What do George Soros, Warren Buffett and a computer have in common? Turns out, a lot.
At least that’s the view of AQR Capital Management, the program-driven investment firm whose founders made their names finding the math behind investment success. A new paper, which isn’t publicly available, posits that a lot of the gains reaped by the legendary managers over time were, in theory, available to anyone using a handful of buy-and-sell signals known to quantitative analysts.
Take Buffett and his Berkshire Hathaway Inc., with its average annual return of 17.6 percent since 1977, twice as much as the S&P 500. AQR analysts claim that had you been able to take Buffett’s investment pronouncements and let computers build quantitative portfolios around them, you could’ve generated about two-thirds of that outperformance on your own.
It’s the latest entry in a Wall Street discussion about how skill combines with luck to explain how active managers perform, a debate that has taken added urgency amid the ascent of passive funds. AQR has a dog in the fight. Factor investing has helped fueled its growth, along with spurring a crush of cheaper mutual funds and smart-beta ETFs tied to things like value and momentum.
Buffett-Like
AQR compared Buffett’s and Soros’s returns with portfolios automatically tuned to investment styles deemed consistent with their philosophies, and found the computers did a fair job of replicating the humans. The paper can be seen as part of a larger effort to promote a version of money management that sometimes seems to defy explanation: How rejiggering stock indexes to emphasize characteristics like low volatility and price momentum is similar to what star investors do.
“If investors want to be more Buffett-like, they don’t have to pick the exact same stocks that Buffett is picking, they just have to pick the same type of stocks,” said Dan Villalon, co-head of AQR’s U.S. portfolio solutions group. “That’s where a lot of the interest behind factors and styles is coming from.”
To be sure, the research doesn’t imply these aren’t gifted managers. Everyone knows Buffett buys cheap stocks, so the fact that the “value” factor could get you closer to his results does nothing to dim his achievement in choosing the strategy and staying with it. AQR’s point is that smart investors often succeed by doing a few things well over time, hinting that passive strategies that share their logic have a chance of keeping up.
“Though our results may seem compelling, we have the clear benefit of hindsight,” the authors said. “These great investors ‘figured it out’ first, had the ability to stick to their philosophies, and rightly deserve their reputations.”
In scanning the market for systems that operate like Buffett, AQR proposed tracking a computer-generated portfolio chosen by the value factor, the quality factor (or stocks with the strongest balance sheets) and the low-volatility factor, meaning those with with the smallest price swings. Combined with the market itself, owning stocks with those traits over the last four decades got you within 4 percentage points of Buffett’s results. Even that gap is statistically insignificant, wrote AQR, and may reflect the benefit of leverage Buffett gets from investing his insurance companies’ cash.