At times the world of modern finance resembles a standoff at the OK Corral. On the one side stand aloof the esteemed fund managers of the era with their long records of outperformance. On the other the academics and quants who wish to shoot them down by 'proving' that their excess profits can be explained away as either lucky or systematically repeatable. In their sights has always been the biggest scalp of all, Warren Buffett, and where many have failed a recent research paper titled 'Buffett's Alpha' looks to have finally shot him down. Essentially the paper finds that Buffett may not have had an 'edge' after all.

The esteemed researchers looked at Buffett's investment vehicle, Berkshire Hathaway, and broke out the performance related solely to publicly traded companies. They then ran some mathematical regressions over the data to figure out what 'factors' could explain the portfolio's outperformance.

All geared up... Firstly, they found that Buffett's equity portfolio performance benefited from his ability to access cheap borrowed money. Basically he was investing $160 into stocks for every $100 he owned. How? Well Berkshire always had a great credit rating which helped, but it also owned insurance businesses which benefit by taking in premiums from customers often years before having to pay out claims. Effectively this 'float' acts as an ongoing interest free loan which Buffett can then invest back into stocks.

...and boring... But what of his stock picking prowess? Buffett has made 19% annually for a zillion years and the market plus the leverage could only explain 10% of that - where did the rest come from? Well it's very simple.

There are a few standard factors that academics use to explain the majority of stock market outperformance. The ones normally mentioned are the following: small caps beat big caps (size), cheap stocks beat expensive stocks (value) and recently rising stocks beat recently falling (momentum). But they found that while Buffett did have a preference for cheap stocks, he had little exposure to small caps or momentum. Previous studies had found the same, suggesting that Buffett's extra profits were due to some unexplainable 'alpha'.

But this set of quants decided to try out a couple of more modern factors to see if they could explain his performance: the propensity for lower volatility stocks to beat higher volatility stocks (i.e. safe beats exciting ) and the tendency for…

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