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Comment by cuspycode | Hacker News Reader

Am I missing something here? To me, Buffett's argument sounds like a reformulation of Sharpe's Theorem[0] from 1991, which states that active investors cannot in aggregate outperform passive investors. This is an easily proved theorem, so what's the catch here? Why would anyone bet against a theorem?

[0] https://web.stanford.edu/~wfsharpe/art/active/active.htm

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There's lots of active traders that aren't hedge funds (day traders, prop shops, bored retirees, bored reddit users), so it's reasonable to test/bet/show if the hedge funds confidently putting themselves out as deserving 2 and 20 are worth it, or if it's predictable which specific funds, rather than the aggregate, are worth it.

what is being tested is not that the _average_ active investor won't beat the market, but that it's impossible (or very hard) to pick a set of active investors that would beat the market.

Because they think they can predict the future and their business model relies on their customers believing that.

Isn't Warren himself proof that you can? He beat the index over a very protract period of time.

No, because Buffett is an individual. The theorem is a statement of aggregate performance.

It's not surprising there exist individual people who are capable of beating the market, just like it's not surprising there exist people who can play sports at an elite level. You likewise wouldn't expect every human to be able to play at the elite level.

Aggregate performance should cluster around a point of central tendency.

And as Buffet himself has said: as Berkshire grows in size they will have a harder time beating the market simply because they are becoming a bigger part of it.

Buffett hasn't beaten the S&P 500 for a while now:

* https://www.fool.com/investing/2019/12/22/5-reasons-warren-b...

He had a good run though. See "Buffett's Alpha":

* https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3197185

The second point in your linked article is the exact point I / he was making.

I see

Warren Buffet also does a lot of deals not on the public market. If I'm not mistaken, a minority of Berkshire's money/value is invested in public stock.

This changes the equation somewhat since he can swoop in (dangling a billion dollar check) and do all sorts of research and investments that are unavailable on the open market.

He also (through Geico and other insurance holdings) gets to invest a ton of borrowed money at what amounts to a negative interest rate. (insurance premiums are, in aggregate, a loan to the insurance company until the customers need that money back. With the added benefit that you can repay less than you were given if your business ops are lean enough. That's why Geico pushes to do sales over the phone or internet, much cheaper than agents).

I am, of course, butchering this explanation. If you want an inside look at what he's doing, his letter to shareholders lays it ALL out.

50% of Berkshire's value / market-cap is in public stock. Everything else they own: Geico, BNSF rail, Berkshire energy, etc. each are the actual minorities.

> Isn't Warren himself proof that you can?

He's not really an "active" investor in the sense he uses the term, I think - his ethos is to buy and hold for a long time - almost the polar opposite of the "managed funds", isn't it?

He used to be a hands on active investor during his early years by hiring and firing people in the companies he controlled.

Under what time-horizon is the theorem valid for?

It's valid for any time period. The crucial point is that the theorem talks about the aggregate returns. It's like if you have 10 cars in a race, and 3 of them run at exactly the same speed which is the average of all ten (i.e. they follow the index), then the average speed of the remaining 7 (the actively managed) must also match that speed, even if their individual speeds can vary a lot.

Because the real world very rarely matches the precise conditions to which a theorem applies.

Not saying it would be a good bet, and not the theorem isn't a good heuristic, but it's not as clear-cut as you're saying.

Edit: I also clicked on the link and it doesn't claim to be a theorem or have a formal proof, it just gives heuristic arguments against using active management, which, again, good rules of thumb, but not ironclad proof in the sense you meant.

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