by Maz Jadallah


Once again this year, Warren Buffett has included investment advice for individual and, new this year, large institutional investors in his annual shareholder letter.  The advice is simple – “stay away from active managers and their high fees and instead buy cheap passive funds that track the overall market, for better or worse.”  Mr. Buffett, if anything, has been consistent in his message to investors.

It’s also very hard to argue with him.  Passive vehicles have out performed active managers over the past decade and at a fraction of the cost to investors.  The basis for Mr. Buffett’s advice couldn’t be more rational – whether a large or small investor, you:

  • Are not skilled at picking stocks
  • Are not skilled at picking stock pickers
  • Even if you were (or got lucky) the fees you’re paying are too high
  • Traditional active funds are inefficient investment vehicles when compared to ETFs

Of course the irony is that Mr. Buffett believes very deeply in stock picking – he after all is a stock picker himself and one of the best at that.  He’s just saying that as an investor – well, you’re not him.

But what if investors could access investment skill cheaply and efficiently, would Mr. Buffett alter his advice?  Presumably, he thinks investors buying shares of Berkshire Hathaway would be a great investment.  You get to own a collection of businesses and stocks curated by Mr. Buffett and his team.  Is a portfolio split equally between the S&P 500 and Berkshire Hathaway stock a bad idea?

The table below summarizes just such a “Buffett” portfolio and compares it to one that is invested in the S&P 500 only.  Both portfolios are rebalanced annually.   Not surprisingly, as a testament to Mr. Buffett’s skill, the Buffett portfolio outperforms.

So why wouldn’t Mr. Buffett recommend the winning portfolio?  Maybe Mr. Buffett wants to avoid the obvious conflict that comes with recommending his own stock to every investor on the planet.  More plausibly though, maybe Mr. Buffett knows a few things:

  • Soon there will be a change in leadership at Berkshire
  • Berkshire’s return profile in the future will likely not match its past
  • Berkshire is not (will not be) as skilled an investor in every asset class and geography (e.g. international equities, fixed income)

All of this begs the question then, besides Berkshire stock, is there another way for investors to access skilled managers relatively cheaply and efficiently?  We believe our active indexing approach provides a solution.  Cloning skilled managers is proven to be effective over time and accessing them using rules-based, passive indexes can give investors the benefits of both passive and active investing in one.

Better yet, combining relatively low cost and efficient active strategies together with passive market funds in one portfolio can build resilience and staying power.

Table 2 below summarizes the returns for a “mirror” portfolio that allocates 50/50 between passive and efficient active strategies as compared to one that allocates to pure passive strategies only.  Both portfolios are rebalanced annually.  See the note at the end of this article for a summary of the allocations.

Again, the portfolio that combines passive with relatively efficient active strategies outperforms one that is passive only.    A more balanced approach should also increase a portfolio’s resilience vs one that is 100% equities like the 50/50 “Buffett” portfolio above.  Table 3 below compares returns during several stress test events.

Active strategies have been the victim of their own managers for long enough – skill exists but when it’s packaged into high fee, inefficient investment vehicles – the only beneficiary is all too often the manager and not the client.   That’s ultimately the focus of Mr. Buffett’s ire. We hope he’d look favorably on our efforts to evolve the way investors access that same skill.

Picture credit:  President Obama awards the Medal of Freedom to recipient Warren Buffett during a ceremony to present the awards at the White House in Washington February 15, 2011. REUTERS/Larry Downing

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