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The Secrets of Buffett's Success

This article was condensed from the print edition of the
September 29, 2012 Economist

If investors had access to a time machine, and could take themselves back to 1976, which stock should they buy? For Americans, the answer is clear: the best risk-adjusted return came not from a technology stock, but from Berkshire Hathaway, the conglomerate run by Warren Buffett. Berkshire also has a better record than all the mutual funds that have survived over that long period.



Some academics have discounted Mr. Buffett as a statistical outlier. Others have simply stood in awe of his stock-picking skills, which they view as unrepeatable. But a new paper from researchers at New York University and AQR Capital Management, an investment manager, seems to have identified the main factors that have driven the extraordinary record of the sage of Omaha.

On a risk-adjusted basis, low-beta stocks have performed better than their high-beta counterparts. Mr. Buffett has been able to exploit this anomaly. He is well-known for buying shares in high-quality companies when they are temporarily down on their luck.

Without leverage, however, Mr. Buffett’s returns would have been unspectacular. The researchers estimate that Berkshire, on average, leveraged its capital by 60%, significantly boosting the company’s return.

Note that this doesn't work for everyone: It is precisely how the Captains of Wall Street ruined the global economy during 2008 i.e., they leveraged an asset class, that until 2008, was considered the safest bet imaginable: Real estate mortgage debt.

However Buffett's timing was considerably better, and thanks to the profitability of Berkshire's insurance operations, Buffett's borrowing costs from this source have averaged 2.2%, more than three percentage points below the average short-term financing cost of the American government over the same period.

Don't you wish you could become a filthy rich investing legend by buying low beta stocks for your portfolio, and by leveraging the portfolio by 60% at a capital cost of 2.2% per year?

Sounds easy, doesn't it? For the full story go to http://www.economist.com/node/21563735