Beaten by Buffett
by Sam Mamudi
Monday, March 8, 2010
Mutual funds dramatically lag Berkshire stock during chairman's tenure
Many investors can only look on with envy when Warren Buffett says his shareholders have seen 20% annualized gains over the past 45 years -- even the best mutual funds pale by comparison.
Only two funds are even on the horizon: Fidelity Magellan Fund (FMAGX), which has returned 16.3% a year during Buffett's chairmanship of Berkshire Hathaway Inc. (BRK-A), and Templeton Growth Fund (TEPLX), up 13.4% a year on average, according to investment researcher Morningstar Inc.
Berkshire's Class-A shares have delivered returns of 22% a year since 1965, based on market price, though Buffett prefers to judge gains according to book value, which stand at 20.3%.
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Using Berkshire's market price gains for fairer comparison with mutual funds, $10,000 invested with Buffett on Oct. 1 1964 -- equivalent to about $60,000 in today's dollars -- would now be worth about $80 million.
The same amount in Fidelity's fund would have grown to about $9.1 million, while Templeton Growth investors would now have roughly $2.9 million.
The returns covered the 45 years through the end of 2009. During that period the Standard & Poor's 500 Index was up 9.3% on an annualized basis -- $10,000 would have grown to nearly $560,000. There were 145 mutual funds at the start of 1965.
The varying dollar amounts highlight the power of compound interest, where seemingly small differences in percentage points over a number of years can mean dramatic differences in what investors can earn.
Funds Under Pressure
Buffett has more structural freedom than mutual-fund mangers, so comparing their performance isn't apples-to-apples. But the differences also highlight the limits of mutual funds, particularly the short-term pressures that most managers face.
"Throughout his tenure he's been a huge proponent of investors thinking of themselves as owners of companies rather than investors [which fits his] extremely long-term approach," said Jonathan Rahbar, mutual fund analyst at Morningstar, about Buffett.
"Mutual-fund managers have incentive to do well on a year-in-year-out basis; if things don't go well for a year or two, they'll see outflows," he added.
Fund ratings firms such as Morningstar might be part of this problem, Rahbar conceded, though he said his firm focuses more on long-term performance. But according to one Buffett investor, the structure of the fund industry makes it harder to invest as he does.
"Mutual funds have to sell to institutions who lump them into style boxes and expect them to be fully invested," said Timothy Vick senior portfolio manager at Sanibel Captiva Trust Co. "And those institutions review a manager quarterly and they change some managers every year."
Short-term pressures lead many fund managers to trade frequently as they seek to gain an edge -- the average fund turns over its portfolio every year, according to Morningstar -- the antithesis of Buffett's approach.
Vick, author of the book "How to Pick Stocks Like Warren Buffett," said his firm typically wants portfolio turnover of no more than 10% to 15% -- holding a stock for between eight to 10 years. Of the fund industry's 100% turnover average, he says, "it's like a gambling den."
Bend It Like Buffett
Templeton Growth Fund uses a value deep value strategy, buying stocks when they're cheap, and keeps its portfolio turnover low, at just over 10%, according to Morningstar.
In fact the fund shares many similarities with Buffett, owing its good performance mostly to consistent, if not overwhelming, gains in good markets and holding up well in down markets, said Kevin McDevitt, senior mutual fund analyst at Morningstar, who covers the fund.
But even here the demands of institutional investors takes a toll, he added, as the fund feels pressure to stick with its investment strategy and stay fully invested. In previous years the fund would hold 10% to 20% of assets in cash, an approach that helped it weather downturns: In 2000, 2001 and 2002, when the Standard & Poor's 500-stock index fell 9.1%, 11.9% and 22.1%, respectively, Templeton Growth's Class-A shares were up 1.7%, 0.5% and down 9.5%. But in 2008 the fund was fully invested and lost 43.5%.
A spokesman for Franklin Resources Inc. (BEN), which manages Templeton Growth, said that staying fully invested likely helped the fund 2009, when it gained 31%.
On a per-share book value basis, Berkshire was up 6.5% in 2000, down 6.2% in 2001 and up 10% in 2002. In 2008, the stock was down 9.6% and was up 19.8% last year. In 2008 and 2009, the S&P 500 fell 37% and gained 26.5%, respectively.
"Though we have lagged the S&P 500 in some years that were positive for the market, we have consistently done better than the S&P in the eleven years during which it delivered negative results," Buffett told shareholders. "In other words, our defense has been better than our offense."
But that approach requires patience, which is often in short supply in the fund world.
"Fund industry pressures run counter to [that] philosophy," said McDevitt. "Buffett has a lot more freedom."
At the end of 2007 Buffett had about $44 billion in cash, according to Meyer Shields, analyst at Stifel Nicolaus & Co. That amounted to about 35% of his investment portfolio, said Shields, though while some of it was a defensive posture he was also holding cash to fund an acquisition.
But even today, with interest rates close to zero, Buffett is comfortable with Berkshire holding a large cash position.
"The $20 billion-plus of cash equivalent assets that we customarily hold is earning a pittance at present. But we sleep well," he wrote in his latest shareholder letter, published Saturday.
Unlike the Templeton fund, Fidelity Magellan Fund is a growth-tilted fund. But unlike the other fund, its performance has been unsteady; most of its success came during the record-breaking run of manager Peter Lynch from 1977 to 1990, during which the fund saw annualized returns of 29%.
"Its very long-term returns are still living off Lynch's success," said Christopher Davis, fund analyst at Morningstar.
Lynch also had a low-turnover approach, and during his tenure Magellan, which today has about $25 billion in assets, was much smaller -- it's hard to get outsized results when managing huge sums, as Buffett himself has acknowledged.
"Our performance advantage has shrunk dramatically as our size has grown, an unpleasant trend that is certain to continue," he wrote in his letter.
As of March 2, Magellan was losing 2% annualized over the prior decade, hurt not only by its size, but also by a fact that highlights another big difference between Buffett and mutual funds: Manager turnover.
Since its launch in 1963, Magellan has had seven fund managers, each with their own approach and distinct results. Meanwhile, Buffett has continued to run Berkshire Hathaway his way.
Said Rahbar: "He's been there longer than any fund manager has held their position."