Most proponents of indexing strategies don’t quite manage to implement a pure index approach. They often come close to pure indexing, but they can’t resist adding some sort of twist. The twist may be a form of market timing or some other active strategy. So far, the way I’ve handled my own portfolio is no different.
I’ve been on a steady transition from a pure stock picker a few years ago to about 70% indexed today. I intend to keep increasing this percentage, but I’m not sure that I’ll make it to 100%. Selling my last stocks will be fairly painless except for Berkshire Hathaway.
After having read all of Buffett’s old letters to shareholders and having held the stock for about 13 years, I’ve become attached and don’t want to sell. I’ve thought through many possible justifications for keeping it, but the only plausible one is that Berkshire is so diversified that it could be thought of as an index of a slice of the American stock market (plus some foreign holdings).
Another factor is that I can’t shake the feeling that Berkshire (BRK) is undervalued right now. There is no reason to believe that my judgement is any better than the market’s judgement when it comes to BRK, and I’ve managed to ignore my gut feelings about other stocks, but I’m stuck on BRK.
So, is there any validity to the argument that BRK is so diversified as to be index-like or am I just being emotional to the detriment of my expected future returns?
It's hard to apply the normal arguments to BRK because it's run by a team who has demonstrated they can outperform the market over long periods and across several orders of magnitude of growth in their portfolio. The normal arguments around indexing would hold this to be impossible (while, in fact, it's only mostly impossible), so it's hard to know how to reason about this situation.
ReplyDelete@Patrick: You hit on another part of my thinking about this dilemma. I like the "it's only mostly impossible" quote.
ReplyDeleteMichael, BRK is a 67-cent dollar at the moment. I'll gladly take them off your hands if you like :)
ReplyDeleteNowhere in your writeup do you even consider doing a valuation of Berkshire. Without this fundamental piece of information, you're making uninformed decisions and resorting to psychological tricks to help your decision-making process.
This may help you: http://www.tilsonfunds.com/BRK.pdf
@Anonymous: Mr. Market will sell you an almost unlimited number of BRK shares at current prices -- you don't need mine :-)
ReplyDeleteNo I didn't mention doing a valuation, but I did attempt one. However, I don't believe that my valuation is better than the market's valuation. So, I won't inflict my analysis on my readers; it might mislead people.
Using valuations only leads to informed decisions if the valuations are reasonably accurate. If they are inaccurate (as they are for most people), then decisions are not profitable.
If you'd read some of my other posts, you would know that I don't tend to making decision using psychological tricks.
I don't trust my ability to pick active stock pickers, so I won't be visiting the link you suggest.
You might want to ask yourself if you had the Berkshire stock in cash, what would you do? If the answer is buy Berkshire stock, then you're good as is.
ReplyDelete@Blitzer68: That's a good one. I used that with some colleagues a little over a decade ago who were trying to decide whether to exercise stock options. I asked them to calculate the total cash value after taxes, think about having this amount, and then asked whether they would want the options back. Most sucked their thumbs and did nothing, but one guy immediately sold everything and never regretted it.
ReplyDelete@Blitzer68: I never actually answered the question, did I? The answer is that I'm not sure. I would probably buy at least a little bit to feel the connection, but I'm not sure whether I would buy a full stake for the expected future gains.
ReplyDeleteI was thinking along much the same lines. In some respects I think it is a good index fund, or at least a good complement to the S&P500: it contains many insurance companies, utilities, and retailers you couldn't get exposure to otherwise. It's diversified, liquid, and tax-efficient. WB doesn't break out a MER for you, but I'm pretty sure its equivalent is low.
ReplyDeleteOf course, I'm an unrepentant tinkerer. [Also, long BRK.B]
Is it not true that BRK is under constant sell pressure because Buffet has gifted millions of stock to Gates?
ReplyDeleteHence will never go anywhere it should?
@Potato: You're doing a good job helping me rationalize keeping BRK. I won't be hasty on this. Even if I choose to sell, I may wait another year or more to make a final decision.
ReplyDelete@Anonymous: If I believed that BRK would sell below its true market value for the next decade because the stock has been gifted to the Gates Foundation, I would buy more. But somehow I think that Buffett and Gates have thoughts on how not to sell shares below their true value.
I think you should hold them due to your respect for the company and Buffett. Also, your current opinion is that index investing is the way to go, but if you keep a little in stocks, you are keeping your mind a little more flexible.
ReplyDeleteI think the risk of a drop in BRK is low. I wouldn't think it would be this low right now. I've owned it about 14 years, and it's been a pretty poor performer, price-wise (of course, I also bought some when the C$ only bought 67 cents US). Growth-wise it has really slowed down. I think I keep it for sentimentality and it's also become a less significant portion of my portfolio. Serves a purpose as a large-cap proxy.
MJ: At the most basic level, BRK cannot be thought of as a proxy index fund. An passive fund attempts to capture the returns of a specific asset class without regard to the individual companies within that asset class (except for practical concerns like liquidity). A better analogy would be a well diversified actively managed mutual fund.
ReplyDeleteThe decision to hold on to it is probably a "cognitive error," strictly speaking. But it's a pretty small one. :)
@Gene: I don't think that holding BRK will make any difference to the future decisions I make about indexing or stock picking. I still look at individual stocks from time to time even though I don't trade them.
ReplyDelete@Dan: I tend to think you're right, although I would add that BRK is "a well diversified actively managed mutual fund" that almost never sells its holdings and has an MER below 1 BP. I'm not hasty about these things and so I will likely continue to hold for a while, but if I ever do sell, I probably will never buy BRK back.
I'm not a shareholder, but I don't think I would sell if I was. It seems like everyone who manages their own investments ends up thinking they're smarter than the market in some way. If it's contained to a small part of the portfolio (the 5-10% rule) there's little harm in it.
ReplyDeleteBerkshire is well managed so the main question is if you're overpaying for that. Despite Buffet being recognized as someone who can't possibly exist, the market regularly discounts his abilities and may be doing so now. Berkshire even managed to buy back some stock below their target price last year which might have been a good time to follow.
On the other hand a low price might be due to justified uncertainty about succession. I would invest in Buffet for the next 40 years but that's not possible. After Buffet there will be someone else who's the best but we don't know who it is and if they'll be better or worse.