while at the same time giving an additional 7.5% average annual return to the overall stock market.
But between October 1976 and March 2017, the volatility of Berkshire Hathaway's stock was 23.5%, while the market volatility was 15.3%.
In addition to being extremely volatile, as we have just seen, Berkshire has delivered pretty decent returns.
So between 1976 and 2017, Berkshire's Sharpe ratio was 0.79, while the market's Sharpe ratio was 0.49.
That is, Berkshire Hathaway gave high returns with more risk.
So now you are thinking that what is Buffett doing such magic that he gets more returns than such high returns, equal his investment? Well.
If you ask any value investor, there's a good chance they'll say Warren Buffett's strategy behind high returns
-"buy low and sell high," and of course a lot of patience.
This is probably true too.
But, there are some interesting facts that will shake all your thoughts about their investment strategy. Come let's see.
Researchers who published in the Journal of Financial Analysts tried to decode Buffett's strategy from their statistical model
and found some very interesting findings.
He found that almost all the returns of the buffet can be explained by the quality and value factors.
Buffet lays out a lot of leveraged positions from which he has the position to take more risks as well as higher returns.
Research Paper Alpha-based researchers at Buffett created a leveraged buffet-style portfolio based on quality and price factors
and compared it to Berkshire Hathaway's portfolio.
So here you can see that the buffet-style portfolio of stocks beats Berkshire Hathaway's portfolio
but if you factor in trading costs and taxes, both portfolio is moving roughly the same way.
Now let's talk about Beta.
Berkshire's beta was less than 1 but at the same time, his alpha was quite high.
That is less volatility and high returns. One reason for this could be that they prefer to invest in large-cap stocks.
Another interesting thing is that Buffett never runs away from the trends going on in the market.
The only problem with a normal retail investor is that he invests without doing proper research following the trend.
Apart from this, there are also some such periods when Buffet had to face the drawdown.
For eg, from June 30, 1998, to February 29, 2000, Berkshire Hathaway's portfolio was down 44% but the market was up 32% in the same period.
In such a situation, the job of any general fund manager will be lost. But here it is Warren Buffet.
They stick to their conviction for a long time and have been able to generate long-term wealth.
Some argue that Buffet's behavior was more of a competitive advantage than stock selection.
Those bad situations didn't scare him and good situations didn't excite him.
When researchers read Berkshire Hathaway's balance sheet,
they found that leverage was the main reason behind such high volatility to invest in such a stable and sound business.
Yes, Buffett has come up with a smart way to maximize his returns by using leverage!
Buffett also invests with some degree of leverage i.e. loans to generate his phenomenal returns.
Of course, the higher the potential for returns, the higher the risk.
Well, Buffett has probably mastered the art of earning high returns at high risk.
Now let's talk about another interesting insight.
If you look at Berkshire Hathaway's returns, you can analyze it roughly from 3 angles.
We talked about leverage. Now let's talk about the other two categories.
Now the returns from publicly traded companies reflect Buffett's stock-picking ability.
Looking at the returns of his privately held companies, he is a proxy of Buffett's managerial prowess.
Well, both Parts, Buffett's publicly listed companies, and private companies have beaten the market with good returns
If we analyze separately, we find that the Sharpe Ratio of Buffett's portfolio of public stocks is more than the portfolio of private companies.
That is, Buffett's public stocks have given better risk-adjusted returns.
It seems to us that Buffett's stock selection skills were far superior to his managerial skills, and that factor in his success played a huge role.
Any investor should stick to a good investment strategy,
and in Buffett's case, it was investing in safe, high-quality, cheap stocks using leverage properly and holding them for a long period of time.
So after all, this is the secret sauce of Buffett's investing!
Hope you guys found this detailed breakdown of Buffett's investing style interesting.
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