Investing in index funds is great: the portfolio is widely diversified (eg. throughout an entire industry or country’s economy), the management cost is low (Vanguard’s S&P500 is 0.05%) and the return is aligned with the market tracked. This is a great alternative to actively managed funds where the returns could be higher but the also higher expenses often negate those benefits.
What if there existed an actively managed fund, widely diversified, with a low management fee and a higher return than the broader market?
Interestingly, Berkshire Hathaway fits this description very well:
- Berkshire Hathaway is a widely diversified company: the conglomerate is a collection of 89 companies, spread across 17 industries like Insurance (GEICO), Food & Beverage (Heinz), Clothing (Fruit of the Loom), Furniture (Cort), Household products (Duracell), Railroad (BNSF), Luxury (Borsheims), Media (Omaha World-Herald) … To add to this diversification, Berkshire’s asset allocation itself it also spread with about 30% cash, 10% bonds and 60% equity.
- Cost of diversification is as low as index funds: the cheapest index funds on the market today, like Vanguard’s VTSAX cost 0.05% / year. If you want to purchase stock of BRK-B (because BRK-A costs a house), with a transaction cost of 5$ if you invest 10,000$, your expense ratio is effectively 0.05%.
- BRK actually beats the market: Every investor is trying to find the strategy that will help him beat the market, consistently, after fees and commissions of all sorts. Over the last 50 years, BRK has generated a compounded annual gain of 21.6% vs 9.9% for the S&P500 with dividends reinvested (see details on page 2 of the Berkshire Hathaway Annual Report).
However if you invest in an actively managed fund, what matters is how good the manager is, right?
- Warren Buffet is one of the best investor in the World: Warren Buffett is without doubt one of the greatest investors in the world and undeniably one of the longest successful investors. Many investors have been able to generate great returns but not for as long as Buffett. Since his take-over of Berkshire Hathaway in 1964, the company has kept growing and is the 4th largest company in the world in market capitalization (just ahead of Microsoft). Indeed, the company is not #1 and you could argue that there is a handful of other companies led by more efficient managers. Which takes us to the following point.
- The company is resilient: the benefits of this wide diversification is that BRK is resilient in business downturns and can sometimes keep growing like it happened in the 2000 dot com bubble. Between 1998 and 2002, BRK-B grew from 33.54$ to 44.48$ (+32%) while the S&P500 went from 980.28 to 855.70 (-12.7%). In 2006 – 2010, BRK-B grew from 58.64$ to 81.75$ (+39%) and while the S&P500 grew from 1280 to 1286 (+0.4%). Because of this resilience, the stock is expected to outperform the market during downturns and slightly underperform during bull markets.
But is Berkshire Hathaway for you? There are 2 points that need to be considered:
- No dividends: all earnings are reinvested, Berkshire does not distribute dividends and according to Buffett, he would prefer to first reinvest in the business, then make new acquisitions and then buy back shares before he would consider giving out dividends. Great for investors looking for growth, uninteresting for investors looking for passive income.
- Berkshire is Buffett: while the Oracle still seems in great shape, he was born in 1930 and won’t live forever so everyone wonders what would happen to Berkshire without Buffett. Can the company survive and continue to grow? After 50 years at the helm of the company, the company now lives and breathes like Buffett. I’m pretty sure Berkshire could keep growing for the next decade even if it’s left on auto-pilot, but a dip after his death wouldn’t be a surprise.
So it looks like BRK is one the best investments one can make: it is managed by one of the greatest investors, it has beaten the S&P500 index by +10% over the last 50 years, the company is very resilient and the competitive advantage of Berkshire Hathaway is so great today it would be extremely difficult for any other company to compete with it.
Do you consider Berkshire Hathaway an index funds, in which you’d invest your savings like you would in an S&P500 index?
Nick – MoneyMiner
Photo credit : DonkeyHotey